Wednesday, December 23, 2009

Is The Mojo Coming Back?

In early February, we did a blog on Abercrombie & Fitch and its Leader’s Trap (see blog Here). The company refused to lower its prices for fear of damaging its high-end, exclusive image. (See “Audio Tip #134: What are the Objectives of Our Pricing Policy?” on The blog predicted that Abercrombie would have to lower its prices anyway.

In late May, we wrote a second blog on Abercrombie & Fitch and its Leader’s Trap (see blog Here). By then, the company had reported a first quarter loss and said that it would have to reduce its prices. We noted in that blog that companies who let their prices stay high for too long take a long time to recapture market share lost in a Leader’s Trap.

The story goes on. In the third quarter of 2009, Abercrombie same-store sales plunged 22%, the eighth consecutive period of sales declines. Profits dropped 39%. The company’s pricing, and some fashion slips, have cost the company dearly. The company has marked down items by 30% to 40%. It is also adding lower-priced clothing and some trendier styles in its stores.

The problem now is the company’s reputation for high prices. By falling into a Leader’s Trap, the company sent some erstwhile loyal customers to competitors such Aeropostale and American Eagle Outfitters. Many of these defecting customers have not come back yet. Some might never come back.

If prices are falling in a marketplace, even high-end, Performance Leader, competitors have to go along, or lose market share. For example, in the tough automobile industry, even BMW and Mercedes have had to offer price and financing incentives to keep sales going. (See “Audio Tip #142: Defensive Pricing Guidelines” on

Thursday, December 17, 2009

Make Them Wait

Three of the largest book publishers have decided to delay the release of their most popular new books to the e-Book market. This is unlikely to be a successful experiment. But another experiment from a fourth publisher offers promise.

E-Book readers, from Amazon, Barnes & Noble and Sony, among others, are some of this years hottest Christmas gifts. These e-Book readers are more than doubling last year’s unit sales. They are pulling the e-Book book sales with them.

The problem, of course, is money. An e-Book sells for about $10. The most popular hard cover books sell for $25 to $27. There’s the rub. The book publishers get about half of that $27 hard cover price. So you can imagine these publishers are less than excited about the opportunity in the retail price of an e-Book at $10, even if they would get all of that $10, which they won’t. (See “Audio Tip #88: Questions to Determine Your Response to a Low-end Competitor” on

So, to try to hold the $27 hard cover market, three major publishing houses have announced delays in allowing their most popular titles to go to the electronic book publication market. HarperCollins Publishers, Hachette Book Group and Simon and Schuster plan to delay a few of the books that carry their highest expectations for profit. The delays will last from four to six months. These delays roughly match the time that the paperback version of a title follows the hard cover version.

On the one hand, these titles are unique Function innovations. Some readers will pay the higher price in order to be first in line to read the new publications. But there are many other unique books. The delays announced so far will cover less than 150 of the total 2000 new book titles issued each year.

The e-Book format is less costly and much more user-friendly. The e-Book is a much less expensive product to produce and deliver. Its digital format allows companies to distribute their product over the internet and to the e-Book readers by wireless connections. The e-Book reader can carry more than 1500 books. The user, then, can carry many books in the space of one paperback. This technology is not going to shrink nor pass away, no matter what publishers decide to do with their most popular new book titles. The cost of book publishing is simply going to plummet. But the revenues available to the industry over time should increase dramatically as new customers enter the market.

This e-Book market is an entirely new market. The e-Book offers opportunities to do things never before possible with hard cover books. The digital format allows companies to provide “special features” that enhance the attractiveness of the e-Book. These special features could include such benefits as interviews with the author, in-person video reviews by some of the country’s best book reviewers and videos of the geographic settings in the book, among others. There will be a lot of these new features (See “Audio Tip #29: Positive vs. Negative Volatility” on These new features, along with the much lower prices charged, will bring a whole new set of e-Book customers into the marketplace. Many of these new customers are not candidates for the $27 hard cover product. They will be happy buyers of the e-Book at $10 with its enhanced features.

A fourth member of the major book publishers, Macmillan, has developed a more creative and more promising approach. This approach envisions the release of an e-Book version of its best sellers on the same day as the hard cover book hits the shelves. The company envisions a “special edition” of the e-Book. This special edition will cost the same as the hard cover book and will be on the market for only 90 days. The special edition will include author interviews and reading guides, along with other material. At the end of 90 days, the special edition will discontinue and the company will issue the standard e-Book format at the lower standard e-Book price.

The publishing industry will fail at its delay experiment. They would be better off embracing the new technology, with its potential for extra Functions and ease-of-use, and then spending the next few years reducing the scale of the paper-based cost structure they carry today. My guess is that a hybrid version of the Macmillan experiment will eventually emerge. Under this hybrid version, all of the most popular books will be available in e-Book format, along with many function enhancements, like those in the Macmillan special edition, for a price a few dollars above the standard e-Book price, but at least 25% below the hard cover price. This approach ensures a much better value proposition for the e-Book customer, builds the e-Book market, and should allow the industry to make an attractive profit at the lower price, due to the much lower cost of production and distribution. Over time, the higher price of the most popular e-Books would gradually fall to the price of the standard e-Book in the market place so that the publisher may reap the rewards from customers willing to wait for a lower price on a good product.

Monday, December 14, 2009

Divorce that Customer?

Times are tough for business in many industries. Demand is off, prices are falling, and competition is fierce. Some companies have responded to these difficult conditions by divorcing their high-cost customers. Is this a good idea?

Perhaps this decision will increase profits. In a very tough market, it is not unusual for many customers to be “unprofitable.” (See the Perspective, “The New Pricing Structure” on These customers may not produce a return on the company’s cost of capital through a business cycle at the industry’s current low prices. Pricing in the industry has fallen far enough that the price must discourage some of the industry’s capacity from producing. Several companies may find themselves pricing through “profitability levels” to maintain their relationship with a customer. This is more likely in an industry with low variable cash costs, such as most capital intensive industries. In these markets cash generation is more important than profits.

So, when should we divorce an “unprofitable” customer? The simple answer to that question is that you want to eliminate any customer who is not generating cash on sales to that customer. These customers are clearly unattractive in a tough market. They may also be unattractive in a better market. Certainly, today, they cost the business cash and are likely not worth keeping. (See “Video 63: Core Customers Part 1: Defining Core, Near and Non-Core Customers” on

There are two caveats to this rule. First, the company has to be sure that the reason the customer is unprofitable and, worse, failing to generate cash, is not that the company’s own cost structure is out of line with the competition. If the cost structure is out of line, that is higher than competition, then it must reduce its costs or get out of the business. (See the Perspective, “The Wisdom of Salomon” on It is doomed to failure over time. The second caveat is that the customer is one who always pays low prices. The company should evaluate the customer relationship over the last few years, through a business cycle, to determine whether the customer is a perennial low-profit producer. If the customer is a low-profit producer through the business cycle, there is little risk in eliminating that customer. That customer does not generate enough money to support the capital his business demands.

Thursday, December 10, 2009

Paying Attention to Low-End Competitors

When do we have to pay attention to low-end competitors? The cell phone operating system business gives us an indication.

There are a number of cell phone operating systems from which to choose. The major suppliers include Microsoft, Google, Apple, Nokia and Research in Motion. Google is the newest entry here, and is beginning to make waves with its free Android operating system. (See “Audio Tip #33: Strong vs. Weak Competitors” on

There are two separate sets of customers for these operating systems. The first, and most important, are the carriers. The four major carriers include AT&T, Verizon, Sprint and TMobile. A secondary set of customers are the handset makers. These companies are secondary because they conform to the demands of the carriers in the U.S. These handset makers include Samsung, LG, Sony Ericsson, Kyocera, Dell, HTC and Apple.

In the cell phone operating system market, Nokia is the leader with its Symbian operating system. Research In Motion, with its operating system for its BlackBerrys, is also strong. The key growth market today is the smart phone market, where Apple has 13% of the market. Apple is gaining market share, at the expense of Windows Mobile, which has managed to hold on to 9% of the market. Google’s Android operating system is on only 2% of the world-wide smart phones. So should the operating system competitors fear Google’s Android? The answer is yes, for a couple of reasons.

The first, and most important, reason is that the largest carriers, all four of them, have agreed to offer Android phones. (See “Audio Tip #29: Positive vs. Negative Volatility” on Whenever the largest customers in the market agree to carry a product, that product has to be taken seriously by other competitors. The adoption of Android systems by the top four carriers argues that Android is a serious competitor.

The next reason is that most of the phone set makers have also adopted an Android operating system for some of their phones. Motorola eliminated Windows Mobile in favor of Android. HTC plans for half of its phones to run on Android this year. And Dell is using Android for its market entry. Most of the other competitors, including Samsung, LG, Kyocera and Sony Ericsson are also making Android devices. Apple will not offer an Android phone. So, the secondary customers have also spoken and affirmed that Android is serious.

Once the major customers have endorsed a low-end competitor, that competitor’s impact on the market will be pervasive. Android will not be a low-end competitor for long. Google will use its growth in the market to fund product innovations which will bring its operating system up to the standards of the better players in the market. Further, the growth of the Android system, which is free, will inevitably reduce the volume of sales or the price, and probably both, of the higher end operating systems. A low-end competitor who continues offering low prices while, at the same time, improving its product’s performance will reduce the margins of all other competitors in the industry. Its performance for price proposition will focus customers’ attention on the marginal differences that the higher end operating systems offer for their marginal prices, depressing either sales or prices. (See “Audio Tip #80: Measuring Customer Cost Savings” on

Thursday, December 3, 2009

One Up, One Down, One Sideways

Three of the leaders of the automobile industry are presenting some interesting new stories. First, General Motors. The new Chairman of General Motors is Edward Whitacre. He is not a car guy. He came from the telecommunications industry, most recently as Chief Executive at AT&T. The Chairman recently asked the head of engineering at GM to call all the customers who had turned in their new cars under a recent quality program. This program offered customers a 60 day money-back guarantee. It allowed a customer who was unhappy with his automobile to turn it back to GM for a full refund. The head of the engineering group charged with calling the new customers noted that the focus on customer satisfaction was new at GM…and long overdue. This is a hopeful development for GM.

GM, for years, has had a poor reputation for reliability and durability. That problem seems slow to change, as witnessed by the recent quality survey by Consumer Reports. This survey criticized the company’s quality, finding it lower than the models from Ford, Honda and Toyota.

If the new top management attention to quality takes hold of the company, it is bound to improve its fortunes. It should move up with this development.

Fortunately for GM, its main competitor, Toyota, seems to be moving down, at least for now. Toyota became the leader in the automobile industry because of its reliability, but that reputation has begun to falter under the blows of recalls for rust problems and sudden acceleration in several models.

In a surprising upset, Hyundai Motors passed Toyota in J.D. Power & Associates survey measuring how many problems an automobile has in its first three months. A few years ago, Hyundai’s reputation for quality was equivalent to Madonna’s reputation for virginity. However, the Korean company instituted stringent measures to improve its quality, measures that seem to be paying great dividends today with their improved reputation and fast-growing market share. (See our blog on the quality changes at Hyundai HERE)

Ford seems to be moving sideways. On the one hand, its 2009 automobiles are getting good reviews from critics and the marketplace. The company is gaining market share. It also reported its first quarterly profit in four years. So, sideways, you ask? Yes, because Ford has a real problem with its cost structure. In October, the UAW refused to grant Ford the same contract terms that it had previously granted to Chrysler and General Motors. The most important part of the better terms that GM and Chrysler won was relief from the many work rules that restricted the work that an individual employee could do on the production line. These work rules make employees inefficient and idle. They reduce the company’s productivity. Not even Ford can face down a cost structure that is higher than those of its domestic and international competitors. Many of these competitors produce in non-unionized plants in the U.S., where work rules do not hinder productivity.

So, Ford is heading sideways until we see what it does to overcome this cost disadvantage. If the company follows the old GM approach of cheapening its fits, finishes and styling, it will lose market share and plunge into big losses. If, on the other hand, the company maintains the style and quality of its new cars, then it has a chance to address its longer term cost problems in ways that might be somewhat less disruptive to the UAW. (See the Perspective, “Achieving the Low Cost Position” on

Ford’s situation is not promising. Many industry leaders, when faced with high and fixed labor costs in their industries, cheapen their products in order to eek out some profitability in the short-term. This always hurts them in the long-term. (See “Video #54: Cost Reduction by Winners vs. Losers in Hostility” on The plight of the legacy airlines serves as an ample reminder of this tendency and its results.