Cisco's New Server Product

Cisco recently announced that it was entering the server market. Details are sketchy right now, but we might take a brief look at what Cisco needs to do to be successful. We will use the Customer Buying Hierarchy as our analytical tool.

A bit of background. Cisco is entering the market for servers in order to increase the amount of the global IT purchase that it is able to address. Cisco claims that today it addresses about 10% of the total annual purchase of IT products. With the introduction of its server product, it believes that it will address 25% of that market.

But growth is not all that is pushing Cisco in the direction of servers. Hewlett Packard looms. Over the last few years, HP has developed and improved its ProCurve networking gear product line. This product line competes directly with Cisco routers and switches. Cisco may feel compelled to respond to HP’s forays into its market by counter-attacking in the server market. (See the Symptom and Implication, “Some competitors proliferate products around the heart of the market” on StrategyStreet.com.)

The Customer Buying Hierarchy holds that customers buy using four criteria: Function, Reliability, Convenience and Price. They use these criteria in that order for all purchases. Let’s use that Customer Buying Hierarchy to evaluate what we know of Cisco’s offering.

Function: Function refers to the characteristics of the product that affect the way the product is used by the customer. It includes all the features of a product. Cisco is entering the high-end of the server market, where margins are good and there seems to be some product differentiation among the competitors. We don’t know anything about the server itself, but the company’s offering integrates the server, networking components, data storage and virtualization software in one integrated package. It appears that the company is offering the hardware/software equivalent of Microsoft’s Windows/Office products. Everything works seamlessly together. These functions individually are not unique. The unique function is that they are all integrated together already in one package. This may give the customer a greater sense that the components will work well together. And it may enable some customers to avoid the cost of services they have needed previously to integrate these components in their IT locations. Cisco is offering a clear functional improvement.

Reliability: Reliability refers to the consistency with which the company delivers on promises made or implied to the customer by its product. There is good news and bad news here for Cisco. The good news is that the company has a sterling reputation for Reliability. Industry analysts claim that Cisco is rarely the Function leader in the industry, but Cisco treats their customers very well and ensures that the customer never gets in trouble using Cisco. It has a powerful reputation with customers as someone you can count on. So, what is the bad news? Cisco’s reputation for Reliability resides in network gear, not in servers. In servers, IBM and Hewlett Packard also have sterling reputations as companies capable of and willing to deliver superb customer service. IT customers trust all three of these companies. But if push comes to shove, wouldn’t the average IT customer trust IBM or HP more in the server product line? Cisco has a hurdle to overcome here. It must find a way to ensure customers that it will help them avoid all potential products from the new Cisco server. This may not be an easy task.

Convenience: This term refers to the ease with which the customer may acquire the product. Cisco looks to be in very good shape. There are several good companies who have signed on to add technology and sales to the Cisco product. Among the partners are such names as Accenture, EMC, Microsoft, VMWare, Red Hat and BMC Software. Customers will have no trouble finding the product and buying it.

Price: We don’t know what Cisco plans to charge for its new server product. One thing is certain. Its price has to be lower than a customer could purchase a high-end blade server and the services to install it. The new product line’s major benefit is that it integrates a number of components already available on the market. (See the Symptom and Implication, “Competitors are changing features of the product” on StrategyStreet.com.) Cisco can not charge more for the integration than the customer would pay to someone else for a final integrated product. In fact, Cisco will have to demonstrate to the customer that it is clearly cheaper to purchase their product than a blade server and accompanying integration services from HP or IBM. Pricing is a big unknown here.

Since we don’t know pricing, we can not reach a final conclusion. However, Cisco has taken on a big challenge here. This will not be easy. In order for this new initiative to produce the kind of results that Cisco hopes for, it is likely that its competitors, HP and IBM, are going to have to fail their customers in some way to enable HP to gain a major share of the market. Current IBM and HP customers are likely to grant these companies time to copy the unique benefits Cisco offers. In most mature markets, competitor failure is as important as a product benefit win in moving market share. (See the Symptom and Implication, “Share is tougher to shift” on StrategyStreet.com.) HP and IBM could fail if they do not create an equivalent benefit and then match Cisco’s prices. This is a tough challenge, but Cisco has met tough challenges before.

The End of a Local Leader's Trap

A Leader’s Trap occurs when an industry leader, usually the first or second company ranked by market share, holds prices high in the face of declining industry prices. The industry leader expects that its customers will remain loyal despite lower cost competition. This decision is virtually certain to fail. Eventually, the industry leader will reduce its prices, but only after losing market share to the lower cost competitor. The North Lake Tahoe ski world is seeing the end of a Leader’s Trap. The world is about to get more interesting for skiers around this area.

Several years ago, one of the largest North Tahoe ski areas, Northstar, developed a ski pass that allowed the pass-holder to ski any day of the week except for Saturday and a few blackout dates around popular holidays. Northstar is a relatively large, well-run resort. While its mountain is fine for families, it is sorely lacking in challenges for the advanced skier. They priced these passes at the equivalent of five or six days’ cost of a regular full day of skiing. As a result of this decision, Northstar gained in popularity. Skiers flocked to the good deal. They skied Northstar on most days and then bought single day tickets at the other ski areas for their Saturday skiing. These pass-holders have been a boon to Northstar (see the Symptom and Implication, “The industry leaders are losing share” on StrategyStreet.com). They bring their friends and family, they buy food and equipment at the village shops and they upgrade the reputation of the resort.

Northstar enjoyed these benefits for the last several years because its two large competitors, Squaw Valley and Alpine Meadows, refused to match their price offering. This was a classic Leader’s Trap. By most accounts, Alpine and Squaw offer a better mountain to skiers. But the prices they charge have caused many skiers to jump ship to Northstar, taking their purchases and buzz benefits with them.

But these days are quickly coming to an end. Squaw Valley has announced new season passes that are very competitive with those at Northstar, and a great deal less expensive than previous season passes. Squaw Valley will now offer a Bronze season pass, good for any day except Saturday and selected blackout dates for $369. Northstar’s equivalent offering is $329. Less expensive, yes, but a whole lot less costly than when Squaw Valley’s adult full-season pass cost $1,449. Squaw Valley also upped the ante. It offers a Silver pass for $469. This pass, which does not have a Northstar equivalent, allows the pass-holder to ski seven days a week, except on selected blackout dates.

This new pricing scheme from Squaw Valley puts a great deal of pressure on all other ski areas in North Lake Tahoe. Alpine Meadows will have to fall in line. Other smaller ski areas, such as Sugar Bowl, Homewood, Incline and Mt. Rose will also have to reduce their prices and offer a season passes with similar benefits. Northstar already is the leader in this pricing approach. It will continue on as it is, though now its price advantage over Squaw has fallen to 11%, from something closer to 75%.

Skiers here may see some additional pricing innovations, such as multiple ski area season passes. Such season passes, at low costs, already exist in Colorado, where a skier can gain access to five separate ski areas, including leaders Vail and Beaver Creek, for a cost that hovers around $500. A season pass granting the pass-holder access to several of the smaller ski areas might be an effective answer to Squaw Valley’s latest initiative.

No matter what happens next, Squaw Valley is out of the Leader’s Trap. It will certainly gain market share next year. (See the Symptom and Implication, “The larger companies are squeezing out the smaller” on StrategyStreet.com.)

Pricing in Highly Competitive Marketplaces

For the most part, the airline industry has been in overcapacity and hostile operating conditions since it was deregulated many years ago. During that time, the industry produced many pricing schemes and even more competitors. Over the last few years, the competitors have decreased, while the pricing schemes have burgeoned.

Many competitors fell away as the industry learned the difficult lesson that all airfares have to be the same or customers will choose the lower cost airfare. TWA, Eastern and Pan American were major carriers who disappeared in intense price competition. Nor did this price competition spare discount airlines. People Express no longer exists, nor does Presidential Airways, among many others.

But the industry learned something a few other industries have also learned. Most customers focus only on the quoted price. They don’t always consider the fees that might accompany their purchase. The airline industry developed an extensive list of add-on benefits for which they charge an extra fee. The list is long and growing. There are fees for checked bags, oversized luggage, priority seating, pets, unaccompanied minors, additional leg room, meals, drinks and snacks. Most of these fees are new over the last three to four years as airlines have found creative ways to increase their revenues by offering a la carte pricing. (See the Perspective, “Discovering Hidden Pricing Power” on StrategyStreet.com.)

These fee revenues have helped the airlines but they have a down-side for the airlines as well. When fees are not transparent, customers learn to distrust the answer when they search for the price of airline tickets. Many customers have learned that the quoted fare will not be the final price they must pay. (See the Symptom & Implication, “Customers are more price sensitive” on StrategyStreet.com.)

Abhorring a vacuum, several companies have rushed to offer information to the consumer about these often hidden fees. Today, companies such as TripAdvisor.com and FlyingFees.com, offer tools to calculate fees for various options a customer may choose while flying. These current tools have limitations. But the travel industry heavy hitters are about to join the battle. The giant, Sabre Travel Network, is about to introduce a broad-based suite of products that will enable travel agents and consumers to specify the services the consumer anticipates using and then see the full price of the ticket, plus the fees, the customer will incur. Further, travel companies are working to standardize the way that airlines include fees in their reservation systems. Some people expect these pricing benefits to be available within the next year. This is very similar to what has happened in the automobile rental industry. An auto renter can easily determine the total cost of the rental before signing on the dotted line.

Until now the airline industry has been able to charge different fees for the same service. For example, a consumer sending an unaccompanied minor on Southwest Airlines pays no additional fee. The same service on Air Tran brings a fee of $39. The service at Continental, Jet Blue and Alaska Airlines costs $75. If you want to fly an unaccompanied minor on the legacy airlines, Delta, American, United and U.S. Airways, the fee is $100.

Much of this pricing freedom is likely to erode as the travel companies bring more pricing information to the consumer. Most consumers will continue to operate the way they have in the past. They will ignore the fees and search for the lowest fare. However, enough consumers will pay attention to the full cost of the airline trip. These people will move their business if prices seem too high for the extra benefits they prefer to buy. This is likely to commoditize the price of these extra benefits.

The airline industry has done the consumer a service with its fee-based pricing innovations. Those customers who wish to fly for the lowest possible price can chose options that have few benefits. Those who want more benefits can chose those and pay for them accordingly. This is a sensible and helpful pricing strategy in a hostile market, for both the airline industry and the consumer.

Function Innovation in a Service Industry

The advertising industry is suffering along with the rest of us. As marketers in all industries retrench and cut costs, advertising agencies are feeling a margin squeeze. They are looking around for new services that might distinguish them from their competitors and enable them to gain share in a declining market. Some of these new services are Function innovations. (See the Perspective, “How Customers Buy” on StrategyStreet.com.) A Function, in our terminology, refers to the characteristics of the product that affect the way it is used by the customers.

Function innovations are powerful in customer economics but, perversely, may not create an industry winner. The reason is that many competitors will tend to copy successful Function innovations. These innovations are easy to see and reverse engineer, hence, easy to copy.

A new Function must remain unique in order for a customer to make a buying decision based on the supplier offering the new Function. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) There are three typical patterns that enable a new Function to remain unique:

* A legal or regulatory barrier such as a patent.

* Competitor economics which prevent or discourage a competitor from investing in the innovation.

* A need for external verification that the Function works and is worthwhile.

Interpublic Group’s Deutsch LA invested $60,000 in a research initiative. They interviewed more than 150 consumers to determine how the average consumer was responding to the bleak economy. Deutsch LA named this research study “America’s Wallet.” The company used this Function innovation creatively. First, it brought the findings to bear on its existing clients. This cemented their relationship with the existing clients and probably helped them gain additional work from these the clients as well. Then the company took its findings to clients that it was not currently serving. The study was interesting enough that some clients did come on board and grant Deutsch LA new work.

What has made this Function innovation successful? In this case, the Deutsch LA’s innovation remained unique using all three patterns that typically keep a Function unique:

* Legal barriers: The “America’s Wallet” product is copywrited and unique.

* Competitor economics: The Function innovation was costly and time consuming to Deutsch LA. Other agencies have been slow to copy this innovation in this recessionary market.

* The need for external verification: One new client who came on board due to the “America’s Wallet” product stated in a public forum that this product was really helpful. The product has a bit of buzz.

Congratulations to Interpublic Group’s Deutsch LA for a successful Function innovation.

An Answer for Pizza Problems?

The pizza industry is struggling. It has been struggling for some time, well before the recession put its icy grip on the industry’s throat. The costs of pizza ingredients have caused the prices in the industry to rise. The industry has always had to struggle with its less-than-healthy reputation. So, for some time, the industry has been losing share to healthier and fresher competition on the one hand, and less pricey hamburger and sandwich competitors on the other.

One company, Domino’s, is responding to these challenges by broadening its menu. It is beginning to sell toasted sub sandwiches in competition with Subway and Quiznos. This is not a promising development for Domino’s.

Subway and Quiznos are already fighting a price war. You have probably seen the ads for “A Footlong For $5” at Subway. The sandwich business, while apparently similar to pizza as a fast-food business, is still a different business than is the pizza business. Other very good fast-food firms have entered different fast-food businesses without success. One notable example is McDonalds. Several years ago, it tried to sell pizza in its stores and failed miserably.

You may see other companies expanding into new businesses that are apparently related to their own business. When you see that, beware. (See the Perspective, “Finding the Open Door” on StrategyStreet.com.) Some years ago a manufacturer watched as its competitors began buying into the distribution channel for its product. In a panic, the company decided that it had to do the same thing or lose its customer base. So it, and most of its competitors, entered the distribution business. The manufacturer had assumed that it would have an advantage in the distribution business because it made the product that would be sold there. Naturally, the distributors who were not purchased by the manufacturers became very upset. In addition, the manufacturers knew little about how to make a success of the distribution business. The result was a very expensive failure for all of the manufacturers who entered the distribution business. The distribution business had different customers with completely different needs than the customers of the manufacturing business. The manufacturers had no real advantages in this business.

Before a company expands into a related business, it needs to be clear on exactly where it has advantages over people already in the business. Otherwise, disaster awaits.

The Flexibility of a Great Retailer

Many people in the United States have heard little of Tesco, but it is a great retailer. In fact, it is the fourth largest retailer in the world, following Wal-Mart, Carrefour and Home Depot.

Tesco has about 30% of the total grocery sales in the U.K. There it operates with several different formats and price points. It has been very successful, both in the U.K. and in the several other countries in which it has operated.

In late 2007, the company opened its first U.S. stores, called Fresh & Easy. There are now 114 of these stores spread out through California, Arizona and Nevada. The Fresh & Easy format calls for small stores of about 10,000 square feet, focused on food, with an “Every Day Low Price” pricing scheme where prices were 10 to 25% below those at regular grocery stores.

The economy immediately presented Tesco with big problems. The Western U.S. has been hard hit by the recession. Customers have grown accustom to “Every Day Low Prices.” As a result, while Fresh & Easy generates more sales per square foot than the industry average, the company has not been able to open as many stores as it had hoped.

The company has responded quickly and creatively. Since customers began to take “Every Day Low Prices” for granted, the company began emphasizing extra low prices on individual items. They promoted low-priced special items, using radio commercials. As an example, the company offered $9.99 Valentines Day bouquets through radio commercials. The company also began emphasizing its Buxted brands in its stores. In the meat isle, these private label products are trimmed less well than the standard Fresh & Easy products and cost as much as 40% less.

These pricing moves are impressive. Most low-end competitors, such as Fresh & Easy in the U.S. market, could not afford to emphasize even lower priced products and expensive mass media advertising. (See the Perspective, “Turmoil Below: Confronting Low-End Competition” on StrategyStreet.com.) Few, if any, low-end retailers would do this, but Tesco did.

The company also has made changes in the look of its stores. The company repainted the walls in pastels and added a warmer color to the concrete floors after customers reported that they thought the stores were too sterile. Remember, most of these stores are less than a year old. The maintenance schedule did not call for a new paint job. But the customer did.

I am not sure whether the current Tesco concept will succeed. It is likely, however, that Tesco will find a format that works well in the United States. Their moves to date demonstrate that they are a flexible and creative company, determined to succeed.

GM's China Problem

GM has been a strong performer in the Chinese auto market. But their sales have hit a wall. In 2008, the Chinese automobile market was up 7%, but GM’s automobile sales were down 16%.

GM is losing market share to the usual Japanese suspects, Toyota and Honda, who are aggressively expanding in China. But the company is also losing market share to the more expensive Audi and BMW models.

What is behind this loss of market share? Two reasons seem apparent. First, GM’s problem with potential bankruptcy in the United States has scared away some of the Chinese consumers. But the problem is deeper than that. There is a significant problem in the cars that GM is offering the Chinese consumer.

GM is competing in China with the Buick brand name. Its best seller is a mid-sized sedan called the Excelle. The Buick Excelle is made in Korea. It is also sold in other emerging markets as the Chevrolet Lacetti. Chinese consumers have gradually become aware of the Excelle’s Korean engineering and they don’t think it is as good as American-designed automobiles. In addition, the Japanese in China, as they have in the United States, have set the quality standard with their automobiles. Some Chinese believe GM is not up to that standard.

GM is beginning to slip with the Chinese consumer because of Reliability failures. (See the Perspective, “Failure Shifts More Share Than Success” on StrategyStreet.com.)

Creative Price Reductions to Gain Share

Not too many of us today would like to be in the retail clothing business. Fine retailers world-wide are suffering a dismal decrease in demand. Jos. A. Bank Clothiers has bucked the trend.

Jos. A. Bank used creative discount pricing to grow its same store sales while around them competitors faced margin carnage. For one day in September, and again for a few days after Christmas, the company offered a “buy one suit, get two free” sale. This was just one of its gimmicks. There have been several others. The company’s sales have grown by double digits in the past three quarters, and same store sales have grown at 7%. (See the Perspective, “Achieving the Low Cost Position” on StrategyStreet.com.)

The company is frank about its approach to pricing in this environment. They are looking to gain market share. These pricing gimmicks would not work unless competitors cooperated. The competitors for Jos. A. Bank must allow them to gain share with discounts by refusing to match their pricing promotions. It looks like Jos. A. Bank succeeded here, at the expense of their competitors.

Slowing a Price Decline with a Low-Priced Product

For the last several years, most landline telephone companies have offered special discount deals to customers who threaten to cut their landline service. But the trickle of customers leaving landline service, and depending solely on cell phones, has turned into a stream.

Verizon believes it has at least a partial answer to slow the customer defection from the landline business. The company is considering introducing a $5 monthly voice plan that would allow customers to receive unlimited calls, but dial out only to 911 and Verizon Customer Service. This is a new low price point in the market. This price point compares with the Verizon unlimited nation-wide home phone plans which start at $40 a month.

Verizon is pricing defensively, trying to keep customers from leaving the company for cheaper pastures. In order to develop this defensive pricing plan, Verizon made three choices: the approach to take, the segments to serve, and the components of price to use to serve those segments. For many more examples of these three choices and how they defend both market share and margins, see our new Perspective, “Meeting Falling Prices with Creativity” in the Perspectives section of StrategyStreet.com.