Failures in Reliability Lead to Share Loss

We have written several times before about the Customer Buying Hierarchy (i.e. customers buy Function, Reliability, Convenience and Price, in that order).  We have also written, on several occasions, about companies winning and failing customers in a marketplace.  In a stable market, failure of a supplier causes more market share to move than does another competitor’s “win” of market share against its peers.  Most failures occur in Reliability. Recently, two of America’s paragon companies have failed their customers on Reliability and are now struggling to catch up.  Other leaders have had a similar problem and have recovered nicely. 

Macy’s is a clear leader in the department store market.  Over the last several years, Macy’s has purchased and integrated other large department store competitors.  For example, in 2005 Macy’s purchased May Department Stores.  As the company worked to integrate these acquisitions and obtain synergistic savings, their attention swerved from customer service.  The company’s failings were greatest in customer interactions with the company’s sales associates.  Nearly half of customer complaints focused on actions of sales associates. These are failures in Reliability.  A customer expects to be well treated by a department store that charges relatively high prices for its goods.  Macy’s failed to do that. The company’s market share began to drift lower as a result of these failures. 

Now Macys is investing a great deal more money and time into the proper training of its sales associates.  This investment is beginning to pay off.  A recent survey of customer satisfaction indicated that the company was making strides in improving its reputation.  Still, it lags the performance of some of its important rivals.  This is still a Macy’s work-in-progress.

Wal-Mart is another industry paragon who drifted from its Reliability promises.  Wal-Mart committed two notable sins.  First, it removed some products that were important to its core customers.  The company did so in an effort to improve the product mix and the margins a better product mix would bring.  Some of its core customer volume began to drift away.  The company also moved away from its aggressive pricing.  Instead of every day low prices, the company began to promote deals on some products while raising prices on others.  Customers didn’t like that either.  Recently, a survey by a retail consulting firm has found that Target Stores offered prices below those of Wal-Mart.  So, Wal-Mart has created Reliability failures in both product availability in its stores and its promise to have “always low prices, always.”  The company’s market share has also drifted lower. 

Wal-Mart now promises to return to its core values and core customers.  It is bringing back the products it once eliminated in favor of higher margin products.  It is getting more aggressive in pricing once more.  This, too, is a work-in-progress. 

Certainly, these leaders can recover from these miscues. We have seen other leading companies struggle with Reliability and yet recover nicely.  For example, several years ago McDonald’s went through a period of time where it was losing market share.  As the company examined the reasons for this market share loss, it noted that customers began to see its prices as high in the quick service restaurant industry.  In addition, its products in stores had developed a reputation as being about the same as or, in some cases, lower in quality than some of its big competition.  Under the leadership of a CEO well versed in operations, the company returned to its roots by emphasizing its core quality values and aggressive pricing.  Today, McDonald’s is the unquestioned leader in the quick service restaurant industry.  Many of its competitors struggle to keep up with McDonald’s. Most fail to do so.  McDonald’s again has gained share in the industry over the last several years.  McDonald’s success in reversing its Reliability failures suggests that the pathway is open for both Macy’s and Wal-Mart.  They both should be able to enjoy similar success.  The odds are they will.

Best Buy in a Leader's Trap

Few industry leaders believe their prices are too high. Often, they are right. They are usually less right in a market where prices fall. Consider GM in automobiles and IBM in personal computers in the past. At one time or another, most industry leaders will get caught in a Leader’s Trap, where they assume that customers will stay loyal to their products because the low-end products do not enjoy their quality and reputation. This assumption rarely, if ever, holds. Best Buy has been in a Leader’s Trap and its assumptions won’t hold this time either.

Through the third quarter of 2009, Best Buy was gaining market share in flat panel TVs and personal computers. However, in the most recent quarter of 2010, the company lost over 1% of its market share in televisions and computers to competitors who were discounting. (See the Perspective, “The Two Best Consultants in the World” on StrategyStreet.com.) Now, if it were just a simple low-end, low value competitor, Best Buy might not worry. But their discounting competition was Wal-Mart and Amazon. By any definition, these companies would count as peers of Best Buy in the television and personal computer retail market.

In the recent quarter, Best Buy emphasized high technology, and high margined, TV and personal computer products. Customers did not follow along. Best Buy noted that it had faced tough competition from off brand televisions at lower price points.

Best Buy could have offered private label products to compete with low-end, off brand, competitors. Its store brands include Dynex and Insignia. The company decided not to emphasize these lower-priced products in their promotions because they have low profit margins. Best Buy “failed” its customer by refusing to offer something that at least half the other competitors could and would offer. (See “Audio Tip #35: How Does a Company “Fail” in a Market?” on StrategyStreet.com.) Nor did competition “win” the customers who switched. Amazon and Wal-Mart simply took what Best Buy allowed them to take. (See “Audio Tip #34: How Does a Company “Win” in a Market?” on StrategyStreet.com.)

The result: Best Buy missed its targets and saw its stock price fall by 15%. The company lost market share to peer competitors. And its sales and profits fell in televisions and personal computers. Competitors gained strength.

Best Buy is a fine company with capable management. It won’t stay down for long. You may expect to see them leave the Leader’s Trap very soon.

Dominick’s Finds a Way to Reduce Price…Successfully

Dominick’s is a wholly owned unit of Safeway, the large retail grocer. They have found a way to use price to gain share in a highly competitive price environment.

If a company wishes to use a discounted price to gain market share, it must assure itself that its competitors will not copy its price reduction. If a competitor copies the price reduction, then the original company’s discount is no longer distinctive and cannot drive a gain in share. Instead, its low prices cause its margins to fall without the offsetting benefit of increased sales volume.

You would like to be able to predict whether a competitor will copy a discount you offer. In the course of many pricing studies, we have found that the likelihood of a competitor responding to a company’s price reduction depends on three factors: the competitor’s knowledge of the price reduction, the company’s capacity to meet that price reduction and, often most importantly, the competitor’s will to meet the lower price. (See “Diagnose/Pricing/Competition and Their Knowledge, Capability and Will” on StrategyStreet.com.)

If your competitor does not know about your price reduction, they can not respond in kind. In some markets, customers do not “shop” a lower price offering to their suppliers in what’s called “last look” Their suppliers may not respond to a competitor’s lower price offering because they do not know of it. The competitor also must have the capacity to respond to the lower price. In the vast majority of falling price environments, most competitors have ample capacity to respond to lower prices. Still, some competitors are unwilling to meet falling prices in an industry. These competitors are in a Leader’s Trap, where they assume that the lower prices will not attract their customers. This is virtually always a losing assumption. The phenomenon of the Leader’s Trap leads us to the third determinant of the likelihood that a competitor will respond to a lower price: does the competitor have the will to do so. A competitor needs the will to do so because its margins are likely to fall, even if it maintains its current market share. Some competitors refuse to suffer the margin consequences and live, at least for a time, in a Leader’s Trap. (See many examples on StrategyStreet/Tools/Grossary/Leader’s Trap)

So, it is difficult for a company to use a low price to gain market share. Difficult, but not impossible. Dominick’s has found a way. Dominick’s is in a price war, not only with traditional grocers, but also with Wal-Mart, Target and discount stores. These competitors of Dominick’s often have lower prices on categories of consumer purchases that Dominick’s would like to sell to their own customers.

Dominick’s has used its “Frequent Shopper Card” information to help it offer low prices to very targeted customers. It analyzed the shopping patterns of its frequent shoppers. It found that some of its customers have assumed that supermarkets are not competitive in some high-priced, high-margin products. These customers then start buying those categories from discount chains and spending their retail grocery money on perishables like milk, meat and produce. Dominick’s used this information to offer shoppers personalized savings on items they have purchased in the past and could purchase again. The store offers these shoppers very competitive discounts on products, which are profitable for Dominick’s, but that customers purchase from other competitors. The shopper is offered a very good deal. The offer comes automatically at the cash register when shoppers use their loyalty cards. The offers are good for up to ninety days on unlimited quantities of the discounted items.

Dominick’s is gaining share with this program because competitors do not have the knowledge of the lower prices. These low prices are not advertised, nor are they available to all shoppers. Instead, they are personalized offers, targeted at customers who are likely to use them soon. These same customers tend to buy these discounted products from other suppliers, assuming that Dominick’s is not price competitive with those other suppliers. Dominick’s picks up some extra sales that pay for the selective discounts it offers and competitors are unable to respond because they do not know about the discounts.

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.

Always Low Prices Meets Lower Prices

Wal-Mart has come to dominate the grocery industry by offering wide product choices and low prices in their 2700 super centers. The company today is the biggest of the industry’s Standard Leaders. (See “Audio Tip #181: Using Physical Measures to Control Costs” on StrategyStreet.com.) And because the company has a well earned reputation for low prices, it found new customers during the last recession.

But underneath the new customer growth it found that some of their Core customers had migrated even further down on the food chain to discounting competitors, such as Save-A-Lot and Aldi stores. These companies offer even lower prices. They are able to offer these lower prices because they are Strippers. These are low-end, Price Leader (see “Audio Tip #83: Price Leader Products and Companies”), competitors who strip benefits from the product offering in order to achieve a low cost structure and consequent very low prices, which attract price-sensitive customers.

Save-A-Lot and Aldi compete with similar business models. They offer from 1400 to 1800 items, which is a small fraction of the offerings in a typical supermarket. The vast majority of their products are private labeled. The stores themselves are small, 15,000 to 17,000 square feet, and the store displays and amenities are spartan. Still, these retailers are growing relatively rapidly in the U.S. Wal-Mart feels like it needs to respond to their growth.

Wal-Mart does offer smaller stores. Their Neighborhood Markets concept are grocery stores in small towns and suburbs. But these are larger formats, averaging 42,000 square feet. The company’s small store format, called Marketside, has a 15,000 square foot footprint but has achieved relatively little presence so far. The Marketside business model has yet to develop any vibrancy.

Can Wal-Mart succeed at the very low end of the marketplace? I wouldn’t bet against them. They have succeeded in Mexico by offering seven separate store formats to meet the needs of consumers at various budget levels.

Coming Back from the Dead

RadioShack Corporation has re-imagined itself as a major seller of smart phones. In an effort to get past its old and dowdy image, it has rebranded itself as “The Shack.” Today, it devotes about half of its relatively small stores’ shelf space to smart phones. It offers phones for most of the major carriers, as well as the Apple iPhone. This re-imaging seems to be helping the company. Its sales and stock price are on the rise.

Competition is getting tougher, however. The leader in electronic superstores, Best Buy, offers smart phones both in its main stores and in its fast-growing small stores, Best Buy Mobile, which sell only phones and phone equipment. Wal-Mart Stores is also a leader in electronics retailing. Wal-Mart is expanding into the fast-growing mobile phone business as well.

Let’s use the Customer Buying Hierarchy to guess at how this market might develop. Without a lot of deep research into the industry, I would guess that Best Buy will emerge as the Function leader. (See “Video #13: Definition of Function” on StrategyStreet.com.) It will offer more phones and more informed advice than will its competitors. The Shack is a Convenience player. They won’t have the Function choices of Best Buy but, with their 6500 locations, they will be a very Convenient buy for many consumers. (See “Video #15: Definition of Convenience” on StrategyStreet.com.) Wal-Mart’s strength will be both Convenience and Price. It offers Convenience in the sense that it offers smart phones, along with many other items that customers will buy much more frequently than they buy a smart phone. Primarily, Wal-Mart will offer low prices. (See “Video #10: Industry Consolidation and Recycling of Capacity” on StrategyStreet.com.) It is unlikely that anyone will compete seriously with them on pricing.

The smart phone market is a fast-growing market. Most of these markets see market shares shift due to Function and Price innovations. These are areas of real strength for Best Buy and Wal-Mart. Convenience will usually be a less important benefit in the movement of market share in these kinds of markets.

Another Quieter Challenge from Below

The majority of citizens go to banks for credit cards, loans and other day-to-day financial transactions. Over the last few years, the banks have easily pushed through significant fee increases in all of their services because most people deal only with one bank and are unlikely to want to go to the trouble to change banks to get lower prices. The result is that lower prices aren’t offered, at least not to the average citizen. (See the Symptom & Implication, “The industry has been able to preserve margins by increasing prices” on StrategyStreet.com.)

There is an exception, though. That exception is Wal-Mart. After carefully dismantling the economics of variety stores, jewelry stores and grocery stores, Wal-Mart is now beginning to stalk the financial industry. They will be successful here because the financial industry is highly unlikely to have the will to compete with Wal-Mart where it chooses to serve customers.

So, where does it choose to serve its customers? At the lower end of the market, of course. Twenty-five percent of U.S. households are unbanked. The bigger banks are not interested in these customers because they will not, or cannot, pay significant fees on financial services. But Wal-Mart wants these customers. Wal-Mart cashes work and government checks, offers prepaid Visa debit cards, and provides money transfer and bill payment services…all services that are highly profitable to the typical bank.

And the business is growing very rapidly. (See the Symptom & Implication, “New entrants are growing much faster than the market” on StrategyStreet.com.) Recently, Wal-Mart opened its one thousandth money center. Each of these money centers is located inside a regular Wal-Mart. The company has also announced plans to grow the money centers by 50% over the next year. Once those additional 500 money centers are open, there will be an average of one money center for every two Wal-Marts in the U.S. This current group of money centers do an average of four million transactions a week, and are a very profitable part of Wal-Mart.

Wal-Mart has not had an easy time of getting into this business. They have tried several times to obtain a bank charter. Such a charter would allow them to take deposits and lend money. The last effort the company made to obtain a bank charter was in 2007. But the banking establishment pressured the government to block Wal-Mart’s application.

The banking establishment has to watch out for these Wal-Mart guys. (See the Symptom & Implication, “Competitors are changing features of the product” on StrategyStreet.com.) Their approach to all businesses is to streamline, simplify, eliminate excess and lower prices. The company’s commitment to increase its money centers by 50% on a decent-sized base within a year is an eloquent testimony that Wal-Mart’s approach works in financial services. They will be a major force.

Wal-Mart and the Customer Buying Hierarchy

Recently, Wal-Mart found that it was losing some customers to competitors. After examining the reasons why, the company discovered that some of its customers were leaving because Wal-Mart had eliminated some of the products the customers were used to buying at Wal-Mart. This situation gives us the opportunity to look at the Customer Buying Hierarchy in a retail business.

We use the Customer Buying Hierarchy to analyze a company’s competitive situation and to evaluate its product and service innovation program. Through thousands of customer interviews, we have seen that customers buy in a four part hierarchy: Function, Reliability, Convenience and Price. And customers buy in the order of the hierarchy. They first solve their Function problem. If they have not chosen a supplier, they then move to Reliability and then to Convenience and finally to Price. Most purchase decisions are made well before the average customer gets to Price. That’s hard to believe, but it is certainly the case.

What do these four terms mean? Function refers to the benefits that the user of the product enjoys. In a retail context, Function benefits include the set of products available for sale and the physical layout and amenities offered at the retail location. Reliability refers to the consistency with which the company delivers on its real or implied promises to its customers. A retail customer usually measures Reliability in terms of product stock-outs and customer service in the event that a product the customer buys does not work as promised. If the customer does not see that the retailer accepts returns for defective products, the customer will consider that retailer to have failed on Reliability. Convenience refers to the ease with which a customer may purchase the product. This is an important benefit in retail, and wholesale as well. A retail customer measures Convenience by the ease with which the customer is able to find the product he wants, chose among the various alternative products, and pay for the product. Finally, there is Price. The Price refers to the net cash costs that the customer must pay for the product, after consideration of all extra charges and discounts.

We have found that most companies actually have some customer purchases in each one of the four categories of the Customer Buying Hierarchy. A company like Wal-Mart will have more in Price than will a high-end company like Nordstrom. But even Nordstrom will have a few customers purchasing because of Price, often because of Price on a particular high-end product.

Wal-Mart has found that it was losing share to competitors. It was losing share because it was failing to offer the Function benefits that it had previously offered. To save costs, it withdrew products from its shelves (see the Perspective, “Achieving the Low-Cost Position” on StrategyStreet.com.) Then, some customers found they had to make a separate trip to another retailer to buy those products. It is worth noting that Wal-Mart lost relatively few customers. These customer losses had a relatively small impact on its market share. This tells us that there are probably relatively few customers who go to Wal-Mart primarily due to its Function benefits. None-the-less, Wal-Mart failed at Function and lost share, even though, for the majority of customers, it continued to be a winner on Reliability, Convenience and Price.

A Pyrrhic Victory?

Wal-Mart stores and Costco Wholesale are disrupting markets again. The market they are disrupting today is the grocery industry. In truth, they have been disrupting the grocery industry for the last several years, to the point that Wal-Mart is now the largest grocery store company in the country. These two competitors drain their competition of their life blood by using low prices. The recession, along with the pressure applied by Wal-Mart and Costco, has reduced the consumer pricing index for food by nearly 3% over the last year.

So, what is an industry leader to do when faced with the Wal-Mart challenge? Kroger answered right away. The company reduced its prices along with those of Wal-Mart. (See “Audio Tip #180: The Real Low-Cost Competitor” on StrategyStreet.com.) The result is that Kroger expanded its market share. This growth in market share came at the expense of other industry leaders, such as Safeway and Supervalu, who did not cut their prices as deeply. (See the Symptom & Implication “As large competitors match low prices, other competitors face difficulties” on StrategyStreet.com.)

There is a rub, of course. Kroger’s margins declined in the face of the price deflation. Predictably, Wall Street pummeled Kroger’s stock.

Wall Street is wrong here. In the long term, the increase in Kroger’s size will enable it to reduce its cost structure compared to that of its smaller rivals. The easiest way to reduce a cost structure is when the company’s sales aren’t growing and you can find opportunities to improve the productivity of the cost structure by increasing efficiency and effectiveness. (See “Audio Tip #196: Why Economies of Scale Exist” on StrategyStreet.com.) It is much harder to reduce costs when the business is shrinking. In a shrinking business, company morale tends to be bad and companies almost inevitably cut muscle as well as fat.

A growing business will also allow Kroger to fine tune its value proposition in the face of the Wal-Mart price challenge. The customer buys Function, Reliability and Convenience before Price. Kroger’s ability to tailor its offerings for a broad swath of customers, and its local presence, are powerful advantages, even in the face of a competitor with lower prices. (See “Video #56: Design to Value as an Approach to Cost Management” on StrategyStreet.com.) Kroger is right.

Delivering More by Offering Less

Over the last fifteen years, the number of items offered in the typical grocery store has increased by over 50%. Customers are beginning to be confused by the number of choices offered at the grocery store. This proliferation of consumer choices is a retail-wide phenomenon. Consumer goods manufacturers have created more varieties, sizes and shadings in order to win more shelf space from retailers and more attention from consumers.

Using the Customer Buying Hierarchy (see Audio Tip #95: The Customer Buying Hierarchy on StrategyStreet.com), the retail consumer would see the product choices as Functions, the consistency with which the products that they want are available as the major form as Reliability, and the ease with which the customer can find, chose and pay for the product as Convenience.

Retailers have decided that the Function innovations of more choices have created Convenience disadvantages in confusion for the customer, so they are cutting back. Wal-Mart found that the average shopper spends twenty-two minutes in its stores. But the confusion caused by the wide variety of products available to the consumer is reducing the number of items they actually put in their shopping carts. Wal-Mart responded to this problem by reducing the choices and shelf space available in slow-moving categories, and increasing them in faster-growing sections. For example, Wal-Mart increased space for shaving cream, trash bags, diapers and flat screen TVs. It reduced space for toilet paper, mouthwash and microwaveable popcorn. In total, the variety reductions outweighed the increases in choices in the other sections of the store. Other major retailers are also simplifying choices.

Retailers believe that they are now selling more and creating better profits with their new approach. Consumers need less time to make a purchase decision and there is now more room on the shelves for the retailer’s own private label products, which carry higher margins.

The beneficiaries on the manufacturer’s side are almost universally the top two brands in the category. Brands with #3 or lower positions lose market share and sales. In this case, tough times for the manufacturers help the leading manufacturers. That, by the way, is not always the rule. In fact, it is the exception. (See the Perspective, “Is Bigger Really Better?” on StrategyStreet.com.)

Another High Profit Industry Comes Under Assault

For many years now, large employers and governments have contracted with pharmacy benefit managers (PBMs) to provide and administer drug coverage for their employees. In turn, the PBMs tell the employers that they will pass on a good part of their purchasing economies to save the employers’ cost. This approach has worked well for the PBMs for years. They have been highly profitable businesses.

These high profits have attracted the attention of a new scary competitor, Wal-Mart (see “Video #3: Predicting the Direction of Margins” on StrategyStreet.com). Wal-Mart is offering businesses low-priced drugs if they sign up to have their employees purchase directly from Wal-Mart’s network of in-store pharmacies. Wal-Mart will offer these businesses a fixed mark-up over its cost for the drugs. While Wal-Mart will not reveal the cost of its purchases, it will have a third party verify the mark-up, thus guaranteeing the business of its deal. Wal-Mart benefits in two ways with this new business program. It guarantees a profit on each sale with its cost plus pricing. It also draws more customers into its stores where it has a chance to sell them other products.

This Wal-Mart product innovation follows on the heels of a similar consumer program they introduced some time ago. In this latter program, Wal-Mart introduced a $4 per subscription generic drug program for consumers. This drug program forced the entire retail drug industry to offer discount plans and it lowered the cost of drugs for consumers.

Wal-Mart is a discounter (See “Video #21: Definition of Price Leaders” on StrategyStreet.com). Will it succeed with this new business-oriented program? A discounter is likely to succeed if it can attract the largest customers in the market place. We call these Very Large customers. Wal-Mart has already attracted one of those very large customers in Caterpillar Company. Caterpillar has purchased drug coverage for 70M employees and their dependents through Wal-Mart. This customer has been so pleased with its savings in the drug benefit program that it has waived co-payments on generic prescriptions that its employees purchase from Wal-Mart. This, of course, makes the Wal-Mart program even more attractive to the employee because it is cheaper than any other alternative available.

The forecast? Costs down for businesses. Lower profits and growth for PBMs. (See the Symptom and Implication, "The industry leaders are losing share” on StrategyStreet.com.)