Wednesday, June 29, 2011

The Mobile Phone Industry and Customer Retention

The mobile phone industry’s growth has slowed.  It is now operating more like a stable, moderate to slow growth market.  This is particularly true in Europe.  To face the challenge of slower growth in the industry, European mobile operators are turning to customer retention, but they are careful of the customers they seek to retain. 

The Europeans have observed that less than 20% of an operator’s customers generate to 80% of the operator’s total revenue.  This pattern repeats itself in many industries.  When we have seen these patterns in other industries, we have also noted that less than 10% of the total customers generate an astounding 50% of total revenues.  These are the really important customers in an industry. 

A company must retain its key customers.  In the mobile phone industry, as in most industries, the largest 20% of the industry’s customers are likely to be what we would call Core customers for the industry’s larger competitors.  A Core customer allows supplier company to earn at least the cost of capital through a business cycle.  The retention of these core customers is of paramount importance to long term company success. It costs a great deal more to find a new customer than to retain and build the relationship with a customer you already have.  In the European mobile phone industry, carriers have found that it costs ten times more to acquire a customer than to retain one. 

The industry has found another important phenomenon associated with customer defection.  Recent research has told it that defection is a social phenomenon.  If defecting customers leave an operator, they usually are not quiet about it.  They tell their friends.  In turn, some of their friends defect as well.  So, the loss of a Core customer to an operator will often bring with it the loss of several other Core customers. 

The mobile phone operators in Europe are working on retention by focusing particularly on those Core customers most likely to defect.  These operators have analyzed the value of their customers and have assigned a rating to each customer.  When a customer calls a call center, the information about the customer, including his rating, is readily displayed on the service representative’s screen.  This customer specific information enables the service representative to respond with different value offers, depending on the importance of the customer.  Most of these offers reflect lower prices for a potential defector.

But the industry is responding to potential defections with more than simple price reductions.  Some companies are developing personal calling rates and plans tailored to individual Core customer habits.  One European company instituted this individual approach and cut its percentage of customers defecting each year in half, from 20% to 10%. 

The industry has found another important phenomenon associated with customer churn.  Recent research has told it that defection is a social phenomenon.  If defecting customers leave an operator, they usually are not quiet about it.  They tell their friends.  In turn, some of their friends defect as well.  So, the loss of a core customer to an operator will often bring with it the loss of several other core customers. 

Customer retention is an important, strategic management imperative, even in fast growing markets

Wednesday, June 22, 2011

A Likely End Game to Hostility

The hard disk drive business has been a lousy place to compete for nearly twenty-five years.  It has been the graveyard of many competitors.  Twenty years ago, there were eighty disk drive manufacturers.  By the mid-90s, there were only fifteen.  By 2001, there were eight, and today it appears there are only four.  But the fact that we are at four competitors, especially the size of the leading competitors, means that the industry is likely to come out of its recurring bouts of overcapacity and hostility. 

As 2011 began, there were five hard disk drive manufacturers.  Western Digital led the market with a 31% market share, followed closely by Seagate with a 29% market share.  Hitachi enjoyed an 18% market share, while Samsung and Toshiba shared the remaining 22% of the market.  Recently, Western Digital agreed to purchase Hitachi.  This acquisition would bring Western Digital’s potential market share to 49%.  The top two of the remaining four competitors would then have a potential market share of 78%.  The top three would have more than 85% of the market. 

Hitachi was not just any other competitor in the market.  It had a well deserved reputation for being the most aggressive price discounter in the market.  Hitachi was the major reason that pricing stayed under pressure in the hard disk market.  Western Digital’s acquisition removed the major discounter.

In the past, acquisitions among the hard disk drive manufacturers brought somewhat better margins to the remaining players, but not as much market share as the acquisition would suggest.  The reason was customers rotating other strong suppliers into their relationships to maintain low prices.  With only four players left, and a dominant leader in the market, there is little purpose for the three followers to discount against Western Digital.  A discounter might pick up some temporary share in a market saturated with “last look” arrangements, but it might face a very aggressive pricing response by one or both of the remaining leaders in the market.  No, rather than discount, the economics for all the players would argue for firm industry pricing.  That is the most likely outcome of this acquisition.

Over the years, we have studied many industries in overcapacity.  Overcapacity produces a hostile market, where returns are low and price competition remains intense.  These kinds of markets end in one of two ways, either demand picks up and sops up the industry’s overcapacity, or the industry consolidates to the point where the top four competitors control 85% or more of the industry’s volume.  The remaining players then demur from competitive price discounts. The majority of industries see demand growth pull them out of hostile conditions.

There is one potential fly in this hard disk ointment.  Computer tablets and other portable devices don’t use hard disk drives.  Instead, they use NAND flash drives.  These are solid state drives.  They are more expensive than hard disks, have a much smaller form factor and are generally more reliable.  Samsung, Toshiba and SanDisk are the leaders in this market.  It could happen that Samsung and Toshiba, two of the four remaining hard disk drive suppliers, use low prices in the hard disk market to create customers for their more expensive flash drives.  It is more likely, however, that these two companies, who are distant followers in the hard disk market, would prefer to see higher prices for hard disks.  These higher prices on a competitive product would help some customers in the market transfer alliance to flash drives.

This acquisition should be a good deal for the remaining four hard disk players.  While some analysts have argued that the hard disk drive market will slowly die under the pressure of the growth in the applications of flash drives, industry observers still see an 8% per annum unit growth for this market over the next five years.  That unit growth should come with better margins for the remaining players.

Wednesday, June 1, 2011

NestlĂ©’s Cost Reduction in the Coffee Business

Nestle is the world-wide leader in the coffee business. They offer coffees at virtually all price points. They invented instant coffee in the 1930s. After the buffets of the commodity markets over the last few years, the company has created a global push to reduce its costs and to increase the quantity and quality of the coffee it buys.

We have found four generic approaches to reducing costs.

• First, reduce the rate of cost of a cost input.

• Second, reduce the cost inputs that do not produce output.

• Third, reduce unique activities and components in processes and the product

• Fourth, spread fixed cost activities over additional product output

Nestle is using the first three of these approaches in its world-wide investment in cost management.

First, Nestle redesigned part of the process. Its scientists developed a new generation of Robusta and Arabica coffee plants for Mexico. The Robusta beans are relatively inexpensive and make up the bulk of the beans in instant coffee. The Arabica beans are more expensive, harder to grow and go to the higher end coffees. Today, Nestle has planted 100 thousand coffee trees in Mexico using its newly designed coffee trees. Once this experiment is complete, the company plans to distribute 220 million plants to coffee growers world-wide over the next ten years.

The use of these new plants will enable Nestle to reduce its rate of cost for the beans it buys. The new plant design increases yields so it eliminates some inputs that do not produce the output of coffee beans. Many long-term coffee farmers are using older trees, which yield fewer beans and lower quality beans. Many of these farmers are leaving the industry since they cannot compete. This magnifies the commodity price problem Nestle faces. Nestle’s new trees fit the region’s climate. They resist disease and allow for larger and easier harvests. These trees will make coffee beans more consistently and predictably available. Nestle will give these trees to the farmers without asking for a firm long-term contract or ownership of any part of the farm. But it should be obvious that Nestle will engender a great deal of farmer loyalty with this program.

Nestle also expects to reduce the rate of cost it pays for its beans with two other cost reduction initiatives. It will offer farming and investing advice to up to ten thousand farmers world-wide. As these farmers become more efficient, Nestle’s costs will drop. In addition, Nestle will also increase the amount of coffee it buys directly from the nearly 170 thousand growers who produce its coffees.

This kind of foresight and innovation suggests why Nestle commands its market leadership.