Reliability in the Purchase Decision

In our StrategyStreet analytical framework, a customer subjects a potential supplier to two levels of elimination: invitation and evaluation. With “invitation”, the customer decides who he will spend any time considering in the purchase decision. In “evaluation”, the customer eliminates potential suppliers on its most important purchasing criteria. Then, the customer analyzes the remaining potential suppliers in detail in order to make his final choice. At both levels, the customer is looking to eliminate suppliers, not to choose one. (See the Perspective, “The Tallest Dwarf” on StrategyStreet.com.) In the final analysis, most buying decisions are the result of the elimination of all other competitors, rather than the positive choice of one of them.

McKinsey & Company used a construct similar to our approach of “invitation” and “evaluation” when looking on consumer decisions in the mobile phone market. It considered three stages of the customer buying decision: initial consideration, active evaluation, and moment of purchase. McKinsey, then, looked at how consumers made their choices at each stage in mature markets and in developing markets. What we see in the McKinsey statistics is the paramount importance of Reliability in getting to serious consideration, even in a relatively fast-growing market like mobile phones. (See “Audio Tip #95: The Customer Buying Hierarchy” on StrategyStreet.com.) The three most important criteria in the initial consideration in a mature market were advertising, previous usage and word-of-mouth. Previous usage and word-of-mouth are indications of Reliability concerns. Advertising can be either Reliability or Convenience. It is Reliability when the consumer looks to advertising as a sign that someone is a serious, reliable competitor. It is Convenience when the purpose of the advertising is to let the consumer know that the company can provide the product. In a developing market, the top three criteria are the same in a somewhat different order. (See “Audio Tip #70: Several Rounds in Evaluation Failures” on StrategyStreet.com.)

The mobile phone market is fast-growing. Differences in Function are important differentiators among competitors in this market, more so than in very difficult, hostile markets. But if the company can not convince a customer that it is a reliable supplier, it will never get the chance to demonstrate its superior Functions.

Reliability is important in every market, even in one with very fast growth.

Reliability in High-End Cars

Several years ago, BMW ran into a problem with its technologically advanced automobiles. It found that some customers were reluctant to buy their cars because the customers were concerned about the cost of maintaining products with such high technology. But BMW believed in its product and felt that the customer should believe equally. So, for more than the last ten years, BMW has offered free maintenance with its new cars. For four years, or 50,000 miles, a BMW customer will not pay for maintenance except for gas and tires. BMW continues to gain share and profitability in the North American market. (See “Audio Tip #160: How Do We Segment Customers by Emotional Needs?” on StrategyStreet.com.) Competitors have noticed.

Now, competition is beginning to offer free maintenance of its own. As always, the devil is in the details of “free maintenance.” The “Gold Standard” BMW covers everything but gas and tires. Competition offers “free” maintenance, but their version of free maintenance does not match BMW’s. Volvo’s “Safe + Secure Coverage Plan” covers five years or 60,000 miles, and includes oil and filter changes and replacement of brake pads and rotors and windshield wipers. Cadillac’s “Premium Care Maintenance” doesn’t cover brakes and is limited to scheduled oil changes, tire rotations, replacement of engine and cabin air filters and a multi-point vehicle inspection.

Other competitors cover what BMW covers, but charges for it. Audi sells a maintenance plan separately with the list price of about $790. Mercedes Benz offers prepaid service packages.

All of these competitors to BMW fall short of the mark. If you were a customer deciding on an automobile to buy, and you cared about the Reliability of the vehicle during the time you owned it, who would you trust more? On the one hand, you have the company that promises true “free maintenance.” On the other hand, you have competitors who qualify, or charge for, their promise of “free maintenance.” If you want to compete with the standard, you have to be at least as good as the standard. BMW still leads the pack in Reliability when it comes to “free maintenance.” (See “Video #14: Definition of Reliability” on StrategyStreet.com.)

The Decline of an Industry Leader

In a tough, highly competitive market place, the avoidance of Failure and a company’s reputation for Reliability are critical to long term success. (See “Video #14: Definition of Reliability” on StrategyStreet.com.) Dell is an example.

For years, Dell was the paragon for the personal computer industry. It had good computers with a build-to-order business model that took in cash before the company had to pay suppliers. Its low-cost business model involved maintenance of low inventories and tight control of its suppliers. Then the wheels came off.

From 2003 to 2007, Dell shipped a number of its mainline personal computers with serious flaws. The facts have come out recently in court documents in a suit filed by a customer against Dell claiming that these faulty computers cost the customer a good deal of money. It seems this customer was not alone.

Dell’s problems showed up because a supplier shipped it bad capacitors. An Asian company, Nichicon, produced bad capacitors, which Dell included in its motherboards on nearly 12 million computers shipped to customers from May 2003 to July 2005. A study of these computers suggested that these capacitors would cause problems in Dell computers 97% of the time, if the computer were used over a three year period.

Dell did not handle this situation well. It placed cost control ahead of customer welfare. (See the Perspective, “Cutting the Right Cost” on StrategyStreet.com.) In some cases, it replaced bad motherboards with other bad motherboards. In other cases, customer service and sales employees went out of their way to conceal these problems. Dell told some of its customers that the customers were at fault for the failing computers because they had over taxed the machines. Nor did Dell recall the faulty computers. Instead, it left it up to the customer to make a complaint before it took action. In the meantime, customers suffered the costs of losing information when their computers failed to function properly. Dell failed its customers and ravaged its Reliability reputation.

Dell is no longer the paragon of the personal computer industry. That mantle now rests on the shoulders of HP and, perhaps, Acer. Dell’s market share has fallen off. In a tough marketplace, the Failure of an incumbent supplier is the cause of most market share shifts in the industry. If an incumbent Fails the customer by refusing to do something that other people can and will do, it will lose market share. Another critical aspect of a company operating in a very tough market is Reliability. The customer has to trust that the company’s products will work, and if they do not work, they will be fixed promptly. Dell at one time had a good Reliability reputation. It gained share on the back of that good reputation. The company has badly frayed that reputation and its failures have caused its loss of market share. (See “Audio Tip #36: The Importance of Customer Retention in Hostility” on StrategyStreet.com.) These failures account, in part, for the share gained of Hewlett Packard.

The Importance of Consistency in the Approach to Pricing

A company has to send a consistent pricing message if it wants its customers to get its message. An example is Asda. Asda is the U.K. arm of Wal-Mart stores. Asda has always advertised itself as the home of “every day low prices.” It strayed from this message during the recession.

As the recession took hold, Asda followed its major competitors in offering promotional pricing, such as temporary price deals and two-for-one specials. (See the Perspective, “The Grasshopper and the Ant” on StrategyStreet.com.)

This approach worked during the recession. The company gained market share. However, as the recession ended, the company lost all of the market share it had gained with its promotional pricing. It then found that its customers were confused about what its pricing tactic really was. The company has re-established its theme of “every day low pricing.” In order to emphasize that theme, it has launched a price guarantee program which guarantees the consumer that its prices will be the lowest among its competitors, whether there is a promotion or not. The program invites the customers to check receipts online, and to obtain a rebate if a competitor is offering a better deal. (See the Perspective, “How Price Kills Profits” on StrategyStreet.com.)

It will take a while for consumers to have confidence in this renewed emphasis on every day low prices.

Pricing in Easy Industries

Here is an example where relatively small differences in price, in normally easy industries, have a big effect in the market.

PepsiCo owns Lifewater. Over the last year, Lifewater’s sales have risen by 85%, while overall sales of bottled water have fallen by 5%. Coca-Cola owns a Lifewater competitor named Vitaminwater. During the same period, Vitaminwater saw its market share shrink.

PepsiCo has been paying more attention to Lifewater. It redesigned its bottle and introduced a no-calorie version of the drink. It also changed its advertising emphasis.

But pricing has certainly played a role in the marketplace. As the recession began to take hold, PepsiCo shaved four cents off the price of Lifewater (see “Audio Tip #106: How do we Predict Competitor Responses to our Price Moves?”), dropping it to an average of $1.18. Vitaminwater chose the opposite approach. It raised its prices by 4%. This produced a 7% swing in price difference between Vitaminwater and Lifewater. This price change meant Lifewater appealed better to both consumers and the channel of distribution. Lifewater used the lower price to increase its retail presence, especially with Target stores. This created greater Convenience for the Lifewater consumer. Overall, Lifewater’s market share increased by 1.6 share points to 3.8%. (See “Audio Tip #45: The Components of Positive Volatility” on StrategyStreet.com.) Vitaminwater’s share dropped from 14% to 11.4%. (See “Audio Tip #46: The Components of Negative Volatility” on StrategyStreet.com.)

Pricing and price differences are never irrelevant. Customers are loath to pay higher prices for products that otherwise seem Functionally comparable.

Situation Bad...About to Get Worse

Over the last year, the U.S. government spent $80 million to prop up General Motors and Chrysler. The intent was to save millions of American manufacturing jobs. The benefits seem to be temporary, at best.

Both Chrysler and General Motors are reducing manufacturing capacity in the U.S. and shifting some of that capacity to Mexico. Over the next decade, Mexico is scheduled to gain most of the GM and Chrysler North American production that is discontinued in the United States. The reason isn’t hard to see. GM and Ford workers in the U.S. earn about $55 an hour, including benefits. The same workers in Mexico earn something less than $4 an hour.

Some in the government are upset about GM and Chrysler opening more facilities in Mexico, while U.S. facilities close. These people simply do not understand global economics. If GM and Chrysler keep their production in North America, all that will happen is that GM and Chrysler, backed by the U.S. tax payers and current shareholders, will pay for the excess wages that the domestic UAW employees now earn. If GM and Chrysler do not move their production facilities to places where costs are lower, other companies will do it for them and take their market share with better cars and lower prices. This has been the scenario for the domestic automobile manufacturers for the last twenty years.

No matter what the U.S. members of the UAW choose to do, their future is going to get worse. (See the Symptom & Implication “Foreign competitors are expanding with low prices” on StrategyStreet.com) Workers in other countries can simply make automobiles cheaper than they can. Chennai, India is a good example. In 2010, this city will produce 1.5 million automobiles. That is well in excess of 10% of the U.S. domestic demand and more than any U.S. state produces. Many major automobile manufacturers have a presence in Chennai.

The investment there is growing much as it is in Mexico. Hyundai, Ford and Nissan are each investing heavily in facilities in Chennai. Hyundai can now produce 650,000 cars a year there. Nissan can produce 400,000 cars annually. This new capacity is coming into a market that already has significant overcapacity in global production facilities. When new low-cost competitors enter the marketplace, they squeeze out the high-cost competitors. Who are the high-cost competitors? Watch where facilities are closing. Oh oh, that seems to be the U.S., where the UAW is holding a significant price/cost umbrella over its low-cost worker competitors, among whom are the Indian and Mexican workers in this story.

This will not have a pretty ending for the United Auto Workers, neither for those working nor for retirees.