Monday, September 28, 2009

From Cheap to Chic

Do you know what a Hyundai is? How about a Kia? Of course you do. They are South Korean automakers. Though they are not top of the consumer mind in the U.S., they are a rising pair. They both belong to the Hyundai-Kia Automotive Group. Globally, this automotive group is the fourth largest automaker. Toyota, General Motors and Volkswagen rank ahead of them. And the South Korean Group is gaining share at a rapid rate. Ten years ago it was the eleventh largest global automaker.

In the United States, Hyundai and Kia began life as Price Leaders. They produced small, cheap cars with relatively low quality. Twenty years ago, these manufacturers’ cars might have been a close substitute with a used car. Not so any more.

Hyundai has become better known with its 100,000 mile warranty, the best in the auto business. The company realized its poor quality reputation was holding it back and invested to improve quality. To convince the U.S. consumer that it was serious, it offered the best warranty in the business.

Hyundai is no longer simply a Price Leader. It has become a true Standard Leader. It has migrated up through the Standard Leader product class, with the Sonata, and has even entered the lower end of the Performance Leader class with the new Genesis. All of the company’s offerings, though, carry lower prices than those of competition.

The combination of low prices and good quality has propelled Hyundai, even in the hostile auto industry. Hyundai sales in the last year grew by 47%, while industry sales were up only 1%.

Hyundai is a good example of a Price Leader who morphs into a Standard Leader over time by offering good performance for a low price. (For more information on Price Points, visit the Diagnose/Products and Services section Most Price Leaders don’t try to do this, but a few carry it off with aplomb. Hyundai is one of them.

Thursday, September 24, 2009

Clever Pricing from Toys R Us

Toys R Us has created the “Great Trade-In” event. This event offers consumers who bring used cribs, car seats or other baby products into a Babies R Us or Toys R Us location a 20% discount on any new product from selected manufacturers in the store.

In a public relations explanation, the company calls this event an effort to keep potentially unsafe children’s items from being resold. But a more realistic spin on this event is that it is a trade-in discount that increases the company’s store traffic.

The trick with discounts always is to control the percentage of the market that qualifies for the discount while still giving the company credit for offering low prices. Companies do this by carefully selecting both the segments that qualify for the discount and the form of the discount itself.

A trade-in allowance is a form of discount. There are at least nine of these forms in common usage, including rebates, coupons, discounts in kind, and several others. Most of these forms reduce the effective cost of the discount for the company. These forms of discount, along with the segments that are eligible for the discount, help a company control the spread of the discount to specific customer segments. In our work to analyze pricing through discounts, we have found that there are at least eighteen common customer segments which companies use. This Toys R Us discount is a loss leader discount, which goes to customers who come to a store in order to get a low price on a product and then may stay to buy other, higher-margined, products.

For more on pricing, see Ideas.

Thursday, September 17, 2009

As Small as a Man's Hand

After several years of extreme drought in Israel, the prophet Elijah sent his servant to look on the horizon for a cloud. The servant returned to say that he had seen a cloud on the horizon but it was as small as a man’s hand. However, in short order, that little cloud turned into a deluge and ended the drought in Israel. This story had a happy ending. There is a small cloud on the horizon for consumer goods that may not have such a happy ending. The retail market share of consumer goods is falling, while that of private labels is growing.

Consumer goods are a special case when we look at low-end, Price Leader, competitors (see Audio Tip #83:
Price Leader Products and Companies
on On average, private labels sell at a 25% discount to branded consumer goods. At the same time, these private label products offer their retailers better margins than do consumer goods. You may be asking yourself, how can the private label producers charge 25% less and still offer better margins to the channel of distribution. The answer lies in the cost of goods sold.

In consumer goods, the cost of goods sold represent a smaller percentage of total revenues than in most other industries. On the other hand, the cost of the marketing and the sales of consumer goods is high. Private label suppliers turn over most of the cost of marketing and sales to the retailers. They have to worry primarily about their cost of producing and delivering the products.

For the last several years, branded consumer goods suppliers have been able to raise prices at will. The branded consumer goods manufacturers needed part of these price increases to cover escalating commodity costs. But another part increased their profit margins. Private label suppliers have been able to compete underneath this price umbrella (see Audio Tip #119: A Price Umbrella on in ways that should frighten the branded consumer goods manufacturers.

The private label suppliers have kept their pricing and margins attractive for their retail channels of distributions. At the same time, though, they have reinvested in the quality of their products under the price umbrella provided by the branded manufacturers. It is getting increasingly difficult for a consumer to tell the difference between private label and its branded competitor.

This difficulty in differentiation is showing up in market shares. Today, private label consumer goods have as much as 20% market share in Wal-Mart, where branded consumer goods carry low prices already. In retailers with higher branded consumer goods prices, private labels have an even higher market share. They control about 35% of the sales at Kroger.

Since these market shares for Price Leader products are very high, you might assume that they are unlikely to go higher. That may not be the case. In Germany, private labels now account for nearly 40% of consumer goods. That’s up from about 20% ten years ago.

A small part of this share shift may be that consumers are shifting their purchases downscale in this tough economy. But that is only a small part of the story. This market share shift to private label products has gone hand in hand with the rise in real prices of the branded consumer goods.

Today, many of the branded consumer goods producers are cutting their prices and increasing their product sizes in order to compete with the private labels. But these branded consumer goods companies may need to go much further (see Audio Tip #105: What is the Effect of a Price on They may need to reduce prices low enough to force private label suppliers to reduce the content and quality of their products so that the differences between their products and the branded products are clear to the consumer. If the branded producers leave their prices high enough to be comfortable for these private label suppliers, these Price Leaders will continue improving their quality and taking market share from these branded industry Standard Leaders.

Monday, September 14, 2009

Slowing up Hulu?

The U.S. online video ad market is growing at 30% a year. Still, it is just a small fraction of total U.S. T.V. advertising spending. The leader in the online market is Hulu. GE’s NBC Universal, News Corporation, and Walt Disney are Hulu’s owners. Hulu and some other video sites provide free professionally-produced videos from its investors. Hulu exists on an advertising business model. Hulu will place one or two thirty-second ad spots during a few commercial breaks for hour-long shows.

Since this market is showing so much growth, the leading cable firms, Comcast and Time Warner Cable, have decided to respond. Comcast has introduced OnDemand online and Time Warner has created TVAnywhere. These are cable trials offered only to existing pay TV subscribers. The paid subscribers get the professional video from cable networks for free. The cable programmers, though, may be putting the same number of ads online as they show on traditional TV, considerably more than Hulu.

What would be the effect of this development on Hulu?

Suppose we divide the world into two types of people: Comcast and Time Warner cable subscribers and everyone else. Clearly the Comcast and Time Warner cable subscribers are going to be better off. They have an online channel to view content for which they have already paid. They just have to watch commercials in the process. (See Audio Tip #64: The Objectives of a Performance Improvement Program on

On the other hand, the part of the world that views Hulu will not be affected at all by these online offerings from Comcast and Time Warner. They will continue watching just as they have over the last few years. Hulu will still have its own exclusive content. Hulu’s growth will not slow.

In the long run, there was probably room for both models. Both the cable companies and Hulu offer exclusive content. They will continue to attract viewers who prefer their proprietary products, just as major network and cable networks do today. In this longer run, the market share prize will go to the company offering the most attractive proprietary content.

The addition of OnDemand online and TVAnywhere are good product and service improvements from the cable companies but they won’t slow Hulu’s growth in the least.

Friday, September 11, 2009

The China Plan for Purchases

China has adopted an interesting plan to reduce the rate of cost it pays for the metals and ores it purchases.

China is a big consumer of stainless steel. It needs nickel to produce this stainless steel. While it has some mines of its own, it needs to import nearly a quarter of its total needs. To fill part of these needs and to give itself some leverage against the largest suppliers of nickel, China has begun forming alliances with the smaller nickel companies. In some cases, China has made an investment in the smaller miner. In other cases, China has guaranteed to take a certain amount of these miners’ production at a fixed price. These alliances have helped the small miners avoid the worst of the repercussions of limited availability of credit in the current economy.

China is trying something similar in the iron ore market. The top three iron ore producers, Rio Tinto, BHP Billiton and Vale control about 70% of the iron ore transported by sea. China has been unable to break the unified pricing approach of these big three suppliers, so it went around them. Recently, it made an agreement with a small iron ore producer, Fortescue Metals, to purchase iron ore at a 3% discount to the international price being charged by the big three. In return, Fortescue will get up to $6 billion in financing from the Chinese to put to the expansion of its business (See Video #40: Price Shaver on

In both these arrangements, China is trying to make a small supplier a lever against a very large supplier to drive down the price. This usually does not work, for two reasons. The first is performance. A smaller suppler simply can not provide for most of the needs of a Very Large customer, such as China. Small suppliers usually can compete only in a limited geographic market and with a limited product range. The second reason is one of cost. Commodity markets are extremely competitive. Scale counts for a lot. Economies of scale rule! (See Audio Tip #195: Economies of Scale and Their Measurement on The smaller competitors will not have the same economies of scale as the larger competitors. The discounts that the smaller competitor must give up in order to secure the business of the Very Large customer more often than not serve to weaken the ability of the smaller competitor to perform to the same level as the largest competitors in the market.

I think China will find that if it wants to break the strangle hold of the largest suppliers in the market place, it will have to convince one of the largest suppliers, rather than one of the smallest, to discount for it.

Tuesday, September 8, 2009

Membership Privileges

The snow skiing season is still a few months away. Still, in preparation for the upcoming season, the ski equipment promotions are underway. One of my favorites comes from Granite Chief. This is a fine retailer of ski equipment in Truckee, California. Each year, the company makes an offer to its customers: Purchase your Ski Service Card by August 31st for $100 and you will have a credit balance for $200 to be used on any of the company’s repair, mounting, tuning and boot-fitting services. Each time the card holder has equipment serviced by the store, Granite Chief will deduct the labor cost from the customer’s Ski Service Card credit. The credit is good only for labor. Any unused balances are not refundable and will not be carried over to the next season. The card expires on May 31, 2010.

This is a common approach to discounting (see Video #43: Four Simple Pricing Rules in Hostile Markets on The trick with a discount is to limit the customer segments who qualify for the discount. In this case, the store limits the discount to those who purchase a membership card. The store, then, further limits the discount to a total dollar amount.

We have seen many examples of club member discounts over the years. These discounts go to customers who have a particular relationship with the company. In some cases, the relationship is that of employee. For example, Delta subsidized new computers for its employees in a program it sponsored with PeoplePC. In other cases, the relationship is a bit looser. These are often “friends and family” programs that extend discounts to chosen customers. For example, recently Saks offered 25% off to “friends and family.” In a similar program, Banana Republic offered 25% off to its “friends and family” holiday shoppers. The codes for this discount program circulated by email on the internet. Not exactly exclusive, was it?

The Granite Chief program is an example of the second type of club member program. These programs offer discounts to members of company-sponsored clubs or affinity programs. Here the company is more specific in the definition of the customers who qualify for the discount. Programs falling into this category include frequent shopper cards offered by grocery stores. In another example, Chico’s, the apparel retailer, offered its best customers membership in the Passport Club. This club offered a permanent 5% discount for every $500 the customer spends.

All of these club member discount programs increase total sales and confirm customer loyalty. For more on approaches to discount products in ways that limit the discount to select customers, please see StrategyStreet/Improve/Pricing/Brainstorming Ideas/Change the Components of the Price.

Thursday, September 3, 2009

The eBook Competition

Amazon and its Kindle products have had the eBook market to themselves since the market began taking off a couple of years ago. The eBook market is now starting to grow fairly fast. Sony has decided to grab some of that growth.

Sony is entering the market with three price points: a $199 entry product called the Reader Pocket Edition, the $299 Reader Touch Edition with a touch screen and the high-end Reader Daily Edition at $399 with both touch screen and wireless capability.

Very fast-growing markets see market share changes due to Function and Price innovations. Let’s use the Customer Buying Hierarchy (see Audio Tip #95: Customer Buying Hierarchy on to evaluate Sony’s prospects against Amazon.

The Customer Buying Hierarchy holds that customers buy using four major criteria: Function, Reliability, Convenience and Price. Customers go through the hierarchy in that specific order and purchase when there is one, and only one, competitor who can offer them a unique benefit.

Function refers to the way the customer uses the product. Function innovations in this eBook market are two types: hardware innovations and content. In hardware, Sony has two Price Points with a touch screen capability that Kindle does not offer. On the other hand, the regular Kindle 2 offers wireless downloads. The only Sony product that offers wireless is the high-end Reader Daily Edition at $399, compared to Kindles’ $299 Price Point. Without considering price, it is hard to call a winner when the Kindle 2 offers wireless connectivity while the Sony offers a touch screen.

Content is likely to be a different story. Sony has adopted the ePub format, which is an international format for digital books and publications. Amazon, on the other hand, offers eBooks which can be read only on Kindle 2 devices, a proprietary approach. Sony argues that its readers can download books from the local library using its format, saving costs. But libraries have only a limited number of digital copies of books available. And, if the market takes off, the authors and publishers are likely to severely limit the number of free library copies available to ereaders. Kindle, for its part, is the progeny of a book retailer. There are many books available through Amazon for the Kindle 2, far more than will be available for the Sony products. In addition, the Apple iPhone and the iPod Touch also allow their owners to read books in the Kindle 2 format. With its extensive experience and product platform already in the market, content providers are highly likely to choose the Kindle 2 format before choosing the Sony format, if they must make a choice. Certainly in the early going, the content, and thus the Function advantage, goes to Amazon and it’s Kindle 2.

Reliability refers to how a company keeps the promises it makes to its customers. For an end user customer, Reliability means that the product works and will be fixed promptly if it does not work. Amazon has a superb reputation for Reliability among consumers. Sony’s reputation is also good. However, since Sony produces mostly electronic gear, its reputation is unlikely to be as good as that of Amazon, who sells mostly digital products. I would guess Amazon gets a slight nod in Reliability.

Convenience refers to the ease with which a customer can buy and begin using the product. Sony’s products will be in 9,000 retail outlets, including all the leaders in the industry, this holiday season. Amazon sells its Kindle online. The customer can see and touch the Sony products in the many retail outlets. Seeing and touching a Kindle is much more difficult for the perspective Amazon customer. The nod in Convenience clearly goes to Sony.

Price is the last consideration. The Kindle 2 product has a price of $299. The Sony Reader Daily Edition has a price of $399. As we noted above, the Sony product offers a touch screen at this price. Kindle does not, at least not yet. The Sony product is a third more expensive than is the Kindle. This additional price is likely to make the Sony product a Performance Leader product (see Audio Tip #82: Performance Leader Products and Companies on, rather than a true competitor for the leading Standard Leader position.

It is going to be difficult for Sony to make the $399 product the most common product in the market. Amazon’s Kindle has already established the industry standard for benefits and price. Sony would have been more successful offering its touch screen benefits at no price increase over the Kindle 2 Standard Leader product. Sony looks to be in a Leader’s Trap here. It will eventually have to reduce that price or see the product garner relatively little market share, likely well below 15% of the market.

Both Sony and Amazon would probably be better off if they responded to the content challenge each offers the other. Sony might try to license the Kindle software and offer that format, as well as the format. Then Sony could have competed on its strengths in making small electronic equipment. Amazon could add the ePub format to its software and open up a new world of content for its customers. This will become imperative for Amazon if a great deal of content comes available in the ePub format that is not also available in the Amazon proprietary format.