Monday, July 27, 2009

Industry Contraction Exposes Potential Low Price Points

The legal industry is suffering just like the rest of us in this economy. Interestingly, not all legal firms are suffering. The firms that are suffering the most are the large firms, who have done well for many years. These firms typically bill their large clients between $700 and $800 an hour for legal work. They have more than 200 lawyers in the firm. The next tier down sees law firms with 200 or fewer lawyers. These firms typically bill clients between $200 and $500 an hour for work done by their senior partners. Overall, the smaller firms seem to be about 25% cheaper than their larger cousins. These smaller firms are actually growing in this economy. While their larger brethren are laying off lawyers, the small to medium sized firms are hiring today. (See Video #6: Competition and Low-Cost Expansion on

These firms are hiring because many of the large clients for corporate legal work are shifting some of the work that they used to give to the larger, more expensive law firms, to these smaller firms. These clients have discovered that they have more than one type of legal need. And, at least in some cases, the legal need is for less skill and cost than the capabilities offered by the largest law firms.

Clearly, the larger law firms are having trouble adjusting their pricing to meet these cheaper legal competitors. It appears they could do so, at least in part, by acknowledging that there is more than one price point for legal work. (See Video #21: Definition of Price Leaders on These larger firms might offer less senior staff at lower costs for projects that would be satisfactorily serviced with less experienced employees. They could create a lower price point that would enable the larger law firms to reduce the loss of business to the smaller firms.

The large clients for the larger firms will always need the larger firms for the most sophisticated transactions. But, in these straitened times, these clients have to reduce their spending. If the large law firms allow them to reduce this spending by shifting work to smaller firms, they are losing an opportunity to preserve their revenues. These revenues can go a long way toward covering the cash fixed costs that all law firms face. (See Video #56: Design to Value as an Approach to Cost Management on

Monday, July 20, 2009

Delivering More by Offering Less

Over the last fifteen years, the number of items offered in the typical grocery store has increased by over 50%. Customers are beginning to be confused by the number of choices offered at the grocery store. This proliferation of consumer choices is a retail-wide phenomenon. Consumer goods manufacturers have created more varieties, sizes and shadings in order to win more shelf space from retailers and more attention from consumers.

Using the Customer Buying Hierarchy (see Audio Tip #95: The Customer Buying Hierarchy on, the retail consumer would see the product choices as Functions, the consistency with which the products that they want are available as the major form as Reliability, and the ease with which the customer can find, chose and pay for the product as Convenience.

Retailers have decided that the Function innovations of more choices have created Convenience disadvantages in confusion for the customer, so they are cutting back. Wal-Mart found that the average shopper spends twenty-two minutes in its stores. But the confusion caused by the wide variety of products available to the consumer is reducing the number of items they actually put in their shopping carts. Wal-Mart responded to this problem by reducing the choices and shelf space available in slow-moving categories, and increasing them in faster-growing sections. For example, Wal-Mart increased space for shaving cream, trash bags, diapers and flat screen TVs. It reduced space for toilet paper, mouthwash and microwaveable popcorn. In total, the variety reductions outweighed the increases in choices in the other sections of the store. Other major retailers are also simplifying choices.

Retailers believe that they are now selling more and creating better profits with their new approach. Consumers need less time to make a purchase decision and there is now more room on the shelves for the retailer’s own private label products, which carry higher margins.

The beneficiaries on the manufacturer’s side are almost universally the top two brands in the category. Brands with #3 or lower positions lose market share and sales. In this case, tough times for the manufacturers help the leading manufacturers. That, by the way, is not always the rule. In fact, it is the exception. (See the Perspective, “Is Bigger Really Better?” on

Thursday, July 16, 2009

Two Companies Who Perform Well in Good or Bad Markets

The hotel industry is struggling today. Demand is off everywhere in the world. Everyone is suffering, including Marriott. But Marriott will survive, and even thrive, in this market. It has been through bad times before and always has emerged the leader in the industry. (See Audio Tip #31: Volatility in Hostile and Non-Hostile Industries on It leads its industry because the top management of the company focuses all its energies on delivering a consistent, predictable product in each of its dozen or more brand names. It is known throughout the business travelers’ world as the most consistent and reliable of brands. A traveler knows exactly what to expect when staying at a Marriott branded hotel and virtually always gets what he expects.

Another company, who happens to be doing well today, with the same ability to thrive no matter what the market is McDonald’s. In its quick service restaurant industry, McDonald’s has the same kind of reputation that Marriott enjoys in the hotel industry. It is the most consistent and reliable of brands. Here again, the top management of McDonald’s pays close attention to the experience a customer has in any of its stores world-wide.

I have had the distinct pleasure of working closely with both of these companies during earlier difficult times. I have come to understand the reasons for their success and will outline just a couple of the more important reasons here. In Marriott’s case, the first reason is CEO Bill Marriott and the approach he brings to the management of the many hotels the company has. Marriott visits rooms, samples food, checks for cleanliness, visits competitors and then issues specific instructions on how to improve. The other senior managers, and their direct reports, emulate the boss with the same attention to detail. This attention produces consistency. The second reason for Marriott’s success is its core value. It is expressed roughly as follows: “If Marriott employees are well taken care of, they will take care of the customer, then the customer will come back.” The company treats employees well, trains them carefully and pays them competitively. These employees proudly deliver superb service to customers, who will return to Marriott in good and bad times.

Though in a different industry, McDonald’s is much the same. Everyone knows the story of Ray Kroc’s establishment of McDonald’s. He is certainly a seminal figure. He was followed as CEO by an equally legendary manager in the McDonald’s world named Fred Turner. Together, these fine leaders created the motto for McDonald’s, calling it QSV&C. These initials stand for Quality, Service, Value and Cleanliness. McDonald’s delivers on all four of these promises more consistently than any of its competitors. A customer knows exactly what he will get at every visit to a McDonald’s in any location in the world. And the customer is far more likely to get that same consistent quality, service, value and cleanliness with McDonald’s than with any other quick service restaurant company. While working at McDonald’s I interviewed every senior McDonald’s executive. In each of those conversations, a reference to QSV&C was an important part of our discussion. Those letters, and what they mean, are seared into the brains of every McDonald’s manager, all to the good of the customer. This focus produces consistency.

Both of these companies rely on franchisees for the overwhelming number of customer experiences. Each control their franchisees and the quality of service they deliver by being the most attractive company in the industry. Marriott and McDonalds’ franchisees make more money than their compatriots in competitive brands. Sometimes these franchisees may complain about the prices they pay to be a franchisee of Marriott or McDonald’s, but they know where their bread is buttered. These companies deliver more reliability for their customers. Their franchisees, who are a major source of their quality delivery, get paid well for that better service.

Both of these companies lead their industries on Reliability in the Customer Buying Hierarchy (see Audio Tip #95: The Customer Buying Hierarchy on You can say the same thing about most strong industry leaders. (See Audio Tip #24: The Customer Buying Hierarchy as Markets Evolve on

Monday, July 13, 2009

Microsoft Gets Pricing Warnings from Competitors

Recently, Google announced that it was creating an operating system to work on the new small netbook computers. Netbooks are the only part of the PC market that is growing today. Google hopes to introduce an operating system there in order to serve as a stalking horse to slip into Microsoft’s share with desktop and notebook PCs.

Also, Cisco has let it be known that it was considering offering a rival to Microsoft’s Office software. This service would let business users create documents they could draft and share through Cisco’s WebEx meeting and collaboration service. Google has already attempted to best Microsoft in the Office world with its Google Apps internet-based alternative. Google has yet to create much traction with this product. The outlook for Cisco’s product must wait until it actually appears. But the point here is al the new competition.

Why is Microsoft seeing so much new competition in markets where it is the overwhelming dominant leader? Because its prices are so high. It is drawing competitors into the marketplace who want a piece of Microsoft’s enormous profit base. (See Audio Tip #119: A Price Umbrella on These competitive forays are likely to continue as long as Microsoft holds the high price umbrella over them. These new competitors have a mighty mountain to climb, so they might not succeed. On the other hand, one of them just might and create real pain for Microsoft. Linux has already damaged Microsoft in some of the large markets that Microsoft serves. (See Audio Tip #102: When is Price Likely to go Down? on

Interestingly, Cisco specifically stated that it was not interested in competing with in selling online applications for corporate users. You probably wonder why. So did I. Here’s why. Microsoft has the following results on a trailing twelve month basis: Operating Margins 37% and Return on Equity 42%. In contrast, has these results on a trailing twelve month basis: Operating Margins of 7% and Return on Equity 9%. I guess the price and profit umbrella held up by Salesforce just doesn’t allow even big companies to crawl in underneath.

Thursday, July 9, 2009

Microsoft Gets Price Warnings from its Customers

Microsoft is introducing Windows 7 to replace its unpopular Vista operating system. The company is at logger heads with its PC manufacturing customers over pricing for the new software.

Here are two of the problems. First, Microsoft intends to charge $50 for an entry level version of the operating system, called Windows 7 Starter Edition, which is triple the price the company gets for the cheapest version of Windows out now. Microsoft charges between $60 and $150 for Vista today, but the PC manufacturers can use the older Windows XP for roughly $15 for netbooks, the only growing sector of the PC market. If Microsoft raises the price for the cheapest operating system to $50, the PC makers have to raise their prices or lose all the profits they have on the netbooks. Second, Microsoft plans to charge an additional $200 for the Windows 7 Home Premium edition. This additional cost would increase the price of a mid-range PC by 50%, from around $400 to about $600.

The PC customers have seen significant changes in their market. Competition has increased and prices have fallen. The average notebook, the source of most profits in previous years, has seen a price decline of about $800 from $1400 in 2004. The average notebook now costs less than the average desktop.

These PC manufacturer customers have an important message for Microsoft. (See Video #1: The Two Best Consultants in the World on They are Microsoft’s key channel of distribution. The customers are telling Microsoft that, if the company charges these prices, sales volumes will fall for both the PC manufacturers and for Microsoft. Microsoft would be well advised to listen to these customers since Microsoft makes a lot more on the average PC than does the PC manufacturer. Microsoft can not, for long, operate at cross purposes with these PC manufacturing customers. High prices to these customers push them to alternative software suppliers. (See Video #7: Constraints on the Ability of Competition to Expand on

Monday, July 6, 2009

Rising Prices in the Face of Falling Demand

Steel demand is down…by a great deal. The world’s steel plants are operating at less than 45% of capacity. This operating rate is one of the lowest ever. Yet, some U.S. stainless steel makers have actually raised prices by 5 to 6% since early May. The price increase does not come because of an increase in demand for stainless steel. That demand is off as well.

How do we explain this phenomenon? The answer lies in the cash costs of the stainless steel companies and their customers. (See Diagnose/Pricing/Company Price Environment on There are high levels of fixed cost in the stainless steel business. Many of these costs, though fixed, are cash costs that must be paid to keep the plant running. Heating units cannot be shut down easily. Yet, the cash cost of keeping them operating are high. If the plants cannot cover their cash costs, they will close in short order. But, despite the losses that the stainless steel producers are piling up in this period of very low demand, they have raised their prices to cover their fixed cash cost of operating their plants on lower unit volume. The price increases of 5 or 6% represent the increases in cash revenues the companies need in order to keep their plants operating.

Normally, these plants would have shut down at this level of economic activity. Their places would have been taken by off-shore manufacturers who incur lower cash costs to operate. But conditions have changed. Customers are changing their suppliers, replacing off-shore producers with domestic supply. Now the American manufacturers have a lower cash delivered cost than do the off-shore competitors they are now replacing. We then ask, why would a customer be willing to pay domestic manufacturers 5% more than they were paying before May?

Steel service centers are major customers for stainless steel. These are the companies who are paying the higher prices to the domestic manufacturers today. They are paying these higher prices for three, cash-related, reasons. First, even at today’s low level of demand, there is enough demand to pass along the cost increase. Second, the capital markets are often closed to these service centers. They cannot get the financing that would allow them to purchase the same amount of steel off-shore that they would be able to purchase in a normal market environment. Third, purchasing foreign steel involves a long term exposure to the price of steel and its demand. Steel that a service center orders today from an off-shore producer will not arrive at the service center for months. These service center customers are unwilling to bear the exposure to the potential fall-off in steel demand, and the resulting fall in spot prices, for steel over the next several months.

So, basic cash economics explains the price in today’s domestic stainless steel market. The domestic manufacturers are able to raise their prices by 5% to keep their plants operating at cash break-even. They replace off-shore producers whose delivered cost to the stainless steel service center customers is now higher than those of the domestic manufacturers. (See Diagnose/Pricing/Industry Price Outlook on

Thursday, July 2, 2009

Industry Evolution Forces Cost Management

The evolution of a market often brings new consumers who prefer, or can afford, only low-priced products. In order to reach these consumers, a company must reduce its costs while it grows.

The British confectionery firm Cadbury dominates the Indian chocolate market. It has 70% market share in the chocolate market and a 30% share of the confectionery market in India. The company began operations in India in 1947. They imported its chocolate bars and sold them to the very wealthy. Later, it developed its own factories in India.

As the Indian market develops, more consumers and potential consumers enter the chocolate market. The growth in the market comes with consumers who live outside the major cities and who have very low incomes. In order to reach these consumers, Cadbury has to offer products that it can sell at very low prices. (See Diagnose/Products and Services/Innovation For Customer Cost Reduction/Four Price Points on To meet these new consumers, the company has developed a product called Cadbury Dairy Milk Shots. These are small chocolate balls that are covered with a sugar shell. A package of two of these balls sells for about $.04. But these low-priced products still drive growth.

But Cadbury can not reach these new consumers with very low-priced products without containing its cost structure. The evolution of the market forces Cadbury to reduce its costs as it grows. Over the last few years, the company has reduced its workforce, moved factory locations from high-cost to low-cost areas, and improved the cost effectiveness of its supply chain. This is all on the base of a company that was profitable to begin with. (See Diagnose/Costs/Measuring Current Economies of Scale on