Thursday, May 28, 2009

High Growth and Falling Profits

Recently, Europe passed legislation aimed at breaking long standing monopolies in Europe’s equity trading systems. As a result, a number of alternative trading systems poured into Europe’s equity markets.

The new market entrants are offering new technology and lower prices. They have succeeded in shifting significant market share away from the former industry leaders. In fact, four of the new entrants now control 16% of the trading in Europe’s equity markets. (See the Symptom and Implication, “Most share shifting in the industry seems to be coming from volume gained within existing customer relationships rather than from new customers” on There is one problem, however, the margins are razor thin.

The problem is pricing. While all these new entrants poured into the market, the prices fell as they jousted with one another to gain their market shares. One of the companies has reduced its prices three times within the last four months. Industry prices are now down about 20%.

What are these new firms going to do about their poor profits? What any self-respecting low-end competitor would do if it has the opportunity. They are going to expand into other more complex markets and other asset classes that carry higher margins. This expansion will add relatively little cost because most of their trading systems costs are fixed. (See Video #6: Competition and Low-Cost Expansion on In addition to improving margins, at least temporarily, this move into new asset classes and customer markets may help them in another way. These new trading systems will become more attractive because they become more of a one-stop shop for customers in the industry. The ability to offer one-stop shopping is usually a benefit offered by the industry’s leaders, whom we call Standard Leaders. This is one important reason that Standard Leaders dominate an industry.

Tuesday, May 26, 2009

The Power of Low-End Products for Industry Leaders

Low-end products can save an industry’s bacon when the industry falls on hard times. Most low-priced products are what we call Price Leaders (see Audio Tip #83: Price Leader Products and Companies on These products offer less Function or Convenience than do the industry’s more important Standard Leader products, for common pricing savings of 25% or more. (See Audio Tip #81: Standard Leader Products and Companies on

These Price Leader products are helping the domestic beer industry today. In the domestic beer industry, Price Leader products are called “sub-premium brands.” These brands saw sales gains of 8% over the last year. In contrast, the industry Standard Leader products, called “premium” beers, saw sales fall 1.4%. “Sub-premium” beers are keeping the industry moving forward. These “sub-premium” beers cost about 25% less than the premium beers, so they offer drinkers an attractive price alternative when the economy gets tough.

Most of the “sub-premium” beer volumes are products of the big brewing companies, including Anheuser-Busch InBev NV, SABMiller PLC, Molson Coors Brewing Company. (See the Perspective, “When Product Mix Matters” on So the industry’s Standard Leader competitors have closed the door on erstwhile Price Leader, private label, suppliers of cheaper brews.

These Price Leader products also have a few cost advantages over the Standard Leader products. Most importantly, the big brewers rely on word-of-mouth and price-based impulse buys to generate sales. They spend very little on advertising these brands. On the other hand, they spend a great deal to advertise the “premium” Standard Leader brands. So, while profits are lower on the Price Leader products, the lower margins are no where in proportion to the lower prices these products seek.

Thursday, May 21, 2009

This Leader's Trap Comes to a Quick End

In February of 2009, we wrote a blog about Abercrombie and Fitch in a Leader’s Trap (see the blog, “A High End Retailer in a Leader’s Trap”). In that blog, we observed that Abercrombie and Fitch refused to discount its products in the marketplace, despite the fact that American Eagle Outfitters and Aeropostale, two of its main competitors, were offering lower prices. We noted that Abercrombie’s market share was falling, while Aeropostale’s was clearly on the rise. We predicted that Abercrombie would have to come out of its Leader’s Trap soon by changing its pricing policy.

Abercrombie has surrendered.

The company reported a larger than expected first quarter loss and said that it planned to lower prices to boost sales. It admitted that this price reduction is a 180 degree change from its previous strategy of keeping prices high through the recession (see the Perspective, “Who has Pricing Power?” on

Earlier in the year, Abercrombie had argued that price-cutting would increase sales but would destroy its high-end image and the company’s future pricing power (see Video #4: The Risk of Slow Demand Growth on Competitors saw otherwise. They took advantage of Abercrombie’s high prices. The predictable result is that shoppers deserted the teen retailer for other retailers offering lower prices. Abercrombie then faced an inventory pile-up and a fall-off in sales.

Once customers begin deserting a company because of its high prices, the company’s Leader’s Trap will always come to an end (see Video #42: Leader’s Trap on When it does end, the company will have lost market share and margin. Some of the market share loss is likely to be long lasting.

Monday, May 18, 2009

Future Trouble for the Branded Foods Industry

Kraft Foods, Hershey Company, Kellogg and Campbell Soup Company reported higher profits recently. The key driver of these profit improvements was higher prices. For example, Kraft Foods’ profit in the first quarter of 2009 grew 10%, while its organic revenue grew 2.3%. Investors cheered because they had feared broad-based price rollbacks in the face of a tough economy.

One analyst noted that the market share improvement for private label products has gone down sequentially. Why don’t we put that analyst’s explanation in different words? How about “private label brands continue to gain share” or, even more accurately, “branded food companies lose more market share to private labels.” These are more realistic assessments of what is happening in the food business. Private labels are gaining share (see the Symptom and Implication, “Large competitors are maintaining price levels as smaller competitors discount” on, plain and simple. Private labels are gaining share under the price umbrella set by the branded food companies.

The branded food companies are subsidizing the growth and long-term health of the private label suppliers. These private label suppliers are not going to be satisfied with market share gained on the backs of their current products. They will improve their products in quality and distribution. These improvements will cause more consumers to find these private label products a good alternative to the branded products.

To illustrate the point, Safeway recently announced that it was expanding its private label brands O Organics and Eating Right, to other supermarket chains in the U.S. and elsewhere. If branded food companies’ pricing would be more aggressive in this market place, Safeway would not be able to expand its private label business. Other private label suppliers would also see thin margins and turn to self-defeating cost reductions in order to keep their profits at an acceptable level.

In the last year, industry-wide private label grocery sales grew by 9%. At the same time, national brands rose less than 2%. Private label products now make up nearly 17% of grocery sales. They will get better as they get bigger. (See the Perspective, “Is your Industry Ripe for Hostility” on

Thursday, May 14, 2009

Punch and Counterpunch in the Online Travel Industry

Orbitz Worldwide, the online travel booking agency, competes with the likes of Travelosity and Expedia. Of the three, Orbitz is the most dependent on airline booking fee revenue for its profits. Travelocity and Expedia both reduced fees for their booking of airline tickets before Orbitz. Orbitz held on to protect its margins. Orbitz began losing market share and reversed course. It announced that it would waive booking fees on most flights booked through May. This brings its pricing in line with its competition.

Then Orbitz did the industry one better. In an effort to grab market share and punish its discounting competition, the company announced a new promotion called “Dare to Compare.” This program brings with it a reduction in service fees on hotel rooms booked on its web site through July 15th. Orbitz is hoping to gain enough market share to offset the reduction in its fees.

Normally, an industry with only three major players is able to protect its pricing structure. Usually, the three players decide there is little to gain in price competition with one another. Apparently, this industry thinks differently. Orbitz most recent reporting found revenue off by 14%, as travelers cut back in the tough economy.

These industry discounts are a waste of margin. The entire industry is likely to copy any leading competitor’s price discounts. After all, the industry lives with the airline industry, where minute-by-minute price matching has become a non-clad rule. These discounts don’t mean much to consumers so they are unlikely to energize demand.

Orbitz also took another step recently that is far more promising. It launched a price-assurance program that automatically refunds customers when a hotel rate below the rate they paid appears on its web site and is purchased by another customer. This innovation improves the company’s Reliability in customer eyes (see the Perspective, “Discovering Hidden Pricing Power” on

For many ideas to improve market share and profits by a judicious use of pricing, see

Monday, May 11, 2009

Variable Pricing to Shift Demand and Increase Revenues

One of our local snow ski areas has started offering a “no wait” pass for snow skiers on busy days. The pass costs $20. This $20 comes on top of the normal day pass the skier has purchased. This additional pass allows the skier to avoid lift lines by going through the “ski school” entry. Other ski areas have begun charging substantial fees for “close-in” valet parking, while letting most skiers park for free at a further distance from the lift lines.

This variable pricing both reduces demand pressures on some services and increases revenues. These variable price mechanisms have become much more common over the last few years. We see them in airlines, at hotels, sporting events, movies and plays and other venues.

Now the concept has come to art museums. Some years ago, some of the largest art museums in the country learned that it could charge substantial admission fees for special shows. Now some museums are bringing the variable pricing concept to day-to-day operations. Some museums are considering charging a premium for the first hour of every day and on weekends when demand is greater than at other times. Others have noted that special exhibitions become more crowded as the exhibition comes to its ends. So, these museums are considering increasing prices as the end of the special exhibition nears. Others are considering charging a fee for those museum-goers who purchase their tickets online in order to avoid lines.

Really, not bad ideas when you consider that many of these museums are under severe financial pressures these days due to the poor economy and falling attendance. And, across-the-board price increases are likely to drive even more patrons away. These, and many other pricing concepts, are available to help you develop your new pricing ideas. Please see the many brainstorming pricing ideas at

Thursday, May 7, 2009

Saving Jobs by Outsourcing

SmithCNC-USA is an Ohio firm that helps small midwestern manufacturers obtain components and raw materials from China and Mexico. The firm’s customers are U.S. manufacturers who are doing small and medium sized production runs. These companies are under severe pressure in the United States because of relatively high costs here compared to those in China and Mexico. This company has convinced its customers that they can save a good number of their jobs, and perhaps, even grow, by outsourcing only part of their production to cheaper foreign sources. The company convinces its customers to outsource just some components in order to save the rest of the jobs in the customer’s organization.

This cost reduction effort is an example of one of the ways companies are able to reduce the cost of Inputs used to produce product Output. A reduction in the rate of cost a company must pay for the Inputs used to produce product Output is equivalent to reducing the number of Inputs. A person earning $10 an hour, who can replace another earning $20 an hour, effectively cuts the labor input by 50%.

There are several ways that companies have found to reduce the rate of cost they pay for their Inputs. These include the following:

* Purchase in larger quantities
* Reduce the quality of the Input
* Change the components in the rate of cost
* Use subsidies offered by third parties
* Request the supplier to lower the price of the Input
* Change the source of supply to a less expensive supplier
* Expand in-house work

The SmithCNC-USA work is an example of a change in the source of supply, which reduces the effective Inputs required to produce the product Output.

For many more examples of ways to reduce the rate of cost you must pay for your Inputs, please see www/strategystreet/improve/costs/reduce the rate of cost.

Monday, May 4, 2009

Product Innovation Using Twitter and Tweetups - Part 2

Kraft Foods plans to introduce its DiGiorno flatbed pizza by offering to host Tweetups for influential users of Twitter (see Part 1 of this blog). In Part 1 of this blog, we described three major types of customer segmentation by need: Physical, Emotional and Intellectual. We also described patterns that companies use to innovate products to meet those needs including: providing information, reducing resources the customer requires for the use of the product and improving the experience the customer has with the product.

In this Part 2 of the blog, we will illustrate the segments of customer needs and the product innovations that Kraft has used with this DiGiorno introduction.

Here are some segments of customer needs that Kraft is addressing with its innovations. Each of the indented concepts is a further refinement of the concept above it:

A. Segments with Intellectual needs

-----1. Knowledge of company and company's product

----------a. Segment with limited or no familiarity with the product

---------------1) Segment using a similar product

B. Segments with Emotional needs

-----1. Segment with needs for status in the community

----------a. Segment with needs for affiliation

---------------1) With a group on the cutting edge

The company addresses these segments with the following patterns of product innovation. Each of the indented concepts is a further refinement of the concept above it:

A. Provide information to the segment

-----1. Attract attention of customers to brand

----------a. Use non-traditional advertising in space available to many people

---------------1) Use an on-line event to provide sampling opportunity

B. Provide a good experience for the initial customer:

-----1. Associate the product with an image to increase customer pleasure in using the product

----------a. Suggest personal characteristics of the user of the product

---------------1) Suggest that users of the product are trend leaders

C. Provide good experience for follower customers
-----1. Increase the customer’s sense of security with the product

----------a. Assure customer that the product tastes good

---------------1) Obtain third party endorsements of the product

To gain a greater insight into the many patterns of segmentation and product innovation, please see and www.strategystreet/com/improve/productsandservices. There you will find over 400 concepts of segmentation of customers by need and nearly 600 concepts of product innovation initiatives. We support these concepts with over 4500 examples. These concepts and examples are brainstorming thought-starters to help you meet the challenge of innovation in your own marketplace.