Monday, April 28, 2008

Allstate's Innovative Pricing

The automobile insurance market has seen price declines since 2006. During this declining-price period, Allstate has done well, gaining market share by offering innovative pricing.

The company instituted a program called “Your Choice Auto”. It launched this program in 2005, just before industry prices started to fall. This Your Choice program offers drivers a specific benefit in return for a slight premium in the cost of their insurance policies. One option in Your Choice offers a 5% rebate on premiums paid by drivers who remain accident-free during the term of the insurance. A second option in Your Choice is “accident forgiveness.” This option guarantees that the insured’s rates will not go up, even if the customer has an accident. These creative uses of the components of a price have increased Allstate’s market share and profits at the same time.

The two examples in this story change the components of the price by changing the performance benefits and the price simultaneously. There are four other components of a price that also improve revenues and profits. You may find them, in their many variations, in the Improve/Pricing/Brainstorming Ideas on StrategyStreet.

Monday, April 21, 2008

A Low-End Competitor May Not Stay at the Low End

One of your competitors may be a low-end player today. If that competitor stays at the low end, the likelihood is that its share of the market will not exceed 15%, even if it is quite successful. However, the very success may breed a significant challenge to industry leaders in the future. If the low-end competitor is earning a good return on investment, it may enter the market for the industry’s higher-end products in order to enhance its own profits and future.

The pharmaceutical industry offers a current example of the phenomenon of a low-end competitor attempting to migrate into the Standard Leader products. Indian generic drug manufacturers, including Dr. Reddy’s Laboratories Ltd., Ranbaxy Laboratories and Glenmark Pharmaceuticals have realized great success and profits in the generic drug business. These are low-end Price Leader companies. Each is a type we call a Predator competitor. Each of these companies is reinvesting some of those profits from its low-end sales into research and development on proprietary drugs. If these early stage investments into the proprietary end of the pharmaceutical business succeed, these formerly low-end companies may well challenge the Mercks and Pfizers of the world.

If this trend seems unlikely, consider that Charles Schwab, Dell, Nucor Steel and Wal-Mart all got their starts at the low end of the market. For more on low-end competitors, see “Turmoil Below: Confronting Low-End Competition” in the Tools/Perspectives section of

Garmin Tail Wags the Dog

Garmin is having big trouble these days. As one of the leaders in the personal-navigational device business, Garmin is besieged by much larger competitors from an adjacent industry. In particular, the cell phone hand set makers are doing the same thing to GPS functions that they did to the PDA market a few years ago. They are turning GPS into one of the functions on smart phones. In 2007, 18% of mobile phones already had the GPS function embedded in them. That percentage may double within a couple of years.

But Garmin has come with an answer to this challenge: it plans to enter the cell phone hand-set market itself. This is equivalent to Goodyear entering the automobile industry. Were Goodyear to do that, it would fly in the face of the facts that the tires are a modest part of the total cost of the automobile and that there is virtually no overlap in the channels of distribution in the two industries. What would Goodyear bring to the automobile industry?

You have to ask the same question of Garmin. It is leaving a market of several hundred million dollars to enter a market where competitors are established with sales of several billion dollars, and a market that is turning competitively ugly itself. Motorola bears witness to that.

How likely is success for Garmin in the cell phone industry? How well do you think Goodyear would do in automobiles?

Thursday, April 17, 2008

Toyota's Good News/Bad News Story

The North American auto market has turned ugly. Normally, analysts expect the industry to sell about sixteen million vehicles a year, about what we sold in 2007. We seem to be on track to sell around fifteen million in 2008. Today GM, Ford and Chrysler are all losing money in the North American market. This is a market that we would define as Hostile. A Hostile market is an industry with low industry-average returns on investment for the majority of the industry’s competitors. Hostility is the result either of a fall in demand or of the expansion of competitors in the marketplace. Most of the history of Hostility in the North American market is due to the expansion of competitors. Now we see both a fall-off in demand as well as the expansion of competitors.

Toyota is the most obvious of those expanding competitors. Recently, Toyota began to suffer sales declines along with its North American rivals. That’s the bad news. The good news, however, for Toyota is that its fall-off in demand was significantly less than that for GM, Ford and Chrysler. A year ago Toyota had a 15.6% share of the market. Now they are up to 16%.

In fact, all of the big three Japanese manufacturers are doing well in North America. A year ago, Toyota, Honda and Nissan, combined, had a market share of 31.9% of vehicles sold. Today it is 33.4%. On the other hand, the big three domestic producers had a market share a year ago of 52.1% of vehicles sold. Today their share is 50.1%. The big three domestic producers have lost two share points. The big three Japanese producers have gained one and a half of those lost points.

Yes, Toyota has problems in North America. It now estimates that it has about one assembly plant’s worth of excess capacity. Still, the good news is that when the market does recover, Toyota is in a very strong position. It continues to gain share. This is the key metric for Toyota.

Typically, the best industry leaders perform well, even in down markets. Toyota is a good example of a leader performing well, despite a Hostile market.

Monday, April 14, 2008

Google versus Microsoft in the Office

Google has entered Microsoft’s most treasured domain, the office suite. Google offers its Apps for free. Using these Apps, a consumer may prepare basic reports and spreadsheets. Google claims two advantages over Microsoft with its Apps product: it operates on the internet, and it is free or very inexpensive in its premium version. So, what might be the outlook be for both Google and Microsoft?

Microsoft has to worry, but not too much at this stage of the game. Over the last few years, we have analyzed several hundred low-end competitors entering a market against an established industry leader. We found that there are four types of low-end competitors. Google is what we call a Stripper product. It offers less functionality and features for a much lower price. These Stripper products rarely achieve market shares greater than 15%, and often much less. Generally, the savings that the consumer sees in the price of the product comes at the expense of product features and reliability that most consumers do not want to give up. So, assuming Microsoft stands still, Google may get a small market share, but probably not enough to really damage Microsoft.

Of course, Microsoft is unlikely to stand still. It has the ability to put its services online just as does Google. The response to a low-end competitor, though, depends on the specific circumstances of each industry. We found that companies, like Microsoft, need to ask themselves a number of questions in sequence to arrive at the best answer for a low-end competitor.

Of course, Google is unlikely to stand pat either. If Google finds a way to make money with its business model, it is likely to invest most of its profits in improving its product to become a true competitor for Microsoft. This has happened in many industries where low-end competitors achieve a foothold in the marketplace. The motorcycle industry in the 1970s is one example that comes to mind, where Honda became a world class competitor by starting at the low-end of the marketplace and working its way up the market.

One thing to watch over the next year or two is whether any large companies adopt the Google Apps product. Google claims several large companies are testing its service. If these tests prove successful for Google, then Microsoft’s challenge is considerably greater because Google will have the resources to upgrade its product sooner rather than later.

Thursday, April 10, 2008

Reality Strikes Discount Air Carriers

After thirty years of unmitigated success in the airline industry, the smaller discount airlines are starting to fall by the wayside. Aloha, ATA and Skybus recently shut down. Others are likely to follow. Even Southwest is feeling the pressure. None of these discounters is able to fully recover the burgeoning cost of fuel.

What does this really mean? It means that the legacy carriers have finally reached the point where their cost structure is low enough that the prices they charge are very difficult for the discounters to get a substantial discount against. Typically a discounter needs to offer a price 25% or so below that of the standard leaders in an industry. That level of discount is getting increasingly difficult for low-end airlines to achieve in today’s airline industry. The balance of power is beginning to shift back to the legacy carriers.

There is more about industry leaders confronting low-end competition in our Perspective, “Turmoil Below: Confronting Low-End Competition” on our StrategyStreet web site in the Tools section, or from MIT’s Sloan Management Review.

Monday, April 7, 2008

The Company Did Not Get an Invitation

Remember the grade school experience when you learned of a party to which you did not receive an invitation? For most of us, that was a hurtful experience. But the failure to receive an invitation can cost real money in the business world, both now and in the future.

In our research, we have found that there are two sources of failure when a new piece of business becomes available. The first is an invitation failure. A company did not get invited to bid. The second is evaluation failure. A company is invited to bid but the customer chooses another competitor. The more damaging of these two failures is the failure to get an invitation. Sometimes this failure can be caused by the customer simply not knowing about the company. More often, this failure occurs because the customer has a strongly negative impression about the company.

If an industry has a majority of customers who refuse to invite the company to bid for new business, the company faces real challenges. Recently, Ford announced that its research had found that both it and Chevrolet would be “considered” (read “invited”) to bid for a consumer’s new car purchase only 41% of the time. Toyota, on the other hand, would be invited to bid nearly 59% of the time. Further, public opinion is “favorable” toward Ford and GM less than 50% of the time. Toyota’s “favorable” ranking is 74%.

The used car statistics reinforce the concern that GM and Ford should have. The domestic manufacturers lose a far greater percentage of their original price after five years than does Toyota. In most automobile categories today, Toyota is priced slightly higher than Ford and GM for equivalent models. The difference is relatively slight, say $1000 to $1500 on a $25,000 to $30,000 automobile. On the other hand, the difference in residual value five years later is greater than 15% of the original purchase price. In other words, Toyota holds more of its original value, by far, than do Ford and GM. So, despite the fact that the original purchase price is higher, the long term cost of ownership is lower with the Toyota. It’s likely that a good deal of this difference in residual value is due to negative experiences that the GM and Ford customers have had after the sale.

How is Ford to overcome this problem? Marketing initiatives aren’t enough. Customers have to see that the Ford product offers the features, reliability and convenience they want, especially in competition with Japanese manufacturers. The customers are looking for an experience that satisfies them. They want to know they can count on Ford. This consumer opinion takes years to develop and to destroy as well. Ford and GM have destroyed a lot of good will with customers over several years. On the other hand, the Japanese manufacturers have built much stronger relationships with customers over the same period of time. This set of impressions will not change easily. The after-sale experience has to be good for the new Ford and GM buyers. Until Ford and GM can reassure customers that their after-sale experience will be good, the market share of these two companies is likely to continue to slip away.

Ford and GM are in a deep hole. We have seen this in other industries. The sad rule is that companies end up in these deep holes because of conscious decisions they made to cheapen their product or reduce their responsiveness to customers in order to improve their margins. Usually the problems they face are self-inflicted. These companies don’t get an invitation because the consumer does not consider them a friend.

Thursday, April 3, 2008

Postponing the Real Clash

Delta recently announced that it was trimming its domestic capacity and shifting that capacity to international flights. It will cut its domestic capacity by about 5%, which will bring its capacity in August of 2008 to a level 10% below that of one year earlier. United Airlines did something similar earlier in the year.

In the short term, this will help these two legacy airlines’ margins because international passengers pay more per available seat mile than do domestic passengers. In the long term, the benefits are considerably less clear because of the encouragement these moves offer to the low-cost airlines.

By withdrawing capacity from the domestic market, Delta and United create more opportunities for the expansion of low-cost and low-priced airlines, such as Southwest and Jet Blue, among others. In most industries where the industry leaders withdraw capacity in order to shore up margins, other industry followers, especially low-cost followers, expand at least by enough to make up for the withdrawal of the leader’s capacity. Usually they expand even faster than the leaders withdraw capacity.

Then what happens? The low-cost carriers become even stronger because they expand where they can produce a cash return on their marginal investments. They then become more formidable competitors for the higher margin business as well. These low-cost people are not going away.

Further down the road, there will be an inevitable clash for higher-margin passengers, such as business travel, between the legacy airlines like United and Delta and the low-cost airlines. When that clash comes, those low-cost airlines will be stronger. It is difficult to predict a winner in that clash.

For an example of how these things happen, consider this: Toyota and Honda began as low-cost, low-priced players in the domestic automobile industry. Today, none of the domestic automobile manufacturers can take on these companies and expect to prevail. Leaders need to stop low-cost competitors earlier, rather than later, in their evolution.