Every price has at least two components: a set of performance benefits associated with the product and a unit price. The unit price is what we call the basis of the charge. This basis is the unit measure the company uses to quantify the price for the product. When you change the basis of charge, you usually change the effective price at the same time. Normally, the basis of the charge, or unit price, expresses a major cost that the supplier of the product incurs. A trucking company charges by weight. Lumber sells by dimension. Gasoline sells by a volume measure. Paper sells by weight.
Sometimes prices in a market are high enough that the suppliers don’t worry too much about their cost structures. (See the Perspective, “What Makes Returns High?” on StrategyStreet.com.) One example is the provision of internet services.
Not too many years ago, AOL, CompuServe and others charged internet users by the minute that the user was connected to the internet. But profits were high in the industry and the growth rates were impressive. Competition forced a change in pricing by changing the basis of charge. Instead of charging per minute of connect time, the industry moved to a flat rate monthly charge. This basis of charge allowed the internet user customer to use all the bandwidth he wanted for this flat rate. This made sense as long as industry profits were very high.
The industry evolved in ways that the early providers did not anticipate. Now the heaviest users of the internet use enormous amounts of bandwidth to download movies and other data. These heavy users are putting a strain on the network capacities of the internet service providers. Costs for some heavy users exceed the revenues they provide under flat rate pricing.
So there is a change coming in future pricing for internet usage. The single flat rate is about to give way to a basis of charge where the speed of the connection and the total usage of bandwidth are considerations for arriving at a price. Pricing is returning to a cost-based basis of charge under the weight of competitors.
AT&T is testing a new pricing approach in selected markets. Its lowest cost offering runs at $19.95 a month. It provides a speed of eight-tenths of a megabit per second with an overall monthly limit on downloads of 20 gigabytes. At the high end of the spectrum, the monthly price jumps to $65 for a service that offers a speed of 18 megabits per second and a monthly cap of 150 gigabytes.
This new AT&T pricing illustrates the shift from the pricing in a young, fast-growing industry, where costs seem less important than customer acquisition, to one where costs of the product become a differentiator of both the attractiveness of the customer and the efficiency of the supplier. (See the Symptom & Implication, “Revenue growth has been high, but has slowed” on StrategyStreet.com.)
Thursday, October 29, 2009
Monday, October 26, 2009
A Lay-up for Lay-away
Toys R Us has introduced a lay-away program for large ticket items that they sell. These items include bikes, dollhouses, play kitchens, car seats, cribs, strollers and other expensive items. This new program from Toys R Us follows successful similar initiatives by Sears and K-Mart last year.
Lay-away programs have been relatively scarce for the last forty years. They were popular during the Depression. However, over the last couple of generations they have given way to the easy credit that consumers have had from credit card companies, banks and mortgage lenders. Of course, this day of easy credit seems to have passed. Hence, the lay-away program recovery.
The customer who puts a product on lay-away deposits with the store 20% of the item’s price, plus all taxes and a $10 service charge. The customer, then, has until December 6 to finish the payments for the products. The customer may make these payments at any Toys R Us store.
Toys R Us incurs real costs to offer this program. It has administrative costs, and probably some additional inventory costs as well, in order to make these products readily available once the customer’s payment schedule has been completed. This price component pays for these costs.
This is an example of an optional price component. Optional price components include such additions to the base price as fees on top of the normal basis of charge, penalties or bonuses for the buyer or seller, price caps, differing periods of agreement to maintain a price and extended payment options. A lay-away plan is an extended payment option. The company is offering this price option in order to increase its sales during a period where sales may be slow due to the current recession.
We have found many other examples of these optional price components, which enable a company to be more flexible with prices in difficult times. You may find these examples in the Improve/Pricing section of StrategyStreet.
Lay-away programs have been relatively scarce for the last forty years. They were popular during the Depression. However, over the last couple of generations they have given way to the easy credit that consumers have had from credit card companies, banks and mortgage lenders. Of course, this day of easy credit seems to have passed. Hence, the lay-away program recovery.
The customer who puts a product on lay-away deposits with the store 20% of the item’s price, plus all taxes and a $10 service charge. The customer, then, has until December 6 to finish the payments for the products. The customer may make these payments at any Toys R Us store.
Toys R Us incurs real costs to offer this program. It has administrative costs, and probably some additional inventory costs as well, in order to make these products readily available once the customer’s payment schedule has been completed. This price component pays for these costs.
This is an example of an optional price component. Optional price components include such additions to the base price as fees on top of the normal basis of charge, penalties or bonuses for the buyer or seller, price caps, differing periods of agreement to maintain a price and extended payment options. A lay-away plan is an extended payment option. The company is offering this price option in order to increase its sales during a period where sales may be slow due to the current recession.
We have found many other examples of these optional price components, which enable a company to be more flexible with prices in difficult times. You may find these examples in the Improve/Pricing section of StrategyStreet.
Thursday, October 22, 2009
The Challenge of a Small Competitor Part 2
Part 2: Pricing and Costs
There is a new, small, credit card issuing company in the market. The company is PartnersFirst and they promise to change the credit card world by making that world more cardholder friendly. This new firm, based in Wilmington, Delaware, has introduced an unusual credit card. The card has no fees and relatively low borrowing rates, along with less onerous penalties. The upstart company challenges the four giants in the industry, Bank of America, Citigroup, JP Morgan Chase and Capital One. Industry veterans formed and run this new credit card company. They believe that the company’s card should be particularly attractive in the light of new Federal rules that restrict credit card practices.
A few years ago, we did an extensive analysis of how a company whose market share was #3 or below in its industry could succeed against much better competitors. (See the Perspective “Rare Mettle: Gold and Silver Strategies to Succeed in Hostile Markets” on StrategyStreet.com.) More specifically, we studied these companies in hostile markets, where pricing pressure was intense and returns for most competitors in the industry were low. If a company could perform well in a hostile marketplace, its model would be instructive in all other marketplaces. We succeeded in finding a number of small competitors who performed well in these difficult markets. They had both growth rates and returns on investment above their industry averages. We named these successful smaller companies Silver competitors.
Once we found those successful competitors, we analyzed their business models to look for common patterns. Our analyses covered segments, product and service innovation, pricing and cost management. We will use our findings to evaluate the prospects for PartnersFirst. We will do this analysis in two parts. Part 1 of the blog covered segments and products. Part 2 will cover pricing and cost management and summarize our conclusions.
Pricing
As the market slips into hostility, the best Silver competitors may offer low prices to gain share. But chronic low prices are not their hallmarks. If the largest competitors in the market are in a Leader’s Trap, Silvers will exploit that price umbrella by discounting against the largest competitors to gain share. However, once the industry leaders match price discounts, Silvers eliminate their discounting. From that time on, they match the changes in the general price levels in the industry.
Silvers do have some price advantages in the customers they serve. Their customer portfolio of Large and Medium customers gives them a very few percentage point advantage over the largest competitors in average unit prices.
PartnersFirst offers very low pricing. Using the SEIU credit card as an example, the basic card carries a 16% interest, does not include any annual fees and imposes no late penalty charges. These prices are likely to stay low since PartnersFirst has agreed that it will not raise rates or change terms without SEIU’s permission. PartnersFirst makes money from the interest rate it charges borrowers. It foregoes the additional revenues from the high fees their credit card issuing competitors charge.
PartnersFirst’s prices virtually guarantee they will have low returns compared to the largest industry competitors. Their revenues per customer will be markedly lower than those of the industry leaders.
Costs
In tough marketplaces, Silver competitors achieve high returns by improving the Productivity of their cost structures. In general, the Silvers can not enjoy the Economies of Scale of the largest competitors in the industry. However, they are extremely disciplined in R&D, marketing, sales and in the general overhead functions. For example, they are fast followers, rather than innovators, in new products. They refuse to spend marketing and sales dollars to attract customers that do not fit their tightly defined profile. Few will undertake large advertising programs. This discipline allows them to have competitive costs.
They can, and do, produce attractive returns with their cost structures. An analysis of over 240 industries we did a while ago showed that companies ranked third or fourth in market share had a 22% and 24% probability, respectively, of achieving the highest returns among the top four market share leaders in the industry. (See the Perspective, “Is Bigger Really Better” on StrategyStreet.com.)
PartnersFirst suffers significant economies of scale disadvantages against the four largest Standard Leader competitors it faces. This disadvantage is compounded by the fact that PartnersFirst has to be very careful to extend credit card loans only to the best credit risks. So, rather than using the industry leaders’ low cost approach, employing automation and computer generated credit scores to determine a consumer’s ability to carry credit, the company has analysts who review each application by hand. This is a much more costly process than the largest competitors have.
Summary
Overall, PartnersFirst seems to have adopted a strategy with very low prospects for success. Its chosen segments are those most sought by the big four competitors. Its value proposition is very attractive to its target segments because it offers high service levels, superb Reliability and low prices. But the company cannot hope to compete in their competitive market with their high costs and low revenues per customer. The company faces a grim future.
There is a new, small, credit card issuing company in the market. The company is PartnersFirst and they promise to change the credit card world by making that world more cardholder friendly. This new firm, based in Wilmington, Delaware, has introduced an unusual credit card. The card has no fees and relatively low borrowing rates, along with less onerous penalties. The upstart company challenges the four giants in the industry, Bank of America, Citigroup, JP Morgan Chase and Capital One. Industry veterans formed and run this new credit card company. They believe that the company’s card should be particularly attractive in the light of new Federal rules that restrict credit card practices.
A few years ago, we did an extensive analysis of how a company whose market share was #3 or below in its industry could succeed against much better competitors. (See the Perspective “Rare Mettle: Gold and Silver Strategies to Succeed in Hostile Markets” on StrategyStreet.com.) More specifically, we studied these companies in hostile markets, where pricing pressure was intense and returns for most competitors in the industry were low. If a company could perform well in a hostile marketplace, its model would be instructive in all other marketplaces. We succeeded in finding a number of small competitors who performed well in these difficult markets. They had both growth rates and returns on investment above their industry averages. We named these successful smaller companies Silver competitors.
Once we found those successful competitors, we analyzed their business models to look for common patterns. Our analyses covered segments, product and service innovation, pricing and cost management. We will use our findings to evaluate the prospects for PartnersFirst. We will do this analysis in two parts. Part 1 of the blog covered segments and products. Part 2 will cover pricing and cost management and summarize our conclusions.
Pricing
As the market slips into hostility, the best Silver competitors may offer low prices to gain share. But chronic low prices are not their hallmarks. If the largest competitors in the market are in a Leader’s Trap, Silvers will exploit that price umbrella by discounting against the largest competitors to gain share. However, once the industry leaders match price discounts, Silvers eliminate their discounting. From that time on, they match the changes in the general price levels in the industry.
Silvers do have some price advantages in the customers they serve. Their customer portfolio of Large and Medium customers gives them a very few percentage point advantage over the largest competitors in average unit prices.
PartnersFirst offers very low pricing. Using the SEIU credit card as an example, the basic card carries a 16% interest, does not include any annual fees and imposes no late penalty charges. These prices are likely to stay low since PartnersFirst has agreed that it will not raise rates or change terms without SEIU’s permission. PartnersFirst makes money from the interest rate it charges borrowers. It foregoes the additional revenues from the high fees their credit card issuing competitors charge.
PartnersFirst’s prices virtually guarantee they will have low returns compared to the largest industry competitors. Their revenues per customer will be markedly lower than those of the industry leaders.
Costs
In tough marketplaces, Silver competitors achieve high returns by improving the Productivity of their cost structures. In general, the Silvers can not enjoy the Economies of Scale of the largest competitors in the industry. However, they are extremely disciplined in R&D, marketing, sales and in the general overhead functions. For example, they are fast followers, rather than innovators, in new products. They refuse to spend marketing and sales dollars to attract customers that do not fit their tightly defined profile. Few will undertake large advertising programs. This discipline allows them to have competitive costs.
They can, and do, produce attractive returns with their cost structures. An analysis of over 240 industries we did a while ago showed that companies ranked third or fourth in market share had a 22% and 24% probability, respectively, of achieving the highest returns among the top four market share leaders in the industry. (See the Perspective, “Is Bigger Really Better” on StrategyStreet.com.)
PartnersFirst suffers significant economies of scale disadvantages against the four largest Standard Leader competitors it faces. This disadvantage is compounded by the fact that PartnersFirst has to be very careful to extend credit card loans only to the best credit risks. So, rather than using the industry leaders’ low cost approach, employing automation and computer generated credit scores to determine a consumer’s ability to carry credit, the company has analysts who review each application by hand. This is a much more costly process than the largest competitors have.
Summary
Overall, PartnersFirst seems to have adopted a strategy with very low prospects for success. Its chosen segments are those most sought by the big four competitors. Its value proposition is very attractive to its target segments because it offers high service levels, superb Reliability and low prices. But the company cannot hope to compete in their competitive market with their high costs and low revenues per customer. The company faces a grim future.
Monday, October 19, 2009
The Challenge of a Small Competitor
Part 1: Segments and Products
There is a new, small, credit card issuing company in the market. The company is PartnersFirst and they promised to change the credit card world by making that world more cardholder friendly. This new firm, based in Wilmington, Delaware, has introduced an unusual credit card. The card has no fees and relatively low borrowing rates, along with less onerous penalties. The upstart company challenges the four giants in the industry, Bank of America, Citigroup, JP Morgan Chase and Capital One. Industry veterans formed and run this new credit card company. They believe that the company’s card should be particularly attractive in the light of new Federal rules that restrict credit card practices.
A few years ago, we did an extensive analysis of how a company whose market share was #3 or below in its industry could succeed against much better competitors. (See the Perspective “Rare Mettle: Gold and Silver Strategies to Succeed in Hostile Markets” on StrategyStreet.com.) More specifically, we studied these companies in hostile markets, where pricing pressure was intense and returns for most competitors in the industry were low. If a company could perform well in a hostile marketplace, its model would be instructive in all other marketplaces. We succeeded in finding a number of small competitors who performed well in these difficult markets. They had both growth rates and returns on investment above their industry averages. We named these successful smaller companies Silver competitors.
Once we found those successful competitors, we analyzed their business models to look for common patterns. Our analyses covered segments, product and service innovation, pricing and cost management. We will use our findings to evaluate the prospects for PartnersFirst. We will do this analysis in two parts. Part 1 of the blog will cover segments and products. Part 2 will cover pricing and cost management.
Segments
Silver competitors usually can not win a primary supplier role position with one of the industry’s largest customers. They rarely possess the infrastructure to serve these customers well. Instead, Silver competitors focus on the second sized tier of the industry’s customers. They focus on the industry’s large, but not the largest customers. As a rough rule of thumb, the largest customers in the industry, the industry’s Very Large customers, purchase 50% of the total industry’s volume. The second tier, Large customers, purchase the next 30% of the industry sales volume. The industry’s first tier of the Very Large customers may make up 7% of the number of the industry’s customers, while the second tier, Large customers, make up 13%. These are only rough estimates. The percentages will vary significantly across industries. (See Video #58: Customer Segmentation by Size on StrategyStreet.com.)
The Large customers that the Silver competitors serve tend to emphasize good service for a reasonable price in their own markets. These customers are not large enough to negotiate the industry’s lowest prices so they pay slightly higher prices than the Very Large customers.
Successful Silver competitors also seek out the better performing Medium size customers. Again using rough rules of thumb, these Medium sized customers may purchase 15% of total industry volume and represent 25% of the total number of industry customers. The best Silver competitors focus their attention on Medium customers who are service-oriented in their own marketplaces.
PartnersFirst’s business model seeks some of the industry’s largest customers, Very Large customers. One of them is Service Employees International Union (SEIU). This union signed PartnersFirst to create a branded card for its two million members.
PartnersFirst pursues some of the industry’s first tier customers by offering an Affinity credit card. With an Affinity credit card, a sponsoring organization, such as the SEIU, agrees that the credit card issuing company will have the exclusive right to brand the credit card with the sponsoring organization’s brand and then market it to the members of the Affinity group. In order to win this business, the credit card issuing company must make a substantial payment to the sponsoring organization. Other sponsoring organizations for PartnersFirst include the Chicago Bar Association and Golf Magazine.
PartnersFirst is flying straight into the headwinds of competition with the biggest industry competitors for this industry’s Very Large customers.
Products and Services
In products and services, the best Silver competitors distinguish themselves by offering service levels that competitors achieve only sporadically. If the Silvers have channels of distribution, they rely solely on them to sell to the end user. They also protect the revenue base of the channel. The successful Silvers will cover a relatively broad spectrum of Price Points within the industry, but will not offer a Price Point that their target segments will not buy. Because Silver competitors concentrate on customers who offer high service levels themselves, these customers tend to buy a mix of product Price Points skewed toward the higher end of the market, which helps the Silver competitors’ profit margins.
PartnersFirst emphasizes service and Reliability in its benefit package. It tries to make the card holders experience a good one. It listens, and responds, to its sponsoring organization customers. PartnersFirst allows its Affinity partners a say in the terms of the credit agreements on the credit cards. For example, the Affinity’s groups must sign off on any changes in rates or fees that PartnersFirst would like to make.
The company’s business model appears to fit nicely with the successful Silvers’ approach of offering high service to their customers, and of emphasizing Reliability in the customer relationship and company benefit package.
Part 2 of this blog will examine PartnerFirst’s pricing and costs.
Thursday, October 15, 2009
The NFL Starts to Play Defense
The NFL is the most popular sports league in the country. For years, it has been able to increase its revenues by selling television time, licensed products, and even tickets to games. This easy market came to an end with this recession. Three quarters of the NFL clubs have held ticket prices flat this year. Even then, only twenty clubs sold out the tickets for their home games. So, ticket sales revenues are likely to drop this season.
All is not lost, however. The Fan Cost Index measures the average price for a family of four to buy four tickets, parking, drinks, hot dogs, beers, programs and caps. In 2009, that index stands at $413. The Index is up 4% over the last year. While the Consumer Price Index is falling, the league still has found a way to raise prices.
Still, some in the league are beginning to become concerned about the fall-off in demand for tickets (see Video 8: Full Explanation of Future Direction of Margins on StrategyStreet.com). These people are taking the first tentative steps in defensive pricing, that is, reducing prices in a falling price environment.
When prices begin falling, a shrewd company will begin to increase the detail with which it prices. It will begin pricing in such a way that price-sensitive customers begin getting lower prices, or more benefits, while everyone else continues to pay the higher, regular, price. (See the Perspective, “Meeting Falling Prices with Creativity” on StrategyStreet.com) This increased detail in pricing does raise administrative costs, but it preserves even more revenues and, so, preserves margins.
A company increases the detail at which it prices by exploiting more of the potential components of a price. These price components include performance benefits, discounts, the basis on which it charges for its product, the period of price agreement and some optional components, such as fees, penalties, price caps and extended payment options. A company using these components is able to restrict the lower prices to selected customer segments and, thereby, reduce the loss of revenues and margins from a broader price decrease.
The NFL is just beginning to stick its toe into defensive pricing waters by using some of these components. The Detroit Lyons are creating an All-You-Can-Eat seating section this season, where fans can eat all the hot dogs, bratwursts, nachos, chips, popcorn and soft drinks they want for a fixed price. This is a change in the performance benefits of the product. The New Orleans Saints are allowing customers to pay their season ticket bills in installments. Of course, the fans have to pay a 1.9% transaction fee. Here, the Saints are using an extended payment option and then adding back a fee to recapture some cost. This approach reduced one component and increased another. The Kansas City Chiefs offered an extended payment option when it allowed its customers to spread their season ticket purchases over four payments. The New York Jets, the Chiefs and the Jacksonville Jaguars have changed the basis of charge for their season tickets. These clubs have introduced half-season plans to offer a cheaper alternative to full-season tickets.
If the recession continues, these will be just first tentative steps. (For more on pricing see, StrategyStreet.com/Diagnose/Pricing.) Pricing can get much more complex and precise as a market becomes more hostile. Consider the airline industry as an example of precision pricing.
All is not lost, however. The Fan Cost Index measures the average price for a family of four to buy four tickets, parking, drinks, hot dogs, beers, programs and caps. In 2009, that index stands at $413. The Index is up 4% over the last year. While the Consumer Price Index is falling, the league still has found a way to raise prices.
Still, some in the league are beginning to become concerned about the fall-off in demand for tickets (see Video 8: Full Explanation of Future Direction of Margins on StrategyStreet.com). These people are taking the first tentative steps in defensive pricing, that is, reducing prices in a falling price environment.
When prices begin falling, a shrewd company will begin to increase the detail with which it prices. It will begin pricing in such a way that price-sensitive customers begin getting lower prices, or more benefits, while everyone else continues to pay the higher, regular, price. (See the Perspective, “Meeting Falling Prices with Creativity” on StrategyStreet.com) This increased detail in pricing does raise administrative costs, but it preserves even more revenues and, so, preserves margins.
A company increases the detail at which it prices by exploiting more of the potential components of a price. These price components include performance benefits, discounts, the basis on which it charges for its product, the period of price agreement and some optional components, such as fees, penalties, price caps and extended payment options. A company using these components is able to restrict the lower prices to selected customer segments and, thereby, reduce the loss of revenues and margins from a broader price decrease.
The NFL is just beginning to stick its toe into defensive pricing waters by using some of these components. The Detroit Lyons are creating an All-You-Can-Eat seating section this season, where fans can eat all the hot dogs, bratwursts, nachos, chips, popcorn and soft drinks they want for a fixed price. This is a change in the performance benefits of the product. The New Orleans Saints are allowing customers to pay their season ticket bills in installments. Of course, the fans have to pay a 1.9% transaction fee. Here, the Saints are using an extended payment option and then adding back a fee to recapture some cost. This approach reduced one component and increased another. The Kansas City Chiefs offered an extended payment option when it allowed its customers to spread their season ticket purchases over four payments. The New York Jets, the Chiefs and the Jacksonville Jaguars have changed the basis of charge for their season tickets. These clubs have introduced half-season plans to offer a cheaper alternative to full-season tickets.
If the recession continues, these will be just first tentative steps. (For more on pricing see, StrategyStreet.com/Diagnose/Pricing.) Pricing can get much more complex and precise as a market becomes more hostile. Consider the airline industry as an example of precision pricing.
Tuesday, October 13, 2009
The Tables Have Turned
Just a few years ago, Dell Computer was the darling of the PC industry. Hewlett-Packard was an also-ran. Today the tables have turned. Over the last year, Hewlett-Packard’s market share has jumped from 18.5% to 20% of the global PC shipments. Dell’s market share has fallen from 15.7% to 13.7%. The change in market share is customers saying that HP offers a better value proposition. (See the Perspective, “The Two Best Consultants in the World” on StrategyStreet.com.)
HP has strenuously reduced its costs at the same time it has gained market share. HP, at one time, was in the middle of the PC pack in costs. Today, its PC operating margin is 4.6%, better than Dell’s operating margin. The superior cost performance of HP is the competitors acknowledging that HP has a lower overall cost.
HP has gained much of its market in the retail side of the business, especially with lower-end products. Most Standard Leaders don’t like lower-end products because they offer low margins and not much reputation (see StrategyStreet/Diagnose/Products and Services/Innovation for Customer Cost Reduction/Price Point Bias).
HP is gaining some of its new market share with very low pricing, a characteristic that used to belong to Dell. Wal-Mart’s recent experience with HP is indicative of the company’s current aggressiveness. Wal-Mart wanted to sell a personal computer for less than the price of the hot Netbook products. Netbooks are mini laptops costing less than $500. Wal-Mart did the consumer research to produce specifications for the proposed full-sized laptop product and passed those to some PC companies. Several responded positively. Dell offered a product for just under $400. Toshiba and Acer offered a product priced just below $350. HP beat all the competitors, though, with a $298 machine.
Dell is allowing Hewlett-Packard to take market share with its low prices because it sees little profit in the low-priced machines. But there is a problem here. HP has already proven itself capable of using its large size to streamline logistics and extract lower purchases of costs from its suppliers. It has smartly redesigned its products to reduce their costs. How is it, then, that Dell, or anyone else, believes that they will be better off by ceding market share to Hewlett-Packard on the basis of low prices? Will Hewlett-Packard become weaker? Will the PC companies losing share become stronger? This is another example of companies in a Leader’s Trap.
HP has strenuously reduced its costs at the same time it has gained market share. HP, at one time, was in the middle of the PC pack in costs. Today, its PC operating margin is 4.6%, better than Dell’s operating margin. The superior cost performance of HP is the competitors acknowledging that HP has a lower overall cost.
HP has gained much of its market in the retail side of the business, especially with lower-end products. Most Standard Leaders don’t like lower-end products because they offer low margins and not much reputation (see StrategyStreet/Diagnose/Products and Services/Innovation for Customer Cost Reduction/Price Point Bias).
HP is gaining some of its new market share with very low pricing, a characteristic that used to belong to Dell. Wal-Mart’s recent experience with HP is indicative of the company’s current aggressiveness. Wal-Mart wanted to sell a personal computer for less than the price of the hot Netbook products. Netbooks are mini laptops costing less than $500. Wal-Mart did the consumer research to produce specifications for the proposed full-sized laptop product and passed those to some PC companies. Several responded positively. Dell offered a product for just under $400. Toshiba and Acer offered a product priced just below $350. HP beat all the competitors, though, with a $298 machine.
Dell is allowing Hewlett-Packard to take market share with its low prices because it sees little profit in the low-priced machines. But there is a problem here. HP has already proven itself capable of using its large size to streamline logistics and extract lower purchases of costs from its suppliers. It has smartly redesigned its products to reduce their costs. How is it, then, that Dell, or anyone else, believes that they will be better off by ceding market share to Hewlett-Packard on the basis of low prices? Will Hewlett-Packard become weaker? Will the PC companies losing share become stronger? This is another example of companies in a Leader’s Trap.
Monday, October 5, 2009
Hostility's End Game
The late 80’s and 90’s were hostile times for the beer industry. The period saw constant price wars. All the domestic competitors, except for Anheuser Busch, suffered from relatively low returns. A hostile industry is notable for constant pricing pressure and very low returns in the industry. The brewing industry certainly fit that description for a long period of time.
Then came the 2000’s. This decade brought a great deal of consolidation to the market. InBev bought Anheuser Busch. SabMiller PLC consolidated operations with Molson Coors Brewing Company. These changes, and others, produced a consolidated industry. Today, the two largest companies control 80% of U.S. beer sales. These companies have introduced products at every price point so they dominate the market at virtually all Price Points.
This dominance gives the industry Standard Leaders pricing leverage. Over the last year, the price of beer, ale and other malt beverages grew 4.6%, while overall consumer prices in the U.S. fell 2.1%. The beer makers now have pricing power that looks much like that of the breakfast cereal makers and cigarette manufacturers. The brewers are able to raise prices, even in the face of declining unit volumes, just as the cigarette manufacturers are able to do. Profits in the domestic market are rising at more than 25% a year. (See the Perspective, “What Makes Returns High?” on StrategyStreet.com.)
Hostile markets end in one of two ways. (See the Perspective, “What Ends Hostility?” on StrategyStreet.com.) Either demand bails the industry out or industry consolidation shifts pricing power back to the industry. In our extensive work in hostile markets, we have observed that three quarters of the time demand growth bails out a hostile industry. The demand in the industry grows and gradually sops up excess capacity. As the excess capacity ebbs away, pricing power returns to the industry participants in order to encourage the addition of the capacity that the customers will need in the future. In the other quarter of the cases, the industry consolidates until four or fewer competitors own at least 75% of the market. And, all remaining competitors must have reached the conclusion that trying to gain share with low price is an exercise in futility. The beer industry has consolidated far more than the average industry. In the average domestic industry, four competitors to own 85% of the total industry market share. In brewing, it only takes two to approach that concentration. (See more on StrategyStreet.com/Tools/Benchmarks/Market Share)
Not many industries succeed at reaching this degree of consolidation. But once they do, the world is their oyster.
Then came the 2000’s. This decade brought a great deal of consolidation to the market. InBev bought Anheuser Busch. SabMiller PLC consolidated operations with Molson Coors Brewing Company. These changes, and others, produced a consolidated industry. Today, the two largest companies control 80% of U.S. beer sales. These companies have introduced products at every price point so they dominate the market at virtually all Price Points.
This dominance gives the industry Standard Leaders pricing leverage. Over the last year, the price of beer, ale and other malt beverages grew 4.6%, while overall consumer prices in the U.S. fell 2.1%. The beer makers now have pricing power that looks much like that of the breakfast cereal makers and cigarette manufacturers. The brewers are able to raise prices, even in the face of declining unit volumes, just as the cigarette manufacturers are able to do. Profits in the domestic market are rising at more than 25% a year. (See the Perspective, “What Makes Returns High?” on StrategyStreet.com.)
Hostile markets end in one of two ways. (See the Perspective, “What Ends Hostility?” on StrategyStreet.com.) Either demand bails the industry out or industry consolidation shifts pricing power back to the industry. In our extensive work in hostile markets, we have observed that three quarters of the time demand growth bails out a hostile industry. The demand in the industry grows and gradually sops up excess capacity. As the excess capacity ebbs away, pricing power returns to the industry participants in order to encourage the addition of the capacity that the customers will need in the future. In the other quarter of the cases, the industry consolidates until four or fewer competitors own at least 75% of the market. And, all remaining competitors must have reached the conclusion that trying to gain share with low price is an exercise in futility. The beer industry has consolidated far more than the average industry. In the average domestic industry, four competitors to own 85% of the total industry market share. In brewing, it only takes two to approach that concentration. (See more on StrategyStreet.com/Tools/Benchmarks/Market Share)
Not many industries succeed at reaching this degree of consolidation. But once they do, the world is their oyster.
Thursday, October 1, 2009
You Mean I Have to Pay for This?
Those of us who fly a lot have noticed how few people have a meal on an airplane anymore. In flight food was attractive when we got it for free, much less so when we have to pay for it.
The WiFi industry is learning a similar lesson. A couple of WiFi suppliers to the airline industry are trying to figure out how to charge for their services. (The WiFi suppliers control the pricing so that the airlines can not give it away, as they have tended to do in the past with other benefits…though that trend certainly has ended.) The WiFi suppliers have found that when the service is free, many customers use it. But when they charge for the service, even at the low price of $1.00, usage drops drastically off.
The companies are trying price schemes that are tied to the length of the trip. One plan charges $12.95 for the service when the flight lasts longer than three hours and $9.95 for flights from ninety minutes to three hours. If the flight is shorter than ninety minutes, the price is $5.95.
The WiFi sellers need about 10% of travelers to pay for internet access in order for the service to be profitable. That will be difficult. A few flights have seen usage in the 12% to 15% range, but they tend to be on longer flights. A large percentage of U.S. domestic flights last less than two hours.
The WiFi suppliers, though, are coming up with a different approach to pricing that is much more likely to succeed. One approach will be to sell packages of service. A business traveler might buy a package of five flights for a fixed price. Once the price has been paid and is out of the customer’s mind, it is more likely that the service will appear attractive while the traveler is on the airplane. In addition, it should be much cheaper to sell a package of five, ten or fifteen flights than it is to sell one unit of service on each flight. In another approach, the WiFi companies are planning to negotiate directly with companies to sell their services in bulk to the companies for use by their employees. This approach has even better cost savings than the package sales. It is a much more efficient way to go. Both of these approaches change the price by altering the basis of the charge for a unit of sale.
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