The Mobile Phone Industry and Customer Retention

The mobile phone industry’s growth has slowed.  It is now operating more like a stable, moderate to slow growth market.  This is particularly true in Europe.  To face the challenge of slower growth in the industry, European mobile operators are turning to customer retention, but they are careful of the customers they seek to retain. 

The Europeans have observed that less than 20% of an operator’s customers generate to 80% of the operator’s total revenue.  This pattern repeats itself in many industries.  When we have seen these patterns in other industries, we have also noted that less than 10% of the total customers generate an astounding 50% of total revenues.  These are the really important customers in an industry. 

A company must retain its key customers.  In the mobile phone industry, as in most industries, the largest 20% of the industry’s customers are likely to be what we would call Core customers for the industry’s larger competitors.  A Core customer allows supplier company to earn at least the cost of capital through a business cycle.  The retention of these core customers is of paramount importance to long term company success. It costs a great deal more to find a new customer than to retain and build the relationship with a customer you already have.  In the European mobile phone industry, carriers have found that it costs ten times more to acquire a customer than to retain one. 

The industry has found another important phenomenon associated with customer defection.  Recent research has told it that defection is a social phenomenon.  If defecting customers leave an operator, they usually are not quiet about it.  They tell their friends.  In turn, some of their friends defect as well.  So, the loss of a Core customer to an operator will often bring with it the loss of several other Core customers. 

The mobile phone operators in Europe are working on retention by focusing particularly on those Core customers most likely to defect.  These operators have analyzed the value of their customers and have assigned a rating to each customer.  When a customer calls a call center, the information about the customer, including his rating, is readily displayed on the service representative’s screen.  This customer specific information enables the service representative to respond with different value offers, depending on the importance of the customer.  Most of these offers reflect lower prices for a potential defector.

But the industry is responding to potential defections with more than simple price reductions.  Some companies are developing personal calling rates and plans tailored to individual Core customer habits.  One European company instituted this individual approach and cut its percentage of customers defecting each year in half, from 20% to 10%. 

The industry has found another important phenomenon associated with customer churn.  Recent research has told it that defection is a social phenomenon.  If defecting customers leave an operator, they usually are not quiet about it.  They tell their friends.  In turn, some of their friends defect as well.  So, the loss of a core customer to an operator will often bring with it the loss of several other core customers. 

Customer retention is an important, strategic management imperative, even in fast growing markets

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 Japanese Pay the Price

The figures are in for U.S. auto sales in 2010. The biggest winners in percentage growth were Hyundai, at 24%, and Ford at 20%. Toyota lost .4% and Honda grew a mediocre 7%. The Japanese struggled in 2010.

Earlier we wrote a blog about Ford’s ascendency and Toyota’s problems (see Blog HERE). Toyota is paying the price for failing its customers. Honda appears to be getting painted with the “failure” brush, though I doubt its punishment is deserved.

I am actually using the word “fail” to mean something specific here. A company fails its customers when it is unable or unwilling to do something that at least half of its competitors can, or will, do for customers. Toyota’s troubles with accelerators, floor mats, and so forth, received extensive media coverage. This coverage clearly has had a negative impact on Toyota this year.

Toyota’s struggles illustrate the win and fail dynamic. In our terms, a “win” occurs when a company is able to do something that the majority of its competitors either can not or will not do. Wins account for a good deal of market share growth in a fast-growing market, but are less important in more mature markets. In a more mature Stable market and, especially, in all Hostile markets, failure moves a significant amount of market share.

Here is what this means. The decision to change a supplier is really two decisions. The first is the decision to leave a current supplier and the second is the decision on which new supplier to take on in your relationship. In the average Stable and Hostile marketplace, more market share moves on failure than on wins. This means that before an established customer will change suppliers, its current incumbent supplier must “fail” the relationship in some way. This failure, then, opens up the customer’s relationship to competition among other potential suppliers. Whichever supplier gains this customer’s volume really did so only after the incumbent failed. We call this gain a “weak win.” The “weak win” would not have happened on a straight-up comparison of performance and price of the new supplier versus the old. The gain only happened after the incumbent clearly failed the customer and then opened the relationship to someone new.

Toyota’s failure was largely a failure of Reliability. It clearly lost share. The companies that gained this share from Toyota, Ford and Hyundai among them, enjoyed some degree of a “weak win” in the domestic automobile market. They may have “won” market share as well, but my guess is that most of their share gains from Toyota fell to them from Toyota’s “failure.”

Evolution of the Smart Phone Market

The smart phone market is growing at a very fast pace. The number of smart phones sold world-wide is expected to grow at a pace of more than 15% a year. This is what we call a Developing market. The smart phone market portrays some interesting developments you might expect to see in other fast-growing markets.

Apple really made the market take flight with its original iPhone. Apple has migrated into the high-end, Performance Leader, part of the market with its iPhone4, selling for $199 with a two year contract. (See the Symptom & Implication, “The industry leaders are losing share” on StrategyStreet.com.) Wisely, Apple kept its old iPhone3 GS on the market as a lower-cost product, selling for $99 with a two year contract.

Competitors have been stumped trying to outflank Apple with new and better functionality. Apple simply has too many apps for most competitors. Only the Android phones, using the Google operating system, have gained share. Nokia and Research In Motion have both lost substantial share in the smart phone market. So, what are the competitors to do? (See the Symptom & Implication, “Competitors in formerly underdeveloped markets have begun meeting one another” on StrategyStreet.com.)

In this market, as in other Developing markets, the competitors strip out some of the expensive benefits of the product and introduce a new lower Price Point. In the smart phone market, the new lower Price Point still delivers one of the most important benefits of a smart phone, internet access. Because these new Price Points have fewer benefits, they cost less and allow the companies to sell to the carriers at lower prices than the Apple i4 product. (See the Symptom & Implication, “Low end products are gaining share of the market” on StrategyStreet.com.) In turn, the wireless service carriers offer lower priced package deals to their users when the packages include the new lower-priced smart phones.

Two developments are of note here. First, the evolution of the market. In this case, as in others, the market develops a new lower Price Point product that satisfies some of the basic needs of the current customer group. More importantly, the new Price Point attracts a new cohort of customers due to its lower prices. Second, prices decline in the market despite the fact that the market is growing very quickly. Prices are declining because costs are going down. Yes. But they are also declining under the press of competition in a market where margins are high enough to sustain lower prices with still-acceptable margins. Virtually all fast growing markets witness falling prices.

Strangling the Goose

Some time ago, we wrote a blog (see HERE) on the declining value of airline miles programs. At the time, we noted that most of those miles awarded were worth less than a cent. In fact, the airlines themselves believe that these miles are worth far less than a cent. That means the miles that you gain return less than 1% of your spending to your account.

Here is an example. United Airlines offers a one year membership in its Red Carpet Club for 70,000 miles. If you are a normal flyer, without particular value to United as a Premier or Premier Executive and so forth, you can buy a one year membership for $425. United Airlines is telling us that its miles are worth 6/10th of 1 cent.

But let’s say you are a highly valued flyer with United Airlines. Let’s assume you are a 1K flyer, one of their top categories. If you are in that fortunate (or unfortunate as you will have it) position, you may purchase a one year membership in the Red Carpet Club for $325. As an alternative, you can purchase the membership with 40,000 of your frequent flyer miles. This is a much better deal. Here your miles are worth 8/10th of a cent.

These airline-sponsored deals strike me as dangerous. (See the Symptom & Implication, “Customers are more price sensitive” on StrategyStreet.com.) They telegraph clearly that airline miles are worth less than 1%. This is dangerous because there are a number of credit cards available to you which will return 1% of your spending every month, in cash. That is a considerably better deal than the United Airline miles offer you. (See the Symptom & Implication, “New competition is entering a settled market” on StrategyStreet.com.) These airline miles keep losing their allure.

Nokia Makes a Bet in the Smart Phone Market

Nokia has a big problem in the smart phone market. It has to do something to change its outlook. It just made a bet with the choice of its pathway to the future.

Nokia produces both the hardware and the operating system for smart phones. Its hardware is the handset and its software is either the Symbian or MeeGo operating systems. The company uses the Symbian software with its less advanced smart phones and the MeeGo system for the more advanced and more expensive phones.

Nokia is losing market share rapidly, especially to phones using Google’s Android operating system. Over the last year, the Symbian operating system’s market share fell from 45% to 37% of the market. In the meantime, Android has garnered 25% of the market, up from less than 4% a year ago. Nokia developed the MeeGo system to counter the flowing tide to both the Android and the Apple operating platforms. These platforms from Apple and Android have nearly shut Nokia out of the high end smart phone business in the U.S.

Nokia has decided against adopting the Android operating system for its phones. It is afraid that the adoption of Android would leave it competing in an increasingly less attractive hardware market, while the profits go to the operating software manufacturers. Nokia is undoubtedly right here. (See Video #3: Predicting the Direction of Margins” on StrategyStreet.com.) The question is, can they catch up fast enough?

Nokia is working hard to get the MeeGo system up to speed for developers. Today, the developers feel that the MeeGo operating system is in its early stages. It is attractive, though, because this operating system supports a number of different products that consumers use, including tablets, televisions and phones. And Nokia has acquired and developed software, called QT, that enables software developers to write an application once and have it work on a number of hardware products.

Nokia has time to get this right. The smart phone market is still a high-end, Performance Leader, product. It will take time for the mass market to adopt the smart phones and their operating systems. Nokia has a large base of customers using its phones and operating systems. Most of these customers would prefer not to leave a supplier they have come to know and like. If Nokia can pull its act together quickly, it can be a strong performer. And, certainly, there will be room for three operating systems in this market. In fact, if Nokia does well, it could still end up the long term leader, a position it has owned in the cell phone market for the last several years. Failing that, it has a reasonable chance to beat out the Apple operating system over the longer term. To accomplish this, Nokia must develop and use its superior economies of scale to price its products aggressively to take share again. (See Video #53: Productivity and Economies of Scale in Hostility” on StrategyStreet.com.)

But, there is a lingering question. Why not hedge the bet by developing Android phones as well? They could maintain good economies of scale and keep handset profits if their software bet fails.

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.

Previews of Coming Attractions in Public Services

A generation ago, public servants earned less than equivalent employees in the private sector. This is no longer the case. Many reports today suggest that public servants earn 25% or more greater compensation than equivalent private sector employees. While a percentage of the workforce employed in private industry union shops has steadily declined for more than thirty years, unionization in the public sector has grown rapidly. This is important because of the inflexibility of many unions in changing work rules and compensation when confronted with economic realities such as tightening budgets.

What might you expect to happen in such an environment? Growth of private sector companies offering the same services, or better, for less money. These private companies operate under the price umbrellas of the public sector. That is certainly happening today, even in the most unlikely of places. A little company in Maryland has grown into the country’s fifth largest library system, measured by number of branches. This small company, Library Systems and Services, Inc., runs fourteen library service systems operating 63 branches. It has $35 million in annual revenue and 800 employees. It ranks behind Los Angeles County, New York City, Chicago and the city of Los Angeles in the size of its branch system.

The company is finding it relatively easy to succeed by cutting overhead and replacing unionized employees with non-union employees willing to do the jobs for less. In a recent $4 million contract, the company pledged to save $1 million a year using its cost reduction techniques. (See “Audio Tip 187: The Components of Productivity” on StrategyStreet.com.)

Nor does the company need to reduce hours and services in order to succeed. The company has found that the operating policies of public libraries often serve to protect job security and ensure high rates of pay. (See “Audio Tip 182: Productivity as a Measure of Physical Costs” on StrategyStreet.com.) Of course, not all people are happy with the success of this company. In particular, the company’s most recent contract came in for severe criticism from the Service Employees’ International Union. That union has 87 members in libraries recently transferred to Library Systems and Services.

As the cost of public employee pay and pensions becomes less bearable in the future, we can expect to see a good deal more of companies like Library Systems and Services. These private companies should also be good investments. Their first need is not to generate greater revenues, though I am sure they will try that. Instead, they need only reduce costs. That should be relatively easy, due to the price umbrella held up by current public sector management of citizen services.

The Fall of an Industry Leader - Part II

Blockbuster declared bankruptcy in September of 2010. According to reports, the company was done in by the online service of Netflix and the in-retail store kiosks of Red Box. That is only partly true. The company was done in, first by its failure to recognize and respond to market opportunities when others created them and, second, by its determination to extract higher prices than its performance in the market warranted. Its failure as a company was a long time coming. It started in the late 1990’s. Since 2002, the company has lost more than $4 billion. Its market value fell from $4 billion eight years ago to just $12 million at the time of the bankruptcy.

In Part 2, we will look at some of the highlights of Blockbuster’s pricing over the last few years.

This may seem surprising, but the industry’s prices began their long-term decline as early as 1982. This is not unusual. Fast-growing industries often see price declines as new competitors enter the market with plenty of capacity to serve even fast-growing demand.

* In the early 90s, Blockbuster changed its pricing scheme. It had offered a movie for two nights at $3. Blockbuster changed its price to $2.50 per night. It also charged late fees. This change in pricing hurt smaller competitors, who often got business when Blockbuster was out of product due to its two-night rental policy.

* By 1994, Blockbuster felt it could raise prices with impunity, and it did raise prices. (See the Perspective, “Can We Raise Margins With a Price Increase?” on StrategyStreet.com.)

* By 1997, prices were coming under pressure due to the fall-off in demand growth caused by other forms of competition. Blockbuster and its video tape competitors had to begin reducing prices. (See the Symptom & Implication, “The Industry is Seeing its Frist Price Wars” on StrategyStreet.com.)

* In 1997, Blockbuster introduced customer loyalty campaigns to hold on to its most important customers. By then the company was earning less than its cost of capital.

* In 1999, Blockbuster introduced a rewards card. The card cost about $10 and allowed a card-holding customer to obtain one movie free each month. It also offered one free movie for every five rented in a month, and one free “Favorites” on Mondays, Tuesdays and Wednesdays. This was an attempt to create greater sales with existing customers. Movies rented for $4 a night, but late fees could often double or even triple that cost.

* In 2002, video on-demand began to grow. One company offered 430 movies for an average of $3 per rental.

* By 2002, several consumer-oriented articles argued that the late fees charged by Blockbuster would be enough to cover the cost of a Netflix subscription. Customers grew angry over the late fee prices.

* In 2002, Blockbuster responded directly to Netflix with three pricing plans. First, a customer could rent two videos at a time for $20 a month. Second, the customer could rent three videos at a time for $25 a month. In the third program, a customer could pay about $60 a year. This would allow the customer to keep three movies during the year without late fees, but the customer would have to pay for all movies rented. In the meantime, Netflix continued charging $20 to rent three movies at a time.

What do we learn from watching Blockbuster’s pricing over the years? During the 80s and 90s, Blockbuster was leading the industry on pricing. This was a double whammy for its competitors. It offered bigger, better stocked stores at lower prices than its competitors. But somewhere in the mid-90s, Blockbuster lost its edge. It decided that it had earned the right to have higher prices simply because it was the leader. Netflix continually beat Blockbuster on pricing. Red Box did the same thing with its $1 per night rental charges. Blockbuster was in a Leader’s Trap, and stayed in that unfortunate position for far longer than most industry leaders. (See the Perspective, “The Leader’s Trap” on StrategyStreet.com.)

Blockbuster engineered its own demise by failing to keep up with the performance of the new leaders in the industry, such as Netflix and Red Box, and by charging more than its competition for performance that failed to match theirs.

The Fall of an Industry Leader - Part 1

Blockbuster declared bankruptcy in September of 2010. According to reports, the company was done in by the online service of Netflix and the in-retail store kiosks of Red Box. That is only partly true. The company was done in, first by its failure to recognize and respond to market opportunities when others created them and, second, by its determination to extract higher prices than its performance in the market warranted. Its failure as a company was a long time coming. It started in the late 1990’s. Since 2002, the company has lost more than $4 billion. Its market value fell from $4 billion eight years ago to just $12 million at the time of the bankruptcy.

In this, and the next blog, we are going to look at Blockbuster’s history. We will only touch on highlights, but the highlights explain much of the story.

We will begin by looking at Blockbuster’s product and service offering over the last twenty years. (See “Basic Strategy Guide Step 7” on StrategyStreet.com.) Here are some of the highlights:

* The video rental market grew very quickly throughout the 80s and the early part of the 90s. By 1993, Blockbuster had 600 stores. It was adding a store a day to that total. In doing so, it was squeezing out of the market many small video stores.

* The first video dispensing machines, precursors to the ubiquitous Red Box kiosks, came out in the mid-80s. They were introduced by Group One using a vending machine produced by Diebold. By 1990, there were many of these machines. 70% of them were available 24 hours a day. Each machine had about 400 tapes available. Blockbuster had none of these machines. (Note: after a very late response, Blockbuster Express now has 7000 kiosks, also made by Diebold.)

* In the mid-1990s, Direct Broadcast Satellite offerings of movies began to cut into the Blockbuster demand. To make up for the slowdown in demand, Blockbuster added music, books, software, movie shirts and mugs. All were failures.

* In 1998, Netflix launched its service. The company grew very rapidly, and was introduced to the public stock market in 2002. At the time, Netflix had less than a million customers. Blockbuster had 8,000 stores world-wide. As late as 2002, the CEO of Blockbuster dismissed the Netflix product as a niche offering.

* In 2001, Netflix, though still tiny, had a far more extensive movie selection than the average Blockbuster store. At the time, Netflix offered a choice of 10,000 separate movies, about ten times what the largest Blockbuster store could offer. In addition to offering more choices, Netflix also provided customer and professional movie reviews and a service that predicted what movies subscribers would like based upon the subscriber’s reviews of previous movies. Blockbuster offered none of these additional services.

* Later in 2002, Blockbuster began to test an online offering, but decided not to enter that market. Instead, it offered the Freedom Pass product, which required customers to go to the store to pick up and return their movies. The Freedom Pass offered unlimited movies for $25 a month. Blockbuster had 9,100 world-wide stores. 70% of the U.S. population was within a ten minute drive of one of its stores. At the same time, Netflix offered its unlimited movies, three movies at a time, service for $20 a month.

* By 2002, Netflix could offer overnight service to 50% of its customers and promised to reach 70% of them with that speedy service within a year.

* In 2003, Blockbuster updated its Freedom Pass program. It offered two movies at a time for $20, three movies at a time for $30. It introduced this program in all 5,500 of its U.S. stores. In the meantime, Netflix reached a count of 1 million subscribers by charging $20 a month for three movies at a time. The Netflix price was 33% lower than Blockbuster’s.

* By 2004, Blockbuster was stumbling badly in its earnings. It held back on inventory, so many popular movies were often out, frustrating customers. (See “Video 54: Cost Reduction by Winners vs. Losers in Hostility” on StrategyStreet.com.) During this year, Blockbuster finally enters the online market, six years after Netflix entered.

* During the period of the early 2000s, Hollywood studios began selling DVDs at relatively low prices. At the same time, the cable companies were offering online movie streaming through their cable boxes. Both of these developments reduced the demand for Blockbuster’s products.

* In 2004, Netflix reached 2 million subscribers and was growing at 80% a year.

* By 2005, Blockbuster was becoming desperate for revenue and margin. The company added video games, DVD sales and DVD resales to its product line. Blockbuster’s online business was flourishing with 1 million subscribers. But Netflix had 3 million. Wal-Mart decided to leave the online rental market and directed its customers to the Netflix program.

* In 2008, Blockbuster offered an online streaming service. To access the service, customers had to purchase a T.V. set-top box for $99 and then pay regular movie fees for each movie they watched. Blockbuster claimed that the T.V. set box was free because they offered a credit for 25 movies to anyone purchasing the box. At the same time, Netflix offered its movie streaming service free to its regular subscribers.

* By 2009, Blockbuster was closing stores at a rapid rate, becoming less convenient for many customers. Netflix and Red Box continued growing rapidly. At the time of its bankruptcy, Blockbuster was down to 3,300 U.S. stores, and falling.

What does this story tell us? In the early years, until the early 90s, Blockbuster was a very successful company. It won, streamlined the video rental market and became the unquestioned industry leader. It then became complacent. It ignored the new channels of distribution, including vending machines, online rentals and video streaming. Other people developed and refined the cost structures of those markets. Blockbuster did eventually enter these channels, but by then it was too late to play catch-up.

In the next blog we will look at Blockbuster’s pricing history to see how that contributed to its failure.

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.

How Hostility Starts

Many years ago, I had the good fortune of living in London for three years. During that time, I would often have lunch in one of London’s many public houses, “pubs” to you and me. They served rich and ample fare such as shephard’s pie, sliced turkey sandwiches and, of course, English “bitter.” Sometimes, after work, I would meet friends for a drink at the same pubs. When I traveled the countryside, I could always rely on a local pub to provide good food and drinks at reasonable prices. They were a more comfortable equivalent of a fast food restaurant. And they were great places to socialize.

Things have changed. A couple of years ago, my wife and I spent a vacation in England. I was anxious to take her to some of my favorite pubs, both while we were in London and while we were in the Cotswolds. To my surprise, most of these pubs were gone. Those that had survived had largely transformed themselves into much more upscale restaurants. Gone were the gorgonzola sandwiches and the cheddar and bread offerings. In their place were white tablecloths and nice silverware settings.

The public house is under significant pressure in Britain. The number of pubs has fallen by 10% in just the last five years. What happened? New competition.

Competition, both above and below pub prices, has reduced the market for pubs. At the lower end of the market, supermarkets easily undercut pub prices with their substantial buying power. At the higher end, the British have expanded their taste for wine. All of this new competition has reduced the sales of beer, the pub’s key product.

This is a picture of the development of a hostile market, where price competition is intense and returns for the industry are often low. A reduction in the number of competitors is a hallmark of a difficult, hostile market. We have studied many of those markets over the last twenty-five years. Most hostile markets are caused by the expansion of competition. The minority examples of hostility are the result of a fall-off in demand. The British pub industry has seen both factors at work. But the most pressing has been the expansion of competition.

For a relatively short summary of how to operate in a hostile market, see these two Perspectives: “Success Under Fire: Policies to Prosper in Hostile Times” and “Use Subtle Strategy in Tough Markets."

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.

Apple's Future in Smart Phones - Part II

Apple is the clear leader in today’s consumer smart phone market. Research in Motion leads the commercial market. I am going to make the case that a few years from now, they will have a single digit market share. They will turn into a Performance Leader, a small high-priced competitor in the market. (See “Video #24: Price Point Specialists in Hostility” on StrategyStreet.com.) This position will be similar to the one Apple holds today in the personal computer market. In Part I of this blog, we described the evolution of Apple in the personal computer market. Apple today produces a marvelous personal computer. It appears that Apple is following the same map in the smart phone market as it followed in personal computers.

Apple owns both the hardware and the software in its smart phones. And it keeps both exclusive to Apple. It had early mover advantage so it garnered virtually all of the apps that people cared to develop for its smart phone platform. But a new competitor has emerged in the Android operating system. Android fills the same role as Microsoft did in the personal computer industry. Microsoft was cheap and available for many hardware platforms. The PC attracted the most app developers. Android is cheap and attractive to app developers. On the other hand, Apple has made life difficult for app developers by forcing them to jump through hoops in order to gain approval to offer apps on the Apple iPhone platform. Today, Apple has something north of 200,000 apps. Android has 70,000 apps. But, as one analyst noted, every app that a number of people are likely to want to use today is already available for both the Android and the iTouch. Apple may have more apps, but most of the apps exclusive to Apple appeal to narrow niches.

Now let’s play forward the next few years. (See “Audio Tip #32: Introduction to Step 7 of the Basic Strategy Guide” on StrategyStreet.com.) Motorola, HTC, LG and Samsung are among the many companies producing Android-based phones. The Android market is growing quickly. It will grow even more quickly as the prices of the Android handsets fall under the pressure of competition in the smart phone hardware market among some big, capable companies. Within a year, the app developers will write new apps, first for the Android platform and second for the Apple iPhone or other smart phone platform. Several years from now, the intense competition in the hardware market will reduce the cost of an Android smart phone low enough to remove a good deal of the profit that Apple now enjoys with the iPhone. (See “Audio Tip #102: When is Price Likely to Go Down?” on StrategyStreet.com.) As the Android smart phone producers continually add the features and capability to make their phones unique for consumers, the Android phones will be nearly as capable as, if not the equal of, the Apple iPhone. And, the Android phones will be much cheaper. Apple will be pushed into a Performance Leader position, where it offers high-priced feature-rich phones and garners a share of the market likely to be in single digits. This will not happen overnight. The smart phone market is still in its infancy. But check back in three to four years.

It will be interesting to see whether this competitive pattern holds in the tablet computer market as well.

Apple's Future in Smart Phones - Part I

Apple is the clear leader in today’s consumer smart phone market. Research in Motion leads the commercial market. I am going to make the case that a few years from now, they will have a single digit market share. They will turn into a Performance Leader, a small high-priced competitor in the market. This position will be similar to the one Apple holds today in the personal computer market. It appears that Apple is following the same pathway it followed in the personal computer market. Perhaps a bit of history is helpful here.

The business model of Apple differed from that of the PC. Apple was not the first personal computer, but it was, by far, the best. And, it got paid for being the best. Apple really created the mass market for personal computers. It had a huge percentage of the marketplace by the time 1981 rolled around and IBM introduced the PC. Apple controlled both the hardware and the software for its personal computer products. On the PC side, Microsoft’s Windows controlled the software, while a large number of companies became hardware producers for the Windows operating system. In the early years of the personal computer, the hardware was far more expensive than the software.

The PC market had a great deal more competition…and cost/price reductions. Apple prevented any other hardware producer from copying its products. There was at least one company who tried, Franklin Computer. But Apple killed them off in the mid-1980s. From that point on, there were no clone producers of Apple machines. The picture was very different on the IBM/Microsoft side. IBM found itself facing many competitors. Most of those competitors we called “clones.” Dell was one of those clones. This large number of hardware competitors reduced the cost of hardware drastically during the late 80s and through the 90s. (See “Audio Tip #196: Why Economies of Scales Exist” on StrategyStreet.com.) The source of much of the cost of the hardware for a personal computer shifted to the Intel or AMD chips embedded in the hardware. Still, AMD constantly challenged Intel, so Intel had to reduce its prices in order to maintain its very high market shares in chips. All of this intense competition reduced the cost of hardware until today the software costs as much as the hardware. Competition forced hardware components and prices down to such an extent that the PC platform had significant price advantages over the Macintosh/Apple platform. Apple was pushed into a high-cost/high-priced hardware position.

The competition in software was much less pronounced. It has only been in the last few years that Microsoft has had to respond to lower cost competition from Linux and Google. These lower cost competitors have had an impact on Microsoft’s prices, but nothing like the impact that the hardware competition had in reducing the price of hardware. The mass market followed the lower priced PC market. Apple today produces a marvelous machine. It has rabid and loyal fans. It also has high prices and a single digit share of the personal computer market. Were it not for the genius of Steve Jobs and his cohorts at Apple inventing new products with higher margins, Apple would be struggling today, much as it was before Steve Jobs returned to the company. It wouldn’t make a lot of money in the personal computer industry because the industry Standard Leaders, the PC producers, are so cost effective, and so much lower in price, than is Apple.

In Part II, we will see how this same pattern is playing out in the smart phone market.

Discounts - Much Greater Than Most Assume

Recently, we did an extensive analysis of various forms of price reductions and discounts. In particular, we were interested in seeing how big discounts tended to be. Across roughly 850 instances of discounts, we found that the median discount was 25%. 75% of all discounts were 10% or greater.

Discounts in distressed markets are often much higher. Numerous examples reside in Florida condominiums. This market grew far too fast for demand and then collapsed quickly. Retail prices for condominiums there have fallen from 30% to 40% off their peak prices. If you are a big buyer, one capable of doing a bulk purchase, discounts are even larger. In one example, a condominium project had a cost of $340 per square foot to build. The complex had 375 luxury units which sat in bankruptcy. A developer bought 165 units at an auction sale at a price of $126 a square foot. That works out to a 63% discount on the cost of new building. (See StrategyStreet.com/Improve/Pricing/Reduce Price)

For comparison purposes, the median customer who is able to purchase a large package of a product buys that product at a discount of about 30% off of the retail price. 75% of these types of purchases have discount equal to or greater than 20%.

Service Levels Go Up, Not Down, in Hostility

A market in overcapacity is hostile. Surprisingly, in a hostile market service levels to customers go up, not down. (See “Video #36: Probable Priorities for Innovation in Hostile Markets” on StrategyStreet.com.) The airline industry is an example. The airline industry has been hostile virtually from the day it was deregulated in 1978 until today. During that time, the industry has made great strides in reducing its costs and increasing its service levels at the same time.

Here are some interesting statistics that bear out this contention. These statistics compare the airline industry in 1969 to that of 2009. In 1969, 172 million passengers flew U.S. Airlines. By 2009, that number had grown to 770 million. In 1969, there were 5.4 million flights. By 2009, the flight numbers had risen to 10.1 million. Service levels, as measured by number of flights and number of passengers, clearly have risen over the last forty years. During that time, safety clearly improved. Fatal accidents per 100,000 departures were 1.3 in 1969 and .1 by 2009. Pricing dropped as well, because costs dropped. In 2009, it cost a passenger 14 cents to fly one mile. The comparable number in 1969, using 2009 dollars, was 34 cents. Today you can get to more places faster by airliner than you could in 1969. Service levels have risen.

Naturally, those of us who fly would complain that service levels in terms of comfort have fallen drastically. Meals used to be free and there used to be ample space for knees and luggage. Those days seem to have passed...or have they?

The airlines have learned time and again that customers will not pay for onboard meals and more leg room. However, those customers who are willing to pay for more comfort can fly in economy plus or business class or first class. The prices for these services today are much lower than they were several years ago. So no matter how you slice it, service levels have risen in the industry when you look at the service levels for which customers are willing to pay.

The same holds true in every hostile industry. (See “Video #37: Performance Innovation Tradeoffs in Hostility” on StrategyStreet.com.)