How and where you raise prices is an important question. The legacy airlines are doing it badly.
The legacy airlines are nickel and diming customers by charging fees for checked bags, and so forth. The reaction of passengers is to view these changes as petty nuisances. Many will try to avoid them by simply bringing even more chattel on board.
This additional demand for overhead space makes travel even more uncomfortable for the Heart of the Market business traveler. (See “Cutting the Right Cost” in StrategyStreet.com/Tools/Perspectives) These valuable customers will have to put up with more crowded overhead bins and delays as people drag even more luggage on to the airplane. The major effect of these new service charges is to disappoint the industry’s customers.
Normally, a company “unbundles” its product and adds additional service charges on previously “bundled” services in order to make small improvements in margins. These changes would usually improve margins by less than 10%. The airline industry needs more than that…a whole lot more. Passengers know a big price jump is inevitable. Recent customer surveys bear this out. The legacy carriers should take advantage of this customer expectation and raise prices to levels that will allow solvency, at a minimum. If that doesn’t work and it knocks out too many leisure travelers, how big is the loss?
Monday, June 30, 2008
Thursday, June 26, 2008
Pricing in today's airline industry - Part 1
I am surprised and confused by the airline industry today. All the legacy airlines have announced substantial capacity reductions, in some cases by more than 20% of capacity. For example, United Airlines plans to ground 100 of its 460 planes in the foreseeable future. Some smaller cities will lose airline service completely. The legacies’ hub and spoke system is about to have fewer spokes.
Here is what confuses me. These capacity reductions come before the airlines try a last ditch effort to simply raise the basic fares. The airlines are grounding planes that can not produce cash at today’s price levels. Fine. Makes sense if you can’t generate cash with the plane. But before doing that, why not raise prices at least to a level that gives the airline enough cash to operate the about-to-be-abandoned route? If customers won’t pay that price, then O.K., ground the planes and refund the advanced-purchased tickets. (See “Costs: The Last Consideration” in StrategyStreet.com/Tools/Perspectives)
The airlines have learned well over the last thirty years that they can not charge premium prices and expect that customers will remain loyal. The airline industry today may be the fastest industry on earth to match prices, but I think there is an opportunity here.
An airline ticket to most locations is still a relative travel bargain. The cost per passenger mile traveled is still well below that of an automobile or rail equivalent. When faced with a choice of no service, the majority of customers would pay more.
How big is that majority? It’s big enough to be worth the attempt to raise prices to levels that the airlines consider reasonable to keep the current fleet flying. Why not try?
The answer to “why not try” is that competitors will not go along. That may not be true today. Even discounters, such as Jet Blue and Air Tran, are suffering in this marketplace. It would be worth a gamble to test their willingness to go along.
Here is what confuses me. These capacity reductions come before the airlines try a last ditch effort to simply raise the basic fares. The airlines are grounding planes that can not produce cash at today’s price levels. Fine. Makes sense if you can’t generate cash with the plane. But before doing that, why not raise prices at least to a level that gives the airline enough cash to operate the about-to-be-abandoned route? If customers won’t pay that price, then O.K., ground the planes and refund the advanced-purchased tickets. (See “Costs: The Last Consideration” in StrategyStreet.com/Tools/Perspectives)
The airlines have learned well over the last thirty years that they can not charge premium prices and expect that customers will remain loyal. The airline industry today may be the fastest industry on earth to match prices, but I think there is an opportunity here.
An airline ticket to most locations is still a relative travel bargain. The cost per passenger mile traveled is still well below that of an automobile or rail equivalent. When faced with a choice of no service, the majority of customers would pay more.
How big is that majority? It’s big enough to be worth the attempt to raise prices to levels that the airlines consider reasonable to keep the current fleet flying. Why not try?
The answer to “why not try” is that competitors will not go along. That may not be true today. Even discounters, such as Jet Blue and Air Tran, are suffering in this marketplace. It would be worth a gamble to test their willingness to go along.
Monday, June 23, 2008
A Silver Competitor Follows the Wrong Strategy
Deutsche Post AG is surrendering in the battle for the ground shipments, the U.S. market for express delivery. Over the last few years, Deutsche Post has purchased both DHL and Airborne in order to compete in the U.S. market. These two competitors were numbers 4 and 3 respectively in the industry. Deutsche Post plans to transfer DHL’s North American Air parcel deliveries to UPS and reduce its U.S. capacity for ground shipments by a third in order to cut losses.
Deutsche Post planned to become one of the top two leaders in the industry, taking market share from UPS and FedEx. This strategy rarely works for a Silver competitor. Deutsche Post’s strategy racked up huge losses, so it has now surrendered.
We define a Silver competitor as a company ranked number three or lower in an industry. There are many examples of successful Silver competitors (see “Rare Mettle: Gold and Silver Strategies to Success in Hostile Markets” in the StrategyStreet/Tools/Perspectives section). These successful competitors follow very carefully planned strategies to avoid the industry’s leading companies, where the industry leading companies are performing well. Two important tenets of a successful Silver strategy: First, seek the Large, second tier, customers in the marketplace and also woo service-oriented Medium sized customers, and avoid threatening the leading competitors in the marketplace by going after the first tier, Very Large, customers. Second, beat the standards of service for the customers in the marketplace.
DHL violated both of these two tenets. It sought out the largest customers in the marketplace in order to win significant market share. This strategy failed when neither UPS nor FedEx “failed” these Very Large customers in order to open these relationships to DHL’s offerings. DHL also failed on its service levels. Deutsche Post combined DHL and Airborne hubs in one location in 2005. This combination proved rocky for customers. Deliveries were delayed and many customers abandoned DHL. DHL lost 10% of its total revenues as these customers left it because of its “failure”. These customers belong to someone else now and DHL will have to wait for that someone else to fail before they are likely to have a shot at gaining that business back.
Deutsche Post planned to become one of the top two leaders in the industry, taking market share from UPS and FedEx. This strategy rarely works for a Silver competitor. Deutsche Post’s strategy racked up huge losses, so it has now surrendered.
We define a Silver competitor as a company ranked number three or lower in an industry. There are many examples of successful Silver competitors (see “Rare Mettle: Gold and Silver Strategies to Success in Hostile Markets” in the StrategyStreet/Tools/Perspectives section). These successful competitors follow very carefully planned strategies to avoid the industry’s leading companies, where the industry leading companies are performing well. Two important tenets of a successful Silver strategy: First, seek the Large, second tier, customers in the marketplace and also woo service-oriented Medium sized customers, and avoid threatening the leading competitors in the marketplace by going after the first tier, Very Large, customers. Second, beat the standards of service for the customers in the marketplace.
DHL violated both of these two tenets. It sought out the largest customers in the marketplace in order to win significant market share. This strategy failed when neither UPS nor FedEx “failed” these Very Large customers in order to open these relationships to DHL’s offerings. DHL also failed on its service levels. Deutsche Post combined DHL and Airborne hubs in one location in 2005. This combination proved rocky for customers. Deliveries were delayed and many customers abandoned DHL. DHL lost 10% of its total revenues as these customers left it because of its “failure”. These customers belong to someone else now and DHL will have to wait for that someone else to fail before they are likely to have a shot at gaining that business back.
Thursday, June 19, 2008
Industry Leader Preempts the Low End of the Market
Recently, Intel announced the Atom chips. These chips are inexpensive, built for ultra-cheap desktop or portable computers called Nettops and Netbooks. The Atom chips for Nettops cost $29 each, while those for the Netbooks will sell for $44. These are both Price Leader products.
In our analyses of price points, we have identified four separate price points in the market place. (See: “Why Do Leaders Lead?” in StrategyStreet.com/Tools/Perspectives) Three of these price points appear in most markets:
- The Standard Leader price points are those that command the middle of the market. They set the standards for all products offered in the market.
- At the high-end of the market, the Performance Leader products occupy the premium-end of the market, with prices starting at 10% over the Standard Leader product. These products offer more performance in the form of Features, Reliability and Convenience than do the Standard Leader products in return for a much higher price.
- At the low-end of the market live the Price Leader products. These products offer fewer benefits, lower performance, than the Standard Leader products. Their prices must be much lower to make up for that. Most Price Leader products have prices at least 25% below those of the industry Standard Leaders.
These price point categories apply to both products and companies. For example, a Standard Leader company will often offer a Performance Leader product in addition to its Standard Leader products.
By introducing a Price Leader product, the Standard Leader company, Intel preempts the low-end of the market. Its main rival, Advanced Micro Devices, Inc. (AMD), might have had an opportunity at that low-end but its unique opportunity has passed it by. AMD will inevitably introduce a Price Leader product in order to continue offering a broad product line, but it will probably not gain much market share from the introduction.
In an unusual move, Intel is ahead of its major customers on this product. Hewlett-Packard and Dell, the two leading U.S. producers of personal computers, had yet to introduce their full lines of Nettops and Netbooks. Instead, some of the industry’s followers dominate these Price Leader computers.
Intel read the tea leaves correctly. Congratulations on an astute innovation.
Thursday, June 12, 2008
Dell Slips at High End
Two years ago, Dell bought Alienware, the leader of the game-oriented personal computer business. Game-oriented PCs are the high-end of the market. They usually sell for several times the price of the average PC. A game-oriented PC is a Performance Leader product (see “Why Do Leaders Lead?” in the Tools/Perspectives section of StrategyStreet.com). In the computer hardware business, the differentiator at the high end of the market is Functionality. This Functionality includes both design and computing capability. If you have these two functional benefits, you can generate word-of-mouth among buyers and become a hot product.
Dell has slipped in this market. The Alienware products had to compete inside Dell with Dell’s original high-end line, called the XPS. The market has not been impressed.
There is not much surprise in this development. If a Standard Leader takes over a Performance Leader product, normally it adds value by maintaining good Functionality while reducing the Price. The Standard Leader creates a good Performance Leader value proposition by using its economies of scale to offer more Convenience at a lower Price, with Functions “good enough” to appeal to most of the Performance Leader customers. As an example, see Toyota’s Lexus product in the early 90s.
Most of the time the Standard Leader’s high-end (i.e., Performance Leader) product competes against smaller Performance Leader specialists, who offer somewhat more Functionality but at a much higher Price to make up for their higher unit costs. Often, they fail to thrive under the onslaught of the “good enough” Performance Leader products from the bigger Standard Leaders.
Dell was not able to maintain a high level of Functionality and did not put price pressure on the other, much smaller, high-end competitors. Where was its value in the market?
Dell has slipped in this market. The Alienware products had to compete inside Dell with Dell’s original high-end line, called the XPS. The market has not been impressed.
There is not much surprise in this development. If a Standard Leader takes over a Performance Leader product, normally it adds value by maintaining good Functionality while reducing the Price. The Standard Leader creates a good Performance Leader value proposition by using its economies of scale to offer more Convenience at a lower Price, with Functions “good enough” to appeal to most of the Performance Leader customers. As an example, see Toyota’s Lexus product in the early 90s.
Most of the time the Standard Leader’s high-end (i.e., Performance Leader) product competes against smaller Performance Leader specialists, who offer somewhat more Functionality but at a much higher Price to make up for their higher unit costs. Often, they fail to thrive under the onslaught of the “good enough” Performance Leader products from the bigger Standard Leaders.
Dell was not able to maintain a high level of Functionality and did not put price pressure on the other, much smaller, high-end competitors. Where was its value in the market?
Monday, June 9, 2008
RV Market in Hostility
The RV market is in hostility. A hostile market sees low returns on investment, even for the industry leaders. One of the largest players in the market, Fleetwood Enterprises, has seen five straight years of losses. Another leader, Winnebago Industries, while still profitable, has seen four consecutive years of falling sales. This hostility has been caused by a rapid and deep fall-off in demand.
Once an industry enters hostility, it will usually witness a “flight to quality” where customers migrate away from weaker competitors toward those offering a better value proposition. (See the Perspective “Success Under Fire: The Policies to Prosper in Hostile Times” in StrategyStreet.com/Tools/Perspectives).
Few companies, even the largest, perform well in hostile markets. For every Toyota there are several companies like GM, Ford and Chrysler. Many of the policies that make a company successful in normal times get in the way during hostility. In fact, some of the rules for success seem downright counter-intuitive. Briefly, there are five rules that seem to be patterns for companies who succeed in hostile markets:
1. Strive for a good mix of both large and medium-sized customers. Ignore demands of small customers.
2. Cover a broad spectrum of price points. Avoid over-reliance on the high or low price points.
3. Differentiate your product and company on the basis of Reliability. Unique product Features are less valuable.
4. Turn price into a commodity. Seek payback in sales volume, not in price.
5. Emphasize productivity and economies of scale in the cost structure, but remember that good value for the customer comes first. You can’t cut unit costs without customers buying the units.
For more description of these patterns and their implications, see “Staying Alive in a Hostile Market” in the Tools/Perspectives section of StrategyStreet.com.
Once an industry enters hostility, it will usually witness a “flight to quality” where customers migrate away from weaker competitors toward those offering a better value proposition. (See the Perspective “Success Under Fire: The Policies to Prosper in Hostile Times” in StrategyStreet.com/Tools/Perspectives).
Few companies, even the largest, perform well in hostile markets. For every Toyota there are several companies like GM, Ford and Chrysler. Many of the policies that make a company successful in normal times get in the way during hostility. In fact, some of the rules for success seem downright counter-intuitive. Briefly, there are five rules that seem to be patterns for companies who succeed in hostile markets:
1. Strive for a good mix of both large and medium-sized customers. Ignore demands of small customers.
2. Cover a broad spectrum of price points. Avoid over-reliance on the high or low price points.
3. Differentiate your product and company on the basis of Reliability. Unique product Features are less valuable.
4. Turn price into a commodity. Seek payback in sales volume, not in price.
5. Emphasize productivity and economies of scale in the cost structure, but remember that good value for the customer comes first. You can’t cut unit costs without customers buying the units.
For more description of these patterns and their implications, see “Staying Alive in a Hostile Market” in the Tools/Perspectives section of StrategyStreet.com.
Wednesday, June 4, 2008
HP/EDS Combination: The Conclusion
This entry is the last in our series of four entries on the HP/ED deal.
The Setting
Hewlett Packard has proposed a take-over of EDS, in order to improve its services, revenues and profits. EDS is #2 to IBM in the computer services industry. Hewlett Packard is #5. The combined company, at $38 billion on revenues, would have only a 5% share of the market. IBM has $54 billion in services revenues and 7% market share. The reaction in the stock market has been mixed. Hewlett Packard stockholders don’t like it. Its share price fell. The EDS shareholders like it a lot better, as their shares increased in value.
A company undertakes an acquisition to achieve one or more of these three objectives: first, acquire a product that it does not have; second, acquire customers that it otherwise could not service; and third, establish a new lower unit cost through the combination of the two companies. We will look at each of these, in turn, in the current HP and EDS deal and then summarize our conclusions in the last entry.
Our Conclusion
As we explained in the previous three blog entries, the combination is likely to succeed in all three of the major objectives of an acquisition. It improves the product offering. It opens up the combined company to new customers. And it is virtually certain to reduce the unit costs the company incurs. A successful acquisition almost always requires success in two of the three objectives in order to make economic sense. This combination meets all three objectives.
This combination is essential to shift market share.
There is a hidden force behind the business logic for the merger between HP and EDS in the computer services industry. The hidden force is the dominance of “failure” in normal market share movement.
Failure moves more market share than does success in most mature markets (see the Perspective, “Failure Shifts More Share Than Success” in StrategyStreet.com/Tools/Perspectives). In most fast-growing markets, there are many opportunities to “win” market share. You “win” market share by offering customers something that other competitors can not, or will not, offer them. But as markets become more mature and growth slows, “winning” market share becomes much more difficult. The reason? Competitors copy the most obvious innovations. These obvious innovations tend to be product Functions or unique Pricing schemes.
Once an industry reaches a slower growth level of maturity, “failure” tends to drive far more market share than does success. By “failure”, we mean that an incumbent supplier does not meet the customers’ expectations. These customer expectations are the result of the customer’s beliefs about the product offerings of other competitors. The “failing” incumbent can not offer the Functions, Reliability, Convenience or Price that the customer expects and “fails” the customer. This “failure” causes the customer to open his relationship to other suppliers.
Once a market becomes “failure” driven, it takes many years to move significant market share from one competitor to another. Then, acquisitions become important to growth and profitability. Of course, these acquisitions have value only to the extent that the acquiring company is able to retain the purchased customers (see “Acquiring Share, Not Sand” in StrategyStreet.com/Tools/Perspectives).
Despite the fact that the #2 and #5 competitors in the marketplace are combining to compete more effectively with the #1 competitor, you should expect little or no price pressure to emerge in the market as a result. This market is highly fragmented with the top competitors holding only 20% of it. That leaves another 80% of the market served by smaller firms. The larger, more sophisticated competitors should grow at the expense of smaller companies, a typical evolution in fragmented markets. Furthermore, the growth in the marketplace, at 8-10% per annum, means that the infrastructure of the industry has to double every eight to ten years. This takes capital and profits and, therefore, reasonable prices.
This combination is a very good bet for success. Not a sure bet, but certainly a good one. However, it is unlikely to be successful very quickly. IBM stumbled for several years as it created a strong services business. IBM bought a consulting firm to help it improve its service offerings. The integration of its acquired consulting firm proved difficult and costly. IBM got over that hurdle and now has a profitable and fast-growing business. I expect that this HP/EDS combination will become far more profitable and fast growing than either current company, even if there are some bumps in the road.
The Setting
Hewlett Packard has proposed a take-over of EDS, in order to improve its services, revenues and profits. EDS is #2 to IBM in the computer services industry. Hewlett Packard is #5. The combined company, at $38 billion on revenues, would have only a 5% share of the market. IBM has $54 billion in services revenues and 7% market share. The reaction in the stock market has been mixed. Hewlett Packard stockholders don’t like it. Its share price fell. The EDS shareholders like it a lot better, as their shares increased in value.
A company undertakes an acquisition to achieve one or more of these three objectives: first, acquire a product that it does not have; second, acquire customers that it otherwise could not service; and third, establish a new lower unit cost through the combination of the two companies. We will look at each of these, in turn, in the current HP and EDS deal and then summarize our conclusions in the last entry.
Our Conclusion
As we explained in the previous three blog entries, the combination is likely to succeed in all three of the major objectives of an acquisition. It improves the product offering. It opens up the combined company to new customers. And it is virtually certain to reduce the unit costs the company incurs. A successful acquisition almost always requires success in two of the three objectives in order to make economic sense. This combination meets all three objectives.
This combination is essential to shift market share.
There is a hidden force behind the business logic for the merger between HP and EDS in the computer services industry. The hidden force is the dominance of “failure” in normal market share movement.
Failure moves more market share than does success in most mature markets (see the Perspective, “Failure Shifts More Share Than Success” in StrategyStreet.com/Tools/Perspectives). In most fast-growing markets, there are many opportunities to “win” market share. You “win” market share by offering customers something that other competitors can not, or will not, offer them. But as markets become more mature and growth slows, “winning” market share becomes much more difficult. The reason? Competitors copy the most obvious innovations. These obvious innovations tend to be product Functions or unique Pricing schemes.
Once an industry reaches a slower growth level of maturity, “failure” tends to drive far more market share than does success. By “failure”, we mean that an incumbent supplier does not meet the customers’ expectations. These customer expectations are the result of the customer’s beliefs about the product offerings of other competitors. The “failing” incumbent can not offer the Functions, Reliability, Convenience or Price that the customer expects and “fails” the customer. This “failure” causes the customer to open his relationship to other suppliers.
Once a market becomes “failure” driven, it takes many years to move significant market share from one competitor to another. Then, acquisitions become important to growth and profitability. Of course, these acquisitions have value only to the extent that the acquiring company is able to retain the purchased customers (see “Acquiring Share, Not Sand” in StrategyStreet.com/Tools/Perspectives).
Despite the fact that the #2 and #5 competitors in the marketplace are combining to compete more effectively with the #1 competitor, you should expect little or no price pressure to emerge in the market as a result. This market is highly fragmented with the top competitors holding only 20% of it. That leaves another 80% of the market served by smaller firms. The larger, more sophisticated competitors should grow at the expense of smaller companies, a typical evolution in fragmented markets. Furthermore, the growth in the marketplace, at 8-10% per annum, means that the infrastructure of the industry has to double every eight to ten years. This takes capital and profits and, therefore, reasonable prices.
This combination is a very good bet for success. Not a sure bet, but certainly a good one. However, it is unlikely to be successful very quickly. IBM stumbled for several years as it created a strong services business. IBM bought a consulting firm to help it improve its service offerings. The integration of its acquired consulting firm proved difficult and costly. IBM got over that hurdle and now has a profitable and fast-growing business. I expect that this HP/EDS combination will become far more profitable and fast growing than either current company, even if there are some bumps in the road.
Monday, June 2, 2008
HP and EDS: The Cost Case
This entry is the third in our series of four entries on the HP/EDS deal.
The Setting
Hewlett Packard has proposed a take-over of EDS, in order to improve its services, revenues and profits. EDS is #2 to IBM in the computer services industry. Hewlett Packard is #5. The combined company, at $38 billion on revenues, would have only a 5% share of the market. IBM has $54 billion in services revenues and 7% market share. The reaction in the stock market has been mixed. Hewlett Packard stockholders don’t like it. Its share price fell. The EDS shareholders like it a lot better, as their shares increased in value.
A company undertakes an acquisition to achieve one or more of these three objectives: first, acquire a product that it does not have; second, acquire customers that it otherwise could not service; and third, establish a new lower unit cost through the combination of the two companies. We will look at each of these, in turn, in the current HP and EDS deal and then summarize our conclusions in the last entry.
The Cost Case
The cost outlook for this acquisition is surely positive. The cost reduction opportunities are plentiful.
EDS was slow to shift some of its infrastructure to lower cost countries, such as India, so it starts out with high operating costs. EDS has operating margins of 6%, which are half those of IBM, and lower than those of HP in the services business. The combination of the two companies will have enough overhead overlap to allow significant cost savings.
HP, as the acquirer, is better positioned to reduce costs. HP’s CEO has proven himself to be an effective cost manager. The HP management group has been fire-tried in the hardware business. The hardware business is much tougher than the services business because it is closer to a commodity with standard features. Cost is always an important element of the hardware business. The combined company is virtually certain to see significant reductions in unit costs.
In our fourth and last entry, we will summarize our conclusions on this combination.
The Setting
Hewlett Packard has proposed a take-over of EDS, in order to improve its services, revenues and profits. EDS is #2 to IBM in the computer services industry. Hewlett Packard is #5. The combined company, at $38 billion on revenues, would have only a 5% share of the market. IBM has $54 billion in services revenues and 7% market share. The reaction in the stock market has been mixed. Hewlett Packard stockholders don’t like it. Its share price fell. The EDS shareholders like it a lot better, as their shares increased in value.
A company undertakes an acquisition to achieve one or more of these three objectives: first, acquire a product that it does not have; second, acquire customers that it otherwise could not service; and third, establish a new lower unit cost through the combination of the two companies. We will look at each of these, in turn, in the current HP and EDS deal and then summarize our conclusions in the last entry.
The Cost Case
The cost outlook for this acquisition is surely positive. The cost reduction opportunities are plentiful.
EDS was slow to shift some of its infrastructure to lower cost countries, such as India, so it starts out with high operating costs. EDS has operating margins of 6%, which are half those of IBM, and lower than those of HP in the services business. The combination of the two companies will have enough overhead overlap to allow significant cost savings.
HP, as the acquirer, is better positioned to reduce costs. HP’s CEO has proven himself to be an effective cost manager. The HP management group has been fire-tried in the hardware business. The hardware business is much tougher than the services business because it is closer to a commodity with standard features. Cost is always an important element of the hardware business. The combined company is virtually certain to see significant reductions in unit costs.
In our fourth and last entry, we will summarize our conclusions on this combination.
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