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.

A Pricing Scheme Guaranteed to Fail

There is a new gift card brokerage product coming to the online market. It’s called CardWoo.com. This company buys your unwanted gift cards at a discount. You mail in your card and they will send you a check for it. The amount of the check, as a percentage of the card value, is not stated in their online information. You, then, have fourteen days to decide whether to accept the check or send it back and get your gift card back.

The problem comes on the other side of the deal. CardWoo then takes the cards it buys and resells them online. The problem is their discount. Most of these cards have face values of $10 to $75. The majority seem to fall in the $25 to $50 range. The discounts CardWoo offers the purchaser of the card range anywhere from 0% (why would anyone do that?) to 5%. 5% of $50, the higher end of most of the cards, comes to all of $2.50. This discount is far too small to really attract many customers. (See “Audio Tip #143: Offensive Pricing Guidelines” on StrategyStreet.com.)

We have looked at more than 800 examples of discounted products. The median discount offered in a marketplace is 25%. 75% of discounts are 10% or more. CardWoo’s discounts are far too low to attract a mass audience. (See “Audio Tip #137: Price Shavers and Their Pricng” on StrategyStreet.com.)

Be Afraid. Be Very Afraid...Oh, Never Mind

The 2010 American Customer Satisfaction Index E-Business Report is out. The report is the product of the research firm ForeSee Results. The research firm uses data provided by the University of Michigan. Analysts argue that the report should sound an alarm for Google and Facebook, two of the web’s most popular sites. Apparently, the companies are not doing as good a job as they have in the past with privacy policies and ease of use of their web sites. The report’s scores are set so that a score under 70 is considered poor. Facebook gets a rating of 64, despite the fact that it is the largest and fastest growing social networking service in the U.S. Google gets a rating of 80. This rating is down from 86 a year ago. What are we to make of this?
Not much.

If you went out today and purchased an automobile that had the styling, operating capabilities and characteristics of an automobile from 1960, you would be severely disappointed. You would compare that car to today’s car and find the older car sorely lacking. How, then, did anyone sell a car in 1960? They sold cars in 1960 because they didn’t have the automobiles of 2010 to compete with those cars. The relevant comparison is not an absolute measure. It is only a relative measure. We have to view Facebook and Google against their competition, not against an absolute standard. (See “Video #70: Overview of Products and Services Part 2: What to Expect” on StrategyStreet.com.)

When you look at these two companies against their closest competitors, they come out rather well. Facebook’s “dismal” 64 rating compares with its nearest rival, MySpace, with its rating of 63. Google’s “falling” rating of 80 compares with Microsoft’s Bing at 77 and Yahoo at 76. The sky is not falling. (See the Perspective, “How Customers Buy” on StrategyStreet.com.)

In any competitive market, the standard is not absolute performance, but relative performance. If a company’s relative performance begins to fall, it will lose market share and you can expect falling quality rankings to account for much of the market share loss. An absolute standard is meaningless. Perfection of performance has a cost well beyond what the vast majority of customers would be willing to pay.

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.

Convenience and Reliability Innovations in a Fast-Growing Market

In a rapidly growing market, one growing faster than 15% a year in units, Function innovations tend to dominate market share movement. That is, Function innovations move more market share, on average, than do innovations in Reliability and Convenience. Often, the second major driver of market share movement in a fast-growing market is Price. Low prices and low-end competition often expand the market and cause significant market share shifts at the same time.

That is not to say that there aren’t Reliability and Convenience innovations. There are. The electronic reader market offers illustrations of these innovations. Barnes & Noble has an electronic reader called the Nook. This electronic reader is lagging in the market today, especially against the Amazon Kindle and the Apple iPad. To build awareness for its Nook product, Barnes & Noble has returned to T.V. advertising for the first time in several years. It wants to distinguish itself in the babble of noise from the many emerging eReaders and Tablets.

Advertising is both a Convenience and a Reliability innovation. It’s a Convenience innovation in that it helps the customer think of the product and know where to look for it. (See “Audio Tip #92: How Do We Add Knowledge to the Customer?” on StrategyStreet.com.) Advertising is also often a Reliability innovation because advertised products have stronger brand names and the aura of Reliability among consumers in a market. So advertising for Barnes & Noble should help the Nook gain some traction in the market. Will it be enough to overcome its laggard status? Probably not, due to its limited Function benefits in the form of attractive book titles. (See “Audio Tip #64: The Objectives of a Performance Improvement Program” on StrategyStreet.com.)

The leader in the market, Amazon’s Kindle, is also innovating its product in the form of Convenience. In the past, Amazon sold the Kindle only through its Amazon.com web site. This policy was in keeping with Amazon’s effort to get consumers of all products to purchase online, rather than through bricks-and-mortar retailers. Amazon has thought the better of this policy, though, with the advent of the Apple iPad. In part as a response to the availability of the iPad in Apple’s stores, Amazon has allowed Target to begin offering the Kindle at Target stores. Offering the product at Target is primarily a Convenience innovation. A customer can pick up the product faster at a Target store than by ordering online. In some ways, it is also a Reliability innovation. The customers can hold the product in their hands and see how the product works. Primarily, though, this is a Convenience innovation. Its main benefit for Amazon will be to prevent some loss of customer market share to a more Convenient iPad product. (See “Audio Tip #93: How Do We Reduce the Resources Used With Our Product?” on StrategyStreet.com.)

Who Are Those Guys?

Whenever an industry finds itself in the enviable position of having freedom in pricing, it usually finds that competition emerges out of the woodwork, from the least expected places. In many cases, the companies in these industries don’t conceive of new competition really having much of a chance to emerge. If they do see competition, they usually dismiss that competition as incapable of offering real competition.

Microsoft dominates the PC software market. It is likely to do so for many years to come. But Linux and Google have emerged to be a thorn in Microsoft’s side. Both of these alternatives have small market shares. However, both are able to limit Microsoft’s pricing power in some of its markets, especially governmental markets. (See the Symptom & Implication, “The industry leaders are losing share” on StrategyStreet.com.)

Healthcare pricing seems to be out of anyone’s control today. Maybe ObamaCare will fix that, though that is hard to see when, overnight, we increased demand without increasing any supply. It is more likely that healthcare will continue; indeed, even accelerate. But there is an emergent competitor: medical tourism. Ten years ago, few of us would have considered going to a foreign country to undergo an important medical procedure. As recently as 2007, more than 750,000 Americans traveled abroad for a medical procedure. That market is growing at better than 15% a year. And as medical tourism grows, so too will the skills and capabilities resident at the medical facilities these tourists visit. They will become stronger competitors. (See the Symptom & Implication, “Competition is expanding with the appearance of discounters” on StrategyStreet.com.)

Higher education is another area where school participants seem to have virtually unlimited pricing power. Along with that power has come a boom in for-profit college and university alternatives. These for-profit institutions are still a small factor in the market, but they are growing very rapidly. Now DeVry University and the University of Phoenix are unlikely to challenge the Ivy League any time soon. But, eventually, they will put the breaks on the pricing freedom in many of the lesser known public and private institutions.

New Capacity in a Shrinking Market

Big companies are pulling out of the petroleum refining industry. In the last year, Shell, Chevron, Valero and Sunoco have put refineries up for sale or shut them down. There is simply too much capacity in the industry. But there seems to be one guy coming in through the exit doors in the refining industry. Marathon Oil just opened a new $4 billion addition to its Louisiana refinery. Further, the company announced that it made a profit in all six of its other refineries in the U.S. in 2009. 2009 was a terrible year for the U.S. refinery business. 2010 isn’t much better.

Why would anyone add capacity in a hostile market with clear overcapacity? These capacity additions turn out to be commonplace. (See “Audio Tip #103: Capacity Creep Expansion of Industry Capacity” on StrategyStreet.com.) In Marathon’s case, the company started its capacity expansion in 2007, while the refining industry was roaring along. It simply took until 2010 to bring the refinery addition online. So this addition, while large, is really the result of expansion in the good times. The new capacity shows up when times have turned bad.

But, virtually every hostile industry sees small amounts, at least 1% to 2% per annum, increases in industry capacity every year. This capacity addition is the result of companies learning how to run their existing capacity with greater efficiency and effectiveness. It is almost a free addition to industry capacity. We call this annual capacity addition, despite overcapacity, the learning curve capacity addition. We named it after the well-known Boston Consulting Group strategic concept from the early 70s. The rate of this free capacity addition depends, in part, on the rate of growth in the industry itself. The faster the industry grows, the more free capacity will come online each year due to this learning curve effect. This effect can be pernicious. In the newsprint industry, the learning curve effect added more capacity every year than demand in the newsprint industry grew. During most of the 90s, the capacity industry’s addition due to the learning curve effect outstripped the growth of industry demand. Every year, hostility got just a little worse because of it. Real prices remained under pressure the whole time. (See “Audio Tip #133: What Tells Us Prices Will be Under Pressure?” on StrategyStreet.com.)

The Pre Looks to Go Post

Nine months ago, Palm introduced its new Pre smart-phone. On the occasion of that introduction, we wrote a blog (See Blog Here) predicting that the Pre would have a difficult time competing in this fast-growing market. It’s problem? Lack of apps. At the time, Apple had 35,000 apps. That number has now grown to well over 100,000. Other competitors today have as many as 20,000 or more apps available. The Pre has relatively few. Its shortage of apps has shown up in its market share. Recently it had 5% of the smart-phone market, a long way behind Apple’s 18% and Blackberry’s 43%.

In response to its failure to generate excitement in the market, the Palm plans to increase its advertising and add 200 company trainers to help Verizon’s sales representatives sell the phones. This won’t work either.

Returning again to the Customer Buying Hierarchy that we use to analyze a market, we recall that customers buy Function, Reliability, Convenience and Price. They buy in that order as well. Customers keep moving through the Hierarchy until they have found a single competitor who can offer them something important to them and that no other competitor can offer. (See “Audio Tip #70: Several Rounds in Evaluation Failures” on StrategyStreet.com.)

Function innovations dominate very fast-growing markets. The smart-phone market has been a very fast-growing market. Function innovations in the form of applications are today’s name of the Function game. If you don’t have apps, you can forget about the other Function innovations in your phone. Today’s competition can copy virtually any Function innovation that resides in the phone itself. Apps are something else again. (See “Audio Tip #97: How Do We Know if an Innovation will Remain Unique?” on StrategyStreet.com.) They require a large installed base, strengths of Research In Motion’s Blackberry and Apple’s iPhone. Application developers have little incentive to design new applications for the Palm operating system when at least three other phone providers, Research In Motion, Apple and Google, stand in front of the Pre and its smaller sibling, the Pixi.

Unless all three of these companies, with far more apps than the Palm phones, fail, the Palm phones don’t have much of a future. No amount of advertising, nor increased sales training, can make up today for a lack of applications. If it is determined to spend its money in what looks like a losing cause, Palm would be far better off buying applications rather than spending money on marketing and sales. Today’s smart-phone is sold by one user showing another all the cool things that the smart-phone can do. That is a much bigger sales force than Palm or even Verizon can afford.

To Bundle or Not to Bundle, That is the Question

For years, the cable industry has bundled its channels into tiers. They create “buy-throughs” which require a customer to purchase more than one tier to get to a particular channel the customer may want. For example, if the customer would like to have a channel in the second tier, the customer must also purchase the first tier along with the second tier bundle, of course, at a higher price.

Customers generally dislike this mode of pricing because they get many channels that they do not watch. The Wall Street Journal reports that Nielsen estimates that households watch an average of 18 channels out of the 130 they receive. So customers are paying for a lot of channels that are of little or no use to them.

This cable pricing approach to bundling is unusual. In the vast majority of cases, bundling is a tactic a company might use to reduce the impact of a falling price environment. With bundling, a company may sell more product, though at a lower price per unit of sale. The greater amount of product sold in the individual transaction, however, helps to preserve the company’s margins, even as prices fall.

There are two major types of bundling. The first type bundles several units of the same product into a package. For example, the airline Cape Air ran a program selling ticket books of ten one-way flights at discounted prices on its flights around Cape Cod and a few other destinations.

In the other type of bundling, a company would create a package of related products. As the recession hit the restaurant industry, Starbucks began offering breakfast deals in which a consumer could get a combination of an oatmeal and a latte or of a breakfast sandwich and a coffee for $3.95.

The cable industry has used the bundles to make the consumer feel like he is not paying a great deal for any one cable channel. The cable companies themselves are largely monopolies in their local areas. They have the freedom to raise their prices faster than inflation, and have done so for a number of years, using this bundled product approach.

Will this approach last for the long term future? That’s hard to say. (See “Video #3: Predicting the Direction of Margins" on StrategyStreet.com.) Certainly prices have gotten very high today. The cable companies have raised the price umbrella over new competition. Consumers would like to find lower prices and media producers are always looking for new channels of distribution. Increasingly, the internet is becoming an answer for both of these players. New services are arising that allow consumers to pick and choose individual programs to watch on the internet, or even on an internet equipped television. (See the Symptom and Implication, “Large competitors are maintaining price levels as smaller competitors discount” on StrategyStreet.com.) That is a real threat to the cable company’s bundled pricing stance.

Retailers as the Source of Creativity

It seems that retailers are often on the leading edge when it comes to innovation and creativity in their crafting offerings. They have an excellent sense of how their customers think.

For example, a couple of years ago, McDonald’s instituted a product offering around the change that a customer was about to receive for his order. Software the company had purchased created a discount offering that allowed the customer to take another item for the change, or slightly less than the change, he was about to receive from his original order. A high proportion of customers accepted these offers. (See “Audio Tip #53: Setting Specific Company Objectives for Many Customers” on StrategyStreet.com) While the additional product was offered at a discount, it still increased the margin on the sale.

Family Dollar stores offer another example. This company has done very well over the last 18 months, despite the recession. In fact, consumers naturally turned to Family Dollar and other very low-priced stores during these difficult times when their budgets are pressured. Family Dollar is not resting on its laurels. In fact, it is adjusting its offerings to fit its current customer needs. Their principal hope today is to retain the new customers it has attracted over the last 18 months. The company has found that customers are focusing on their needs, rather than their wants. So Family Dollar has added more food items and reduced offerings of appliances and other home categories. The company is also trying to increase its share of its customers’ purchases. It hopes to increase the total purchases on each customer’s visit and to shift some of those additional purchases to higher margin items. (See “Audio Tip #60: Customer Segmentation by Needs” on StrategyStreet.com.)

It offers the following example of its marketing changes to increase sales: If the company advertises underwear and laundry detergent in its regular flyer, both items may increase proportionately in sales. However, the laundry detergent often brings with it additional purchases that would be used with the detergent, such as fabric softeners, bleach and paper towels. These latter additional items carry higher margins because they are not included in the regular flyer discount offerings. The company has found that sales containing laundry detergent advertised in the flyer were 14 times more likely to include fabric softener, which wasn’t advertised, than the average transaction.

Retailing has become a data-hungry industry, and the retailers have grown in their understanding of customer needs by mining that data to develop creative merchandizing innovations that help both their customers and their bottom lines.

A Fast-Growing Market Under Attack from Below

There are a hundred thousand job sites in the U.S. and abroad. These sites charge employers to post jobs on their web sites in order to attract qualified employees. The big three in the market include Monster, CareerBuilder and Yahoo!HotJobs. With unemployment rising world-wide, these job sites are still growing. However, they are losing market share to emerging alternatives.

These alternatives are considerably less expensive than the big three. One of these alternatives, LinkedIn, has a professional orientation. This site offers a suite of services, called Talent Advantage, that has gained more than a thousand customers, double the number it had in 2008. This company is particularly good at finding, and offering up, what’s known as “passive” candidates. These are potential hires who are currently employed and not looking for a new job. The LinkedIn network has the capability of “pushing” candidates to employers who meet preset criteria. And LinkedIn is cheap in comparison with the big three.

Another inexpensive alternative is Twitter. Recruiters using Twitter can send messages to their followers who, in turn, copy the messages to blogs covering professional areas where potential candidates might be reading.

Monster, the largest and best known of the job sites, is responding by improving its services:

* It moved its call center from India to South Carolina
* It developed “contextual search” technology that improves the quality of the candidates developed on a search
* It reduced the number of steps required to upload a resume
* It created a feature that shows job-hunters how they can move from one field to another

We have studied several hundred low-end competitors (see Audio Tip #87: Potential Low-end Competitors in a Marketplace on StrategyStreet.com). There are four distinct types of low-end competitor. Most industries see at least one of these four types. To respond to them, an industry Standard Leader (see Audio Tip #81: Standard Leader Products and Companies on StrategyStreet.com) has the following choices:

* Ignore the low-end competitor, if it is unlikely to expand
* Block the competitor using one of the Standard Leader’s exploitable advantages
* Acquire the competitor, if it is available for a reasonable price
* Add a new price point to flank the low-end competitor
* Increase the company’s level of benefits at the Standard Leader price point
* Drop prices, where all else fails

In many cases, a good Standard Leader can respond to a low-end competitor in ways that maintain its growth and protect most, if not all, of its margins. (See Audio Tip #142: Defensive Pricing Guidelines on StrategyStreet.com.)

Growth Rates that Count

No matter the rate of growth in a market, the key growth measures to watch are those of the various Price Points. Here is an example.

The U.K., as the U.S., is in a recession. As a result of tougher times, customers are trading down their purchases in retail stores, including grocery stores. A beneficiary of this trade-down in the U.K. is the supermarket chain, J. Sainsbury PLC. Sainsbury is the U.K.’s third largest food retailer. It picked up customers from some of its more upscale grocery competitors.

Sainsbury has three lines, or Price Points, in its market. These Price Points grew at significantly different rates than the company grew during 2008. The company’s “Basics” brand is the smallest of its three Price Point labels. It is also the least expensive. This brand reported a 40% rise in sales in the third quarter from a year earlier, as customers traded down to less expensive groceries. The company’s higher Price Point brand “Taste the Difference” saw a decline in sales during the same period. The company’s sales for stores open for at least a year grew 4.5% in 2008. But the growth rates at the two Price Points were very different from the company overage.

In any market, whether growing or declining, a company should know the growth rates, not just of the industry as a whole, but of the Price Points in the industry. The real growth or decline story comes at the Price Points. And it is at the Price Points, rather than at the overall market, where the company focuses its decisions.

Avoiding Wastage of Resources

Honda has the most flexible auto plants in the U.S. It does so with simple modifications to the robots and assembly lines used to assemble its products. Of course, this high degree of flexibility is the result of significant investment over many years. Part of this investment included the company’s efforts to ensure that vehicles are designed to be assembled in the same way, even if the parts of the vehicle differ. This flexibility has become a key strategy advantage for the company as the auto market gyrates due to volatile gas prices. Honda has the capability of adjusting its production faster than any of its competitors.

Creating factory flexibility is one way that a company reduces the units of Input it requires to produce a unit of Output. In Honda’s case, the units of Input it was able to reduce with flexibility included employees and capital required to produce an automobile.

This flexible factory has enabled Honda to reduce downtime for employees and the plant assets. Downtime merely wastes the resources available for production. The auto industry has been reducing costs aggressively for many years. Honda is one of the companies who have done this well. (See the Symptom and Implication, “The industry is reducing costs aggressively” on StrategyStreet.com.)

Here are some examples of ways other companies have reduced their unplanned downtime:

• Allow work in process to follow multiple paths to completion to avoid delays at any waypoint
  
  
• Break bundled supplies into their component parts where components of a bundle are used at different rates
  
  
• Enable an employee, or a component, to serve multiple functions
  
  
• Ensure that all required components are available at each step in the process
  
  
• Duplicate critical components to avoid any potential shutdown of the process due to the failure of a single component
  
  
• Have ready answers for issues that can slow or stop a process
  
  
• Offer a service package to customers to avoid the failure of the product at the customer location. This service may also bring a price premium.
  
  
• Build installation instructions into a component
  

There are many hundreds of ideas to help a company reduce its unit costs and improve its overall productivity, measured as units of Input divided by units of Output, on StrategyStreet.com (see the Improve/Costs section of StrategyStreet). But any cost reduction program should focus on the right costs. (See the Perspective, “Cutting the Right Cost” on StrategyStreet.com.)

Low-End Competitor Exposes Fundamental Strategic Errors of the Leaders

Low-end competitors don’t think like industry leaders. As a result, they often blow big holes in the leader’s plans.

For twenty-five years, from the early 70s until the late 90s, the color television manufacturing market was one of the worst places on Earth to compete. Those companies who did survive, and there weren’t many, became hard-bitten competitors with no illusions about the inevitability of success of even the largest companies. The two largest U.S. competitors, RCA and Zenith, are now nearly-forgotten names. GE was another titan victim of the inexorable pressure of intense price-based competition.

But then something magic happened to the industry, the advent of flat panel television. The prices for these televisions were ten to twenty times that of the average consumer television before the introduction of flat panels. The industry survivors got well in a hurry. They went from poorly performing companies to stock market stars. They could sell more than they could produce. Profits were high and the future seemed bright.

The best of the industry leaders in the flat panel business included Philips Electronics, Sony and Samsung. These companies built their business model in the world of a component parts shortage by creating their own proprietary technologies and by manufacturing many of their key components in their own factories.

These leaders held on to the proprietary business model too long. The demand for these flat panel televisions and the components that go into them was so high that independent manufacturers entered the market. Soon these independents had created economies of scale that were actually better than those enjoyed by the current industry leaders.

Now, there emerges another threat to the leaders’ business model. This time it is a market threat in the name of Vizio. This company entered the market at the low end, producing basic products for prices often one-third or more below those of the industry leaders. In a very short period of time, Vizio went from barely existing to control of 12.4% of the LCD TVs shipped in the domestic market. Sony had 12.5% and Samsung had 14.2% at the same time.

Where did Vizio find its market? At the low end of the distribution channel. The company started with Costco, who gave it its real foot-hold in the market. On the basis of that success, Vizio expanded its distribution into other low-end retailers, such as Wal-Mart’s Sam’s Club and BJ Wholesale Club.

The result has devastated the new-found wealth of the large TV manufacturers. Flat panel TV average prices fell 24% during 2007 and the large manufacturers are seeing trouble in their profit margins. But Vizio continues to grow.

What did the industry leaders do wrong? There are at least five lessons here. First, they let economies of scale get away from them by watching independent manufacturing companies gain better economies of scale. Second, the leaders then failed to use those lower cost component companies to source some or all of their needs. Third, they priced their products for the short term, rather than the long term. They provided an umbrella on pricing that allowed low-end competitors, to under-price them by more than 25%. They have sustained the umbrella over these fast-expanding competitors, who continue to use those profits to build even stronger businesses to compete with the leaders. Fourth was a price point problem. The industry leaders paid little attention to the smaller versions of the LCD markets. Because the leaders short-changed the low price points of the market, they also encouraged companies like Vizio. Fifth, the leaders served the low-end distribution channels poorly. Vizio has got of its traction from channels of distribution who emphasized the low end of the market. Vizio and their ilk could never have succeeded to this extent were it not for the fact that the industry leaders served those channels of the market poorly.

Now the industry leaders are paying the price with falling margins. The battle to beat back the Vizio will be much more difficult now that the company has become so large.

We have seen a leading company make these same five missteps before. Compaq trod this pathway in the very early 90s. They allowed the PC “clone” manufacturers to use the Vizio strategy to take share. Eventually, Compaq dropped its prices to those of the “clones” and revamped its management of costs. But too late. Dell was one of the “clones.”

For more information about the types of low-end competitors and how to combat them, see “Turmoil Below: Confronting Low-End Competitors” on StrategyStreet.com in Tools/Perspectives.

The Company Did Not Get an Invitation

Remember the grade school experience when you learned of a party to which you did not receive an invitation? For most of us, that was a hurtful experience. But the failure to receive an invitation can cost real money in the business world, both now and in the future.

In our research, we have found that there are two sources of failure when a new piece of business becomes available. The first is an invitation failure. A company did not get invited to bid. The second is evaluation failure. A company is invited to bid but the customer chooses another competitor. The more damaging of these two failures is the failure to get an invitation. Sometimes this failure can be caused by the customer simply not knowing about the company. More often, this failure occurs because the customer has a strongly negative impression about the company.

If an industry has a majority of customers who refuse to invite the company to bid for new business, the company faces real challenges. Recently, Ford announced that its research had found that both it and Chevrolet would be “considered” (read “invited”) to bid for a consumer’s new car purchase only 41% of the time. Toyota, on the other hand, would be invited to bid nearly 59% of the time. Further, public opinion is “favorable” toward Ford and GM less than 50% of the time. Toyota’s “favorable” ranking is 74%.

The used car statistics reinforce the concern that GM and Ford should have. The domestic manufacturers lose a far greater percentage of their original price after five years than does Toyota. In most automobile categories today, Toyota is priced slightly higher than Ford and GM for equivalent models. The difference is relatively slight, say $1000 to $1500 on a $25,000 to $30,000 automobile. On the other hand, the difference in residual value five years later is greater than 15% of the original purchase price. In other words, Toyota holds more of its original value, by far, than do Ford and GM. So, despite the fact that the original purchase price is higher, the long term cost of ownership is lower with the Toyota. It’s likely that a good deal of this difference in residual value is due to negative experiences that the GM and Ford customers have had after the sale.

How is Ford to overcome this problem? Marketing initiatives aren’t enough. Customers have to see that the Ford product offers the features, reliability and convenience they want, especially in competition with Japanese manufacturers. The customers are looking for an experience that satisfies them. They want to know they can count on Ford. This consumer opinion takes years to develop and to destroy as well. Ford and GM have destroyed a lot of good will with customers over several years. On the other hand, the Japanese manufacturers have built much stronger relationships with customers over the same period of time. This set of impressions will not change easily. The after-sale experience has to be good for the new Ford and GM buyers. Until Ford and GM can reassure customers that their after-sale experience will be good, the market share of these two companies is likely to continue to slip away.


Ford and GM are in a deep hole. We have seen this in other industries. The sad rule is that companies end up in these deep holes because of conscious decisions they made to cheapen their product or reduce their responsiveness to customers in order to improve their margins. Usually the problems they face are self-inflicted. These companies don’t get an invitation because the consumer does not consider them a friend.

What Do We Really Believe?

There were two items of interest in recent press reports. Both suggest something about our fundamental beliefs in our economic system. The first instance occurred in California. The State Insurance Commissioner asked Allstate to reduce its automobile rates in the state by nearly 16%. Allstate insures about 10% of California automobiles. The owners of these automobiles will save about $124 per car. The reductions came because the state concluded that the companies were charging too much for their services.

In a separate event, the State of Arkansas ordered sixty companies who offer payday-lending services to close down immediately. These payday lenders advance money to a borrower to bridge the period between paydays. The lenders charge a fee, plus interest. The State of Arkansas concluded that this service violated a constitutional requirement that bars lenders from charging an annual interest rate higher than 17%.

Both of these stories are examples of a lack of belief in the effectiveness of a capitalist system. There is no indication in either case that new entrants are barred from entering the market. If the automobile insurance companies charge too much, their profits will be unusually high. New companies will enter the California market with a promise of lower prices to attract their customer sales volume. The same would hold true with payday lenders in Arkansas. If California and Arkansas believed in the effectiveness of capitalism, they would simply wait until the new entrants reduced the prices in the state. They apparently do not believe that capitalism works.

There is a new (rich) sucker born every minute...

For those fortunate few out there who travel to London regularly, I envy you. What I don’t envy are the hotel rates you pay, which are averaging over $600 a night in the city. We have seen hotel rates go up a great deal in the U.S., as well, over the last few years. New York is a particular example of that phenomenon. The hotel companies have finally run out of the excess capacity they had from 2000 until 2005. Occupancy rates are high and room rates are even higher. Just the time to invest in new hotel rooms. That is, it’s the right time if you are a hotel company and want to keep your regular customers satisfied and coming back because you always have a room for them.

It is an awful time to invest if you happen to be an individual who thinks he can make a killing in London real estate. In London, as in parts of the U.S., there is a fad for what’s called buy-to-let hotels. This phenomenon sells individual hotel rooms to investors who hope to make a good return on investment by letting out these hotel rooms. Bad idea, at least today. Room prices are above replacement costs. Room rates are extraordinarily high because prices have to be high enough to discourage demand, not because the cost of replacing those hotel rooms is anywhere near the $600 they are commanding today. These poor investors are buying at the top of the market when they have no business requirement to keep customers satisfied. If this investment were such a great deal, do you think it is likely that the current hotel owners would be willing to part with their precious ownership? Not likely.

This is a capital intensive industry where there has been, and will be again, overbuilding. It is a regular cycle in hotels, even luxury hotels. These are likely to be very poor investments for these individuals who are buying at the peak of a market. They should have been buying in 2001, when prices were depressed. Then they had a chance to make a decent return.

Debt Crisis: Worse than Some Commentators Tell Us

I ran into a neighbor today. He is an attorney who, for many years, has run a successful practice specializing in working for creditors to recover defaulted debt payments. We began talking about the economy and I, half jokingly, said “at least your business should be up in this credit crisis.” He quickly corrected me. “My business is really getting squeezed now because of this credit crisis.” The credit squeeze affects him at both ends of the market. First, in the demand for his services. His credit-extending clients have drastically reduced their lending because of current and anticipated defaults. One of his clients, a automobile leasing firm, faced so many defaults that they have stopped writing new leases entirely. At the other end of his business, he is also suffering because he is unable to collect as much as he once could. The people who are defaulting are often under water on their automobile or house values compared to loan values. These debtors simply turn the asset back over to the creditor. If the borrower has no equity, nor enough income, the debt goes unpaid. So he suffers just like everyone else in the economy. Well, that’s not totally correct. He did tell me that the attorneys who are doing very well right now are those who handle evictions, which follow closely on the footsteps of forecloses.

His story brought to mind something I read the other day. A well-informed commentator was explaining that the credit crisis should not cause a great deal of worry for most of us because the sub-prime loans were only 1 to 2% of all the mortgages outstanding. I think there is an important fallacy in this argument when you consider who takes the loss and where they take it. The banks are taking most of these losses. And the losses are coming out of the banks’ capital. Banks use this capital as the basis of their lending. Roughly speaking, the banks can lend six dollars for every dollar of capital. So, if a bank loses 2% on its mortgage lending, the loss carries through to the capital base of the bank. The bank will be unable to make the equivalent of 12% of its mortgage loans in the future. A 6 to 12% reduction in mortgage lending sounds a lot more treacherous than 1 or 2%. You compound this, of course, with the other credit losses that will follow as the people who have defaulted on their mortgages also default on their other important debts.