Cable T.V. and Customer Retention

Recently, I decided to test the waters for a less expensive television experience. I have been a loyal cable subscriber for thirty-five years, but friends have told me that other systems, especially satellite, are cheaper. I went online to DirectTV.com to check their packages. We have been spending about $112 a month. The equivalent package from DirectTV appeared to be about $81 a month. I was shocked at the size of the price difference. DirectTV was more than 25% less expensive than Comcast, my cable supplier.




Given the size of these price differences, I did some investigation in what is happening in the market. Today there are four potential television service suppliers: cable, telephone companies, such as AT&T and Verizon, satellite and internet companies, such as Netflix and Hulu. The cable companies command 60% of the market. Phone companies have less than 15% of the market. The satellite firms, including DirectTV and Dish, control most of the rest. The internet firms are still small, though they may become larger in the future. Over the years, the cable companies have held a high price umbrella over the satellite companies. Now the phone companies are getting under this umbrella as well. The cable companies lost two million subscribers last year. The phone companies picked up most of that loss, while the satellite firms picked up a bit. The combination of the phone and satellite companies took virtually all the growth there was in the market.



Customer retention is a big deal. Even in fast-growing markets, you would like to be able to retain your customers when competitors seek them out. The cable companies have sought to retain customers by emphasizing more services to higher spending customers. These customers tend to be less price-sensitive. It appears that the cable companies are going to have to alter their courses. They simply can not afford to let their competitors take away their market share. Eventually, the competition will be as big and as strong as they are. They will lose the market leverage that a leader enjoys. For examples see GM in autos, IBM in the PC market and U.S. Steel in the steel market.



The T.V. market is speaking in clear tones. The phone and satellite companies offer a better value proposition. The cable companies have to listen soon.

Cable T.V. and Customer Retention

Recently, I decided to test the waters for a less expensive television experience. I have been a loyal cable subscriber for thirty-five years, but friends have told me that other systems, especially satellite, are cheaper. I went online to DirectTV.com to check their packages. We have been spending about $112 a month. The equivalent package from DirectTV appeared to be about $81 a month. I was shocked at the size of the price difference. DirectTV was more than 25% less expensive than Comcast, my cable supplier.

Given the size of these price differences, I did some investigation in what is happening in the market. Today there are four potential television service suppliers: cable, telephone companies, such as AT&T and Verizon, satellite and internet companies, such as Netflix and Hulu. The cable companies command 60% of the market. Phone companies have less than 15% of the market. The satellite firms, including DirectTV and Dish, control most of the rest. The internet firms are still small, though they may become larger in the future. Over the years, the cable companies have held a high price umbrella over the satellite companies. Now the phone companies are getting under this umbrella as well. The cable companies lost two million subscribers last year. The phone companies picked up most of that loss, while the satellite firms picked up a bit. The combination of the phone and satellite companies took virtually all the growth there was in the market.


Customer retention is a big deal. Even in fast-growing markets, you would like to be able to retain your customers when competitors seek them out. The cable companies have sought to retain customers by emphasizing more services to higher spending customers. These customers tend to be less price-sensitive. It appears that the cable companies are going to have to alter their courses. They simply can not afford to let their competitors take away their market share. Eventually, the competition will be as big and as strong as they are. They will lose the market leverage that a leader enjoys. For examples see GM in autos, IBM in the PC market and U.S. Steel in the steel market.


The T.V. market is speaking in clear tones. The phone and satellite companies offer a better value proposition. The cable companies have to listen soon.

News Corp Responds to the Market for “Free”

The newspaper industry has faced a mighty challenge over the last few years. There is so much “free” content to complete with them. Newspaper revenue continues to plummet. Internet users are reluctant to pay for content. All the free content, supported by advertising revenue, has decimated the newspaper industry. The industry’s cousin, the magazine industry, is not far behind.

This trend can’t continue forever. Already, many people are asking themselves how much they can trust the information on the internet. The need for Reliability drives the demand for Snopes.com. How many “free” web sites can earn enough from advertising to pay all their bills? An effective industry answer to “free” may be forthcoming in the News Corp online newspaper called “The Daily.” The Daily will cover general news, sports, arts and opinion in a format dedicated to the Apple iPad. In addition to the written content, the product will carry high definition video and 360 degree photos. The same product will be available in a few months for the Android-based tablet computers.

The Daily will sell for $.99 a week, or $39.99 a year, a very low price compared to newspapers. With this model, the product receives revenues both from the subscribers and from advertisers. Subscribers have the Reliability benefit of knowing that the content producer cares about facts, accuracy and readable writing style. Advertisers pay for eyeballs that follow a Reliable product.

The Daily is what we call a Next Leader product. This is a product that offers much better than industry standard performance for a low price to a specific subset of industry customers. The Next Leader can offer the very low price because it has a much lower cost structure than is typical in the industry. There are two basic types of Next Leaders. The first are Reformer products. This type of Next Leader product reduces the benefits for the user (usually Function benefits) while increasing the benefits for the buyer (usually Reliability and Convenience benefits) compared to the industry Standard Leader product. The second of the two types of Next Leader products are Transformer products. These products increase the benefits of the user but offer, at least initially, fewer benefits to the buyer than the Standard Leader product offers. The Daily is a Reformer product. It offers the Convenience of formatting fit for a tablet computer so it provides easier access for a segment of the industry’s customers. Its low cost structure results from its elimination of printing presses and distribution costs.

If this new tablet-based product offers a quality read, it will hasten the day when virtually every newspaper and magazine is offered first online and only secondarily in hard copy. The online versions will come at a fraction of the cost of the hard copy versions. Readership is certain to grow.

The Long and Arduous Journey of the Airline Industry May be Reaching an End

The government deregulated the airline industry in 1978. Since that time, the basic pricing in the industry, as well as airline fortunes, have been more or less continuously on the downward slope. It has been a very long trip down.

The industry may be heading up again, though. In the third quarter of 2010, the average domestic airfare was 11% higher than a year earlier. Profits returned to the industry in 2010 behind higher prices. In some part, these higher prices were the result of the additional fees that most of the domestic carriers charged passengers for checked baggage, better seating, rerouting and so forth. Still, the industry was able to hold its higher prices.

These prices are holding because the major industry players are less enamored of discounted flying. All of the big airlines are finding ways to extract prices from industry customers. Now that airline capacity utilization is high, the industry is more careful about capacity additions. Higher prices are here to stay.

The consumer still is far ahead. Even at these higher prices, ticket prices are a bargain. In fact, ticket prices, adjusted for inflation, are 20% below the levels of 1995. The industry has continuously stripped benefits from the base product in order to save costs. In 2010, the industry added back a few of those benefits (for example, economy plus seating) for an additional charge. We may see more of that over the next few years.

The Advent of the F-commerce Evolution

Don’t look now, but we are entering the world of F-commerce. What is that, those of you older than thirty will ask? F-commerce is selling through a Facebook page.

The trend is early yet, but likely to turn into a stampede. JC Penney and 1-800-Flowers.com both have established full E-commerce stores within their Facebook page. The stores include check-out and other features you typically find on an E-commerce web site. Facebook claims that twenty-five of the largest retail sites are already integrated with Facebook, as are seventeen of the twenty-five fastest growing retail sites.

Think of Facebook as a virtual mall. There are all kinds of people wandering around there, talking to one another. Facebook offers a nice opportunity for a company to interact with customers and allow them to bring their friends into the conversation to evaluate styles and colors and so forth. If a company integrates its storefront with the Facebook page, its Facebook “friends” will never have to leave the virtual mall in order to purchase. This is an important product innovation.

Product innovations reduce customers’ effective costs in one of three ways: add information about the product and how it is to be used, reduce the resources the customer must use with the product, or improve the customer’s experience with the product.

This innovation improves the customer’s experience with the product by increasing the customer’s sense of security in using the product. It allows the customer to get her friends’ opinions on what she is purchasing. Secondarily, the Facebook store reduces the customer’s resources used with the product by reducing the time the customer must spend in using the product. The innovation reduces the steps the customer must take to make a purchase and it places the company’s product closer to the customer’s location.

This is going to be a train to the destination of millions of customers. Every mainstream retailer has to get on board.

Apple Gets Crossways with App Developers

Recently, Apple rejected a digital book application from Sony. The disagreement here is over how and when Apple collects for its services. Apple is playing a dangerous game.

In theory, Apple has the right to insist, under its terms for developers, that any app, which offers customers the ability to purchase books outside of the app, offer the ability for customers to purchase within the app at the same time.

Here is the rub. In its application, Sony sends customers to its own web site where they complete the purchase of a book. By routing the customers to its own web site, Sony is able to avoid a payment of 30% of revenues to Apple.

Others, including Amazon, with its Kindle, and Barnes & Noble, with its Nook, have been able to sell e-books by sending users to the companys’ own web sites. Apple simply was not enforcing its policy requiring developers to use its in-app purchasing feature to buy new content.

A 30% charge on revenues is a high price to pay Apple. Apple may be setting itself up for future loss of market share by enforcing this policy. If the Android platform does not put the same requirement on its app developers, the developers will have a strong incentive to avoid the 30% charge by encouraging customers to purchase using an Android device rather than an Apple device. Alternatively, the application developers may charge a higher price for purchases through Apple.

Apple’s unique strength has been its superior list of available applications. Apple’s enforcement of this requirement to purchase inside the app so that Apple can collect 30% of the revenues puts at risk its major advantage. Apple needs to compromise here by charging a lower price or no price at all. After all, it already makes high profits on its hardware and software product combination. It also makes profits on many of the downloaded apps. The application developers are customers too. Why make their life difficult? Does the benefit Apple provides a seller justify 30% of revenues? Sounds pretty rich.

A Fast Growing Market Begins Developing Reliability and Convenience Innovations

In a fast growing market, new Functions and lower Price drive more share gains than do Reliability and Convenience (see Customer Buying Hierarchy descriptions on StrategyStreet.com in the Perspective, “How Customers Buy” and in “Video 25: Short Explanation of Customer Buying Hierarchy”). After awhile, though, market growth begins to slow and Function innovations become less important than innovations in Reliability and Convenience. We can see this developing in the wireless applications market.

This market has been on a tear for the last few years. Recently, Amazon announced that it was planning to enter the market for phone applications by creating an online store selling apps for smart phones running Google’s Android software. Amazon will then compete with Google’s web site offering apps that work on the Android system.

Amazon’s entrance shows developments in both Reliability and Convenience. Amazon offers Reliability innovations in at least two ways. First, Amazon encourages the reviews from its customers of the products it sells. These customer reviews are important sources of Reliability information about a product. Second, Amazon insists that any app it sells will not sell for a lower price anywhere else. This Reliability innovation assures a customer that Amazon will have prices that are competitive with anyone.

Amazon also brings great Convenience to this market. There are so many apps today that the market is becoming chaotic. Amazon will organize these applications in ways that fit with its customer base. Amazon has a long history of doing this very thing with other products. Just as importantly, Amazon already has a working payment arrangement with millions of customers. It is particularly adept at the “one click” payment system, which enables a customer to pay for purchases very quickly.

Amazon’s entry is a good example of a natural evolution in a fast growing market.

The ETF Arms Race

In our previous blog (See Here), we discussed Vanguard and its unseating of Fidelity as the largest money manager in the U.S. Vanguard has done this with low-priced attacks on virtually every market Fidelity serves. Fidelity, and much of the rest of the market, is allowing Vanguard to get away with this, at least for now. In this blog, we want to see how pricing affects even a fast-growing market and then watch what happens when a Vanguard flexes its muscles in such a fast-growing market.

Exchange Traded Funds (ETFs) are some of the hottest products in the financial industry today. They are cheaper and, often, more tax efficient than are mutual funds. Because of these advantages, many independent registered investment advisors and individual investors have shifted out of mutual funds and into ETFs. The ETF market is growing rapidly.

A year ago, Schwab decided to take share in this market by using low prices. Schwab offered eight ETFs to its customers on a commission-free basis. Since Schwab is such a leader in the market, the company’s move started a war. (See the Symptom & Implication, “The industry is seeing its first price wars” on StrategyStreet.com.) In short order, E-Trade, Fidelity and Vanguard joined the fray. Fidelity offered twenty-five iShares ETFs, commission-free. Recently, TD Ameritrade upped the ante. This company offered more than one hundred ETFs, commission-free, to both individual investors and investment advisors. This is a real arms race in the fast-growing ETF market. Prices on already inexpensive ETFs continue to fall.

Why this focus on industry prices? The industry has learned that high prices cost you market share. This is a sure signal that customers are having increasing difficulty making buying decisions among the top industry ETF providers on the basis of Function, Reliability or Convenience. When an investor can not chose among peer competitors on the basis of performance, that is Function, Reliability or Convenience, they make their decisions on the basis of Price. (See the Perspective, “What Ends Hostility” on StrategyStreet.com.)

In this price war, Vanguard stands to gain the most, at least in the short term. This company is well known for its low-cost funds. So far this year, Vanguard has garnered 37% of the new money coming into the ETF market. Their 37% share of new money is greater than the combined shares of the two biggest ETF companies, iShares and State Street Global Advisors, combined.

For their part, the top two ETF sponsors argue that they will not be drawn into a price war. This is simply a Leader’s Trap. You can ignore these protestations. They, and everyone else in the market, will have to respond to Vanguard, or stand aside and watch Vanguard trample them in the market.

Vanguard vs. Fidelity

We are going to use this blog, and the next one, to speak more about pricing. Over the years, we have learned some surprising things about pricing. For example, in the average market, price moves much less share than most people assume. (See the Perspective, “The Price Segment” on StrategyStreet.com.) In most markets, the true price-driven market share volatility is 15% or less of the current volatile, changing, market share. You might ask how that can be. But the explanation is relatively easy. Most of us buy most of the things we purchase on the basis of a unique Function, better Reliability, or more Convenience, before we even get to Price. Did you buy your last car on the basis of Price? How about those snow skis? Were they the cheapest on the market? Do you stay in the cheapest hotels or drink the cheapest beer? True Price buyers are in the minority. And before these buyers get to Price in the decision sequence, they have satisfied themselves that there is no important difference among competitors on Function, Reliability or Convenience.

Even more surprising to most people is that in a hostile market, one with severe overcapacity and intense price competition, price moves even less share. We have worked in many hostile markets. In all of them, the true price-based volatile market share was less than 5% of the available volatile share. The reason for this phenomenon is that in a true hostile marketplace, virtually all competitors have learned to copy lower prices, or face an immediate loss in market share. (See the Perspective, “Why Price Cuts Don’t Build Share” on StrategyStreet.com.) For an example, look at the airline industry. When one airline offers a price discount, all the other peers of that airline offer the same discount on the same flight to the same locations.

Now I am going to offer what seems to be an exception to these “guidelines” I have just set down. The exception appears to be Vanguard in its competition with Fidelity Investments and the other money managers. This year, Vanguard Group replaced Fidelity as the largest U.S. mutual fund company. Fidelity had held that number one ranking since 1988, when it passed Merrill Lynch. At one time, the Fidelity Magellan fund, while it was run by Peter Lynch, was the world’s largest mutual fund. In 2000, it reached $110 billion under management. Lynch had a phenomenal record, but his successors did not. Today, the Fidelity Magellan fund has less than $30 billion under management. The biggest mutual fund today is the Vanguard 500 Index Fund at $87 billion under management.

The big difference between a managed fund and an index fund should be performance. A managed fund is supposed to earn more than an index fund. Some do, most don’t. So many investors have been migrating to the lower-priced index funds. Stock index funds charge an average of 29 cents per hundred dollars invested. Actively managed funds charge more like 95 cents.

Vanguard has unseated Fidelity by offering low-cost funds. Fidelity offers mostly managed funds. Vanguard is the ensign bearer for index funds. Investors seem to pay more attention to management costs when returns are already low. Over the last ten years, Vanguard has taken in more than $4 in new money to manage for every $1 Fidelity has gained. Almost 80% of the new money coming to Vanguard this year went to index funds. Exchange traded funds, ETFs, are even cheaper than many index funds. Vanguard has over $100 billion in ETF funds. Fidelity has side-stepped that business.

So Vanguard appears to be winning in the market due to pricing. How does that jibe with the guidelines we talked about? The key rule is that a customer does not buy on Price until after the customer has satisfied herself, that there is no important difference to the customer on Function, Reliability or Convenience, so the customer decides on Price. Vanguard has proven to many investors that it is the Functional equivalent of Fidelity, that its returns are Reliable and that it is equally Convenient to purchase, so many customers buy on Price. The price markets here are the index funds and the exchange traded funds. Fidelity needs to offer exchange traded funds to stay in the game. What really is happening is that Fidelity is “failing” on Price while Vanguard beats the other competitors on the basis of Reliability and Convenience.

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.

Microsoft Phone 7 - A Long Row to Hoe

Recently, Microsoft introduced Windows Phone 7 Mobile software. This is all new software that Microsoft hopes will stop its slide in market share. It is going to have tough sledding.

Until this introduction, Microsoft’s market share in the mobile software business was dropping off a cliff. The company was one of the early entrants into the market. In 2004, it owned 22% of the market. By 2009, its share was down to 9%. Today it is about 5%. Microsoft was quickly fading away. But maybe the new software can help.

For a bit of perspective, we have to explain that there are five separate players involved in this marketplace: the operating system developers, the phone manufacturers, the wireless carriers, the software application developers and the ultimate users. Each of these entities are in separate businesses and represent separate competition. Microsoft plays in the market exclusively as an operating system developer. That’s what Windows Phone 7 is. The Google Android system is another stand-alone mobile operating software platform. So has been Hewlett Packard’s Palm mobile operating software. Three other competitors offer their operating software only in combination with their handset hardware. These include Nokia, with the Symbian operating system, Research In Motion’s Blackberry products and Apple’s iPhones.

The market share ranking today among those competitors in total operating software starts with Nokia’s Symbian, followed by Android, then Blackberry and Apple. Each of these has a market share that are multiples of Microsoft’s current share. Microsoft is fifth, followed by Palm and others.

The new Windows Phone 7 software is a wholly new product. It is completely different than the previous Microsoft mobile software. So different, in fact, that none of the thousands of applications written for the previous Microsoft software will work with Windows Phone 7. The company must start from scratch with applications.

Consumers love applications and make many of their buying decisions on the basis of these applications. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) Today, Apple has about 250,000 applications, followed by Android with about 70,000. The differences between the two are probably much less than these numbers would indicate because most of the popular applications are available on both platforms. You can see this in the marginal purchases. Android garners more of the current new purchases than does Apple. So, for all practical purposes, Apple no longer owns a significant application lead on Android.

Windows Phone 7 faces a real hurdle with applications. In some ways, it offers a few benefits over the Android and Apple operating systems. For example, it works off of “tiles” that enable a user to get information somewhat faster than in the Android and Apple software. It works easily with Microsoft Office software and it enables gamers to connect to online games easily. These are modest innovations at best, and likely to be followed by others quickly. For example, Motorola already produces software for its phones that pretty much duplicates Microsoft’s “tiles.” Apps are the big problem.

If you are an applications developer, Microsoft would likely be far down your list of the companies for whom you would write new application software for a smart phone. Android and Apple would lead the pack. Nokia, Research In Motion and others offer more current customers than Microsoft but pose difficulties for developers. Microsoft would fall below all these firms. Microsoft has to solve this problem quickly.

Application developers are also likely to be leery of Microsoft and its continued presence in the market. Not only has the company lost share, but it introduced a software platform called Kin in the spring of 2010 aimed at young people, between 12 and 20. This product did not stay in the market even two months. So developers are likely to hold fire on their application development for the Windows Phone 7 platform until they are relatively sure that the product will succeed.

Microsoft is backing its Windows Phone 7 introduction with a $100 million advertising program emphasizing the ease with which a user can get to the information most important to the customer. This seems to me to miss the mark. This advertising investment is a Convenience innovation that advises the customer why the Microsoft system is faster and, therefore, better. (See “Video 15: Definition of Convenience” on StrategyStreet.com.) But it seems that most of the smart phone purchases today are the result of other current users’ recommendations and demonstrations. This is a Reliability innovation. These current users are apt to emphasize the Function benefits of their phones rather than the speed of access to information.

Microsoft might have spent this money differently. It is already paying some developers to create applications for its platform. My guess is that their $100 million might have been much better spent paying for applications, where Microsoft is likely to fail on the basis of lack of Functions rather than paying for the Convenience innovation of advertising.

Market Share Volatility in a Fast Growing Market

The smart phone market continues to grow quickly. The market for the operating systems on smart phones illustrates one of the patterns you will see in a fast growing market.

In order to see these patterns, we will use the Customer Buying Hierarchy. We will evaluate the reasons for market share volatility using the Customer Buying Hierarchy. Market share volatility is market share that moves from one supplier to another. (See “Audio Tip #26: Introduction to Step 6 of the Basic Strategy Guide” on StrategyStreet.com.) This market share movement may happen because new customers enter the market, where all competitors may compete for the customer, or because customers simply change their suppliers. The Customer Buying Hierarchy (CBH) holds that customers buy: Function, Reliability, Convenience and Price, in that order. (See “Audio Tip #95: The Customer Buying Hierarchy” on StrategyStreet.com.) New Functions or lower Prices dominate the causes of market share volatility in fast growing markets.

The emergence of the Apple iPhone, with the Apple operating system, illustrates the impact of new Functions. The Apple operating system virtually exploded on the market and probably created the consumer interest in smart phones. Apple was able to gain a quarter of the smart phone market very quickly on the basis of its many unique Functions, the result of the thousands of apps written for the operating system.

More recently, the growth of the Android operating system illustrates the second major driver of market share volatility in high growth markets, low Prices. The Android operating system is growing very quickly now, taking share from the Research in Motion, Apple and Microsoft operating systems. What is its advantage? It’s free. The handset manufacturers and the cell phone service providers like an inexpensive operating system. So, it turns out, do many customers. The Android operating system is now grabbing market share by the handfuls. There is no let-up in sight.

The Kindle as a Razor

Amazon is proving to be a stubborn competitor. Many people thought Amazon would be severely damaged by the market entrance of the Apple iPad. After all, the iPad does many more things than simply provide an eBook reading experience. But, the Kindle is not going away easily. The company claims that it appeals to “serious readers,” which it estimates at about 10% of the population, and Amazon is chasing that 10% avidly.

Amazon is using the Kindle as a Loss Leader. Recently, a company estimated that the cost of the Kindle, that is all its parts and labor, was about $185. Amazon claims that the cost is much higher. This cost was not a great deal of the problem when the Kindle2 sold for $400, about its introductory price. Nor was it a problem when the Kindle sold for $289, the cost of the second version. Now, the new and improved Kindle3 has a price as low as $139, well below the estimated $185 cost. Amazon is taking a significant haircut on the cost of the Kindle in order to populate future customers for its eBooks. The company makes an attractive profit on its eBook sales and uses the Kindle as the razor to its eBook razorblades.

Amazon has also hedged its bet. Kindle eBooks also are readable on the iPad, so we are about to see an interesting contest between a very inexpensive Kindle and the iPad for the eyes of future eBook readers.

This razor and razorblade strategy is common (see StrategyStreet.com/Improve/Pricing/Reduce Prices). Here are some of the other places it has taken place:

* Caterpillar often reduced prices on new equipment in order to assure itself of the replacement parts business.

* The Palm Trio 600 had a list price of $600, but a consumer could buy it for as little as $330 with a phone service contract.

* Nintendo subsidized the sale of its game consoles in order to boost the sales of its game software.

* Restaurants offer free, or inexpensive, appetizers at the bar in order to increase alcohol sales.

* Charles Schwab offered a $400 analysis of a client’s holdings, including two hours worth of in-person advice, in order to increase the odds that it would be able to manage the client’s money for a yearly fee.

These Loss Leader pricing innovations are worthwhile whenever the revenues from the attendant products, which follow the Loss Leader product, are worth considerably more than is the Loss Leader.

Pricing in the Dog Days of August

It seems that not many people wanted to spend the weekend in Philadelphia during August. Hotels that might be full during the week were sparsely populated on the weekends. But, Marriott was not taking this situation lying down.

The Philadelphia Marriott came up with an innovative pricing strategy. Any guest who booked a two-night stay starting any Friday during August into mid-September had to pay only the price of the highest outside temperature for the Saturday night rate. So, the guest paid regular prices on Friday night and the heavily discounted rate, based on the day’s high temperature, for Saturday night. A clever approach to discounting.

This is one of several approaches companies have used to get through periodic, or seasonal slow demand times. Companies have used the components of a price in order to bring customers to its products during slow times. For example:

* A construction company changed its list price much as did the Philadelphia Marriott. It priced its services very aggressively for the months of January and February so its customers would move work forward that would normally be done in the spring or summer.

* Other companies change the definition of their product to reach a new, lower, price point. Companies who sell fractional ownerships of private jets offer discounts up to 25% for flying on off-peak days.

* Other companies make direct payments to customers. We can see this approach with the current Orbitz program called Price Assurance. Orbitz refunds customers the differences in fare if a customer purchases an airline ticket and then sees the price of the ticket fall before he leaves on his trip.

* Some sellers throw in a free, or heavily discounted, product from a third party. For example, as the housing market became more difficult, some sellers offered to outfit a media room or pay closing costs for their buyers.

We believe that a company facing a tough pricing environment can gain a lot by studying what other companies have done when facing the same circumstances. We have many of these examples on our web site. (See Improve/Pricing on StrategyStreet.com.)

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.

A Win on Both Price and Convenience

A few forward-thinking retailers have adopted predictive analytics in their loyalty programs. Among the few to use this tool today are Sam’s Club, CVS and Kroger. These programs offer both Convenience and Price advantages to individual customers. It is a true break-through innovation.

The Sam’s Club program provides a good illustration. Sam’s named this program eValues. This program offers bargains tailored to each Sam’s Club member. The member must be part of Sam’s Club “Plus” program. These “Plus” members may print out individually tailored eValues offers at a kiosk at the entrance to the store or by email or by visiting the Sam’s Club web site. Sam’s Club prepares these individualized offers by drawing on the purchasing history of the individual “Plus” members. Their purchasing history predicts what bargains and product combinations will attract the individual customer.

This eValues program is both a Convenience and a Price innovation. (See StrategyStreet.com/Diagnose/Products and Services/Customer Cost System) It is a Convenience innovation because it helps the customer find and choose products more quickly within the store. It is a Price innovation because it offers discounts on products the customer typically buys, or might buy. eValues is highly effective. The average coupon brings a response rate of 1% to 2%, but the eValues program results in customers getting the discount on 20% to 30% of the products where discounts are offered.

The stores’ loyalty programs become more relevant to their most important customers and the stores’ sales per customer visit increase. Clearly a win win situation.

How to Fail in a Market You Dominate

The cable T.V. companies are the big dogs in the television industry. So far, no one has been able to unseat them, though they seem to be trying to unseat themselves. The cable industry is losing customers to satellite T.V. and phone companies entering the video market. The rate of these customer losses is significant.

In 2006, the cable T.V. companies controlled nearly 69 million video customers. By 2009, that number had fallen to 63 million. (See the Symptom & Implication, “The industry leaders are losing share” on StrategyStreet.com.) The problem is both price and service. Many consumers see these cable T.V. companies failing on both Price and Reliability. (See “Video #14: Definition of Reliability” on StrategyStreet.com.)

The cable T.V. companies have responded to the incursions of satellite and phone companies with discounts. Most of these discounts come in the form of bundles of products, including two or three choices among T.V., internet and telephone. Some of the discounts came in the form of free services during a promotional period. Still, the prices for cable T.V. have gone up every year faster than inflation. The discounts slowed, but did not stop, customer defections. Customers felt gouged.

A more troubling failure has come with customer service. We have all heard that power corrupts. Well, the cable T.V. companies had great market power for a long period of time. That power didn’t corrupt them in the moral sense, but certainly caused them to ignore the common tenets of good customer service. They offered service on their terms. Customers could take it or lump it. And customers became resentful.

Of the two failures, one of high prices and the other of Reliability failures with poor customer service, the most troubling is the Reliability failure. People tend not to forget and forgive Reliability failures for a long period of time. General Motors will be living down its reputation for less than stellar automobile quality for a long time. The same fate awaits the cable T.V. companies. (See “Audio Tip #35: How Does a Company "Fail" in a Market?” on StrategyStreet.com.)

No Red Letter Day for BlueStar

Illinois opened its electricity market for non-residential customers in 1999. In 2010, about 75% of the electric load for commercial and industrial customers is purchased through alternative suppliers. That deregulation was a big success.

The state then deregulated its residential market in 2002. Virtually no one paid attention. Now there is a competitor about to enter the residential market where few have dared venture in the last eight years. But this entry is virtually certain to fail. BlueStar Energy is an alternative electricity supplier based in Chicago. This company is offering twelve month contracts that would lock in prices for consumers and save them an average of $6 to $7 per month over what those consumers would have paid to Commonwealth Edison.

We have to translate these $6 to $7 a month savings into percentages in order to have any perspective on the company’s prospects for success. These savings amount to an 8% to 9% savings for the consumer. This is not nearly enough to attract many new consumers.

We maintain a database of several hundred price reductions done over the last twenty-five years. These price reductions will vary according to the discounters’ objectives, target segments and with the components of price conveying for the discount. There is a strong warning for BlueStar in this price data. Their discount is not enough. Across our entire database of price reductions, the median discount is 25%, 75% of all discounts are 10% or more. That makes BlueStar’s 8% to 9% offering pretty sickly. (See StrategyStreet/Improve/Pricing/Reduce Price)

But the story gets worse if you are a low-end Price Leader as BlueStar is. BlueStar offers no advantage to the consumer other than price. That makes them a Price Leader. Price Leaders have to offer higher-than-average discounts in order to win significant market share. Low-end competitors have median discounts of 33%, 75% of them offer discounts of 20% or more to their customers.

Apparently, there are four other companies that Illinois has certified to supply residential electricity. They are waiting to see whether BlueStar is successful before entering. They won’t be coming. And BlueStar won’t be staying.

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.)