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.

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.

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 Importance of Consistency in the Approach to Pricing

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

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

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

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

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.

Using Finance to Reduce a Price

Dell is struggling to keep up with HP in the personal computer market. There is one part of the market, though, where Dell remains the clear leader, the small business market. Part of the reason for the company’s success in this market is its financing package. It is more generous with financial support than its competition. It may offer interest-free financing when companies purchase $25,000 or more of new computers. The company offers other creative financing deals. In one of these deals, a customer bought $30,000 of computers on a three-year lease plan that allows the customer to keep the equipment when the lease expires. Overall, Dell says that 22% of its small and medium-size business customers use Dell to finance their purchases. This 22% is up from 17% just two years ago. The company is gaining share by using its financing muscle, despite the chancy economic environment.

Offering financing, whether subsidized or not, is a way of extending the time a customer has to make its cash payment to the supplier. This is a form of discount. In our analysis of several thousand price reductions over the last twenty-five years, we have identified fifteen distinct forms of discount. The offering of financing is one of those forms. Many industries have relied on financing to build their businesses, even in difficult times. The automobile industry has used financing to offer attractive lease rates and payment plans to its customers using captive finance vehicles, like GMAC. GE has used its captive finance arm to finance customers in many of its product categories. In fact, GE has seen its captive finance arm grow into a lender in many markets where GE does not even compete as a supplier.

The home building industry has also used financing creatively. For example, last year Lennar offered special financing with no money down and a 3.625% mortgage rate for the life of its loans on purchases of Lennar’s newly built homes. Subsidized financing helped Lennar win new customers in an abysmal market. (See the Symptom & Implication, “Demand in the industry is falling” on StrategyStreet.com.)

Even small businesses use the extension of financing to build their businesses. Faryl Robin is a New York company that sells high-end women’s shoes. In the expectation that it would build its business with long-time customers in a tough economy, the company offered additional financing. In 2009, it offered retail customers with whom it had a long-term relationship an additional sixty days over its normal thirty day payment period for the customer to make its full payment for shoes she had purchased.

One Up, One Down, One Sideways

Three of the leaders of the automobile industry are presenting some interesting new stories. First, General Motors. The new Chairman of General Motors is Edward Whitacre. He is not a car guy. He came from the telecommunications industry, most recently as Chief Executive at AT&T. The Chairman recently asked the head of engineering at GM to call all the customers who had turned in their new cars under a recent quality program. This program offered customers a 60 day money-back guarantee. It allowed a customer who was unhappy with his automobile to turn it back to GM for a full refund. The head of the engineering group charged with calling the new customers noted that the focus on customer satisfaction was new at GM…and long overdue. This is a hopeful development for GM.

GM, for years, has had a poor reputation for reliability and durability. That problem seems slow to change, as witnessed by the recent quality survey by Consumer Reports. This survey criticized the company’s quality, finding it lower than the models from Ford, Honda and Toyota.

If the new top management attention to quality takes hold of the company, it is bound to improve its fortunes. It should move up with this development.

Fortunately for GM, its main competitor, Toyota, seems to be moving down, at least for now. Toyota became the leader in the automobile industry because of its reliability, but that reputation has begun to falter under the blows of recalls for rust problems and sudden acceleration in several models.

In a surprising upset, Hyundai Motors passed Toyota in J.D. Power & Associates survey measuring how many problems an automobile has in its first three months. A few years ago, Hyundai’s reputation for quality was equivalent to Madonna’s reputation for virginity. However, the Korean company instituted stringent measures to improve its quality, measures that seem to be paying great dividends today with their improved reputation and fast-growing market share. (See our blog on the quality changes at Hyundai HERE)

Ford seems to be moving sideways. On the one hand, its 2009 automobiles are getting good reviews from critics and the marketplace. The company is gaining market share. It also reported its first quarterly profit in four years. So, sideways, you ask? Yes, because Ford has a real problem with its cost structure. In October, the UAW refused to grant Ford the same contract terms that it had previously granted to Chrysler and General Motors. The most important part of the better terms that GM and Chrysler won was relief from the many work rules that restricted the work that an individual employee could do on the production line. These work rules make employees inefficient and idle. They reduce the company’s productivity. Not even Ford can face down a cost structure that is higher than those of its domestic and international competitors. Many of these competitors produce in non-unionized plants in the U.S., where work rules do not hinder productivity.

So, Ford is heading sideways until we see what it does to overcome this cost disadvantage. If the company follows the old GM approach of cheapening its fits, finishes and styling, it will lose market share and plunge into big losses. If, on the other hand, the company maintains the style and quality of its new cars, then it has a chance to address its longer term cost problems in ways that might be somewhat less disruptive to the UAW. (See the Perspective, “Achieving the Low Cost Position” on StrategyStreet.com.)

Ford’s situation is not promising. Many industry leaders, when faced with high and fixed labor costs in their industries, cheapen their products in order to eek out some profitability in the short-term. This always hurts them in the long-term. (See “Video #54: Cost Reduction by Winners vs. Losers in Hostility” on StrategyStreet.com.) The plight of the legacy airlines serves as an ample reminder of this tendency and its results.

Couponing and Price Leaders

In the bleak economy in the first half of 2009, coupon redemption rose 19% compared to the same period in 2008. Even the largest Price Leaders (see Audio Tip #83: Price Leader Products and Companies on StrategyStreet.com) have had to go along with this development. The three largest discount clubs, Costco Warehouse, Sam’s Club and BJ’s Wholesale Club have increased their couponing to club members. (See Audio Tip #120: Using Low Price to Gain Share in Hostile Markets.)

Each of these three clubs carries a membership fee to join the retailer. These club membership payments entitle the retail shopper to take advantage of the large scale purchase economies each of these stores enjoys. The stores pass on these purchasing economies in the form of low prices for their members. Often these low prices alone are enough to provide these club-oriented retailers with attractive sales growth. However, even they have suffered in the bad economy of 2009 as consumers have spent less on discretionary items.

Now each chain is offering tailored coupons to selected members. Sam’s Club offers electronic coupons through kiosks at its stores. Today these coupons are offered to its highest paying membership categories, the Advantage and Business Plus cardholders. With the new coupon program, these selected members will receive three new coupons, good for about a month.

BJ’s has traditionally accepted manufacturers’ coupons which Sam’s does not accept. In the last few years, it has also provided members with coupons available at its web site for purchases in its stores.

Costco has been offering once-a-year coupon books, containing discounts with expiration dates staggered throughout the year. This keeps customers coming back to take advantage of the discounts. About a year ago, it began sending monthly coupon books with discounts expiring after four weeks.

In a tough market, even the lowest-priced of the Price Leaders have to offer something extra to keep the customers coming in.

A coupon is a form of discount (see Audio Tip #114: The Key Components of a Price on StrategyStreet.com), the method a company uses to convey a discount to a customer. Our research has determined that there are eight other forms of discount. Many of these forms reduce the cost of the discount to the company, while giving the full value of the discount to the customer.

Two Pathways to Low Cost

There are two pathways to low cost: Focus on particular customers and their product needs; or create economies of scale. When you combine both, you have a powerful low-cost engine that is also attractive to customers.

Several years ago, I consulted for a high tech company. This company sold components for a much larger technology system. The company’s customers were many times the size of my client. Most of the technology system companies who could have been my client’s customers produced their own component rather than purchasing from a merchant outside supplier like my client.

I asked my client CEO how he expected to out-perform the in-house competitors he faced in the marketplace. He had to be at least as good, if not better, in Function, while being lower in Cost and Price. His answer was focus. His company did nothing else but produce this component. Everyone in his company focused their attention on improving the component and reducing its cost. He argued that his in-house competition did not have the same advantages of focus that he had. His focus would produce lower costs and prices, which would be visible to these larger companies over time. Then his business would grow very rapidly.

I was reminded of this story while reading of a study done by Forrester Research. This study explains some of the changes happening in the outsourcing market.

Several Western companies who had opened centers in India to perform back office work in a cost-saving move have now sold these operations. Several of these companies had decided early-on that they could save the 15 to 20% profit margin that Indian outsourcers typically charge by building their own centers. In many cases, this has proven to be a false economy.

The Forrester Research study estimated that it cost about 25% more for a company to operate a captive center in India rather than to have an outside company provide the same services. In other words, the outsourcing company is able to create a profit for itself that allows it to finance and grow its business, and still charge prices 25% below the costs of the captive center. (See Audio Tip #182: Productivity as a Measure of Physical Costs on StrategyStreet.com.)

How can this be? The answer comes in noting the buyers of these centers. (See Diagnose/Costs/Quantifying Cost Reduction Objectives on StrategyStreet.com.) In virtually every case, the buyer of these centers, which western companies are closing, are large Indian outsourcing firms, such as Wipro Ltd. (See Audio Tip #196: Why Economies of Scale Exist on StrategyStreet.com.) As these Indian outsourcers purchase the centers from the western companies, they gain two important benefits. They acquire experienced employees and guaranteed contracts from the western companies extending for a period of years. These Indian acquiring companies then have the benefit of both focus and economies of scale. This combination will make them an even stronger presence in the market.

New Product in a Fast Growing Industry: Bing

After failing more than once to create an innovative and attractive search product, the persistent Microsoft is back with a new entry called Bing. Let’s use the Customer Buying Hierarchy to evaluate the prospect for the Bing’s success.

The Customer Buying Hierarchy (see “Video 27: Full Description of How the Customer Buying Hierarchy Works” on StrategyStreet.com) holds that customers buy a product using four categories of evaluation: Function, Reliability, Convenience and Price. Function (see “Video 13: Definition of Function” on StrategyStreet.com) refers to the features of the product that affect how it is used. Reliability (see “Video 14: Definition of Reliability” on StrategyStreet.com) refers to the benefits of the product that assure the customer that it works and will continue to work. Convenience (see “Video 15: Definition of Convenience” on StrategyStreet.com) refers to the ease with which the customer may find and purchase the product. Price is the cash cost the customer pays for the product.

We will begin with a look at Function differences. The search industry has two customers: The consumer searcher and the advertiser. This new Microsoft entry is drawing some good reviews for consumers and some wait-and-see opinions from advertisers. Bing offers some new Function innovations that reviewers prefer to Google’s search results. It appears that the consumer will find Bing an improvement on Google. The advertisers, however, are adopting a wait-and-see attitude. Google’s market share, at over 60% of the current search market, is massively larger than is Bing or its Microsoft predecessor. Even Yahoo Search is much larger than is Microsoft in the market. Many of these advertisers plan to wait to see whether Bing will become the new Google.

The Reliability and the Convenience advantages in this market belong solely to Google. The company name has become a verb describing a search. Most people know about the Google product and believe it to be the market leader. A large percentage of desk top and lap top computers have the Google toolbar with its search box resident on their computers. Google is an easy default choice for most searchers.

So, what is the outlook for Bing? The success of Bing largely depends on what Google does to respond to the Function advantages Bing is bringing to the market. This is still a fast-growing market. This works in Bing’s favor. Consumers are likely to be willing to try something new if they think it might help. Switching to Bing from Google or Yahoo offers little difficultly. Microsoft has the cash to put on quite a marketing blitz. All of these Convenience factors work in Bing’s favor. However, Microsoft has to rely on the forbearance of competitors in order to win in this marketplace. It has to maintain its unique Functions in order to best Google in a world Google dominates. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) If Google copies Bing’s new Functions, Bing will lose its advantage and will not succeed. The Reliability and Convenience advantages that Google enjoys today give it time to copy Bing’s Function advantages without losing much of its current market share.

If Google neutralizes Microsoft’s Function advantages soon, Bing will bring only modest market share changes.

How 'Bout We Throttle This Golden Goose?

Now that GM has entered bankruptcy, there are many opinions crossing the wires about the likelihood of the new GM being a successful stand-alone company. I thought I might as well add to this crowd noise.

First of all, let’s consider the problems that caused the bankruptcy. The first, and least forgivable, cause was the management team. The management team, some years ago, gave away the store to the UAW. They promised wages, benefits and work rules that were non-competitive in the world market. They agreed to numerous, costly work rules, high wages, generous time off and extensive retiree benefits. Once they had made these concessions, management was afraid to face the prospect of a long strike that might have recaptured some of the company’s cost competitiveness. Effectively, labor costs became fixed.

The second source of the problem was the UAW or, more specifically, the leadership of the UAW. Once labor costs became fixed, they “owned” the golden goose called GM. They have watched for years as GM gradually ebbed away because of the high costs that the union contracts imposed on the company. They stuck to unbelievably ill-advised programs like the Jobs Bank, even while GM was hemorrhaging losses. Tell me. What did the leaderships of General Motors and the UAW study at school that led them to conclude that they could withstand an uncompetitive cost structure on the world stage? Who teaches that economics course?

Once management realized that it had put itself in an untenable cost position, it made changes to its products in order to reduce all the other costs of the product, other than wages. (See Video #47: Rules for Cost Cutting in Hostility on StrategyStreet.com.) Among these changes, the company created look-alike cars across its various platforms. It reduced the quality of its finished product so that the company developed a reputation among consumers for poor workmanship. This reputation caused the resale value of GM cars to fall below those of its international competitors and raised the cost of ownership for its customers. In another similar move, the company cheapened the interiors of its automobiles so that a customer sitting in a GM car found its quality of finish well below that of its competition. All of these, of course, were self-defeating cost reductions. This is a common phenomenon in tough markets. Common, but destructive. These changes caused GM to see its market share fall by about 1% a year for many years. The further the company’s market share fell, the more onerous was its labor cost structure with its high fixed costs.

So, O.K., the company has entered bankruptcy and most of its investors have suffered disastrous losses. Will GM emerge as a successful company? After all, the UAW has surrendered some of its high wages and some other rights, especially the right to strike for the next several years. And, the UAW is now a major owner of the new General Motors.

We have seen this movie before, however, with United Airlines. The labor unions, especially the pilots’ union, became major shareholders of United Airlines in trade for wage growth, as that company sought to restructure in order to reduce its cost structure. Union members in the airline industry, though, quickly figured out that a dollar of wages was worth a lot more to the union member than was a dollar of profits to all shareholders. High and uncompetitive wage demands continued, despite the fact that United Airlines was losing both market share and profits. Eventually, the pilots demanded, and won, such a high level of compensation that United Airlines slipped into bankruptcy. So much for the benefits of union ownership.

There is a simple test to determine whether GM will be successful as a stand-alone company. It is not a test of management capability or will. It is more a test of the insight that this saga of destruction has brought to the leadership of the UAW. The current contract between the UAW and General Motors is the size of a telephone book. If the company and its key union end up with a contract more the size of a college term paper, the odds of success are high. If the contract remains the size of a telephone book, we tax payers can plan to spend a whole lot more money on GM for a lot more years. It won’t succeed as a stand-alone company.

Pricing in Highly Competitive Marketplaces

For the most part, the airline industry has been in overcapacity and hostile operating conditions since it was deregulated many years ago. During that time, the industry produced many pricing schemes and even more competitors. Over the last few years, the competitors have decreased, while the pricing schemes have burgeoned.

Many competitors fell away as the industry learned the difficult lesson that all airfares have to be the same or customers will choose the lower cost airfare. TWA, Eastern and Pan American were major carriers who disappeared in intense price competition. Nor did this price competition spare discount airlines. People Express no longer exists, nor does Presidential Airways, among many others.

But the industry learned something a few other industries have also learned. Most customers focus only on the quoted price. They don’t always consider the fees that might accompany their purchase. The airline industry developed an extensive list of add-on benefits for which they charge an extra fee. The list is long and growing. There are fees for checked bags, oversized luggage, priority seating, pets, unaccompanied minors, additional leg room, meals, drinks and snacks. Most of these fees are new over the last three to four years as airlines have found creative ways to increase their revenues by offering a la carte pricing. (See the Perspective, “Discovering Hidden Pricing Power” on StrategyStreet.com.)

These fee revenues have helped the airlines but they have a down-side for the airlines as well. When fees are not transparent, customers learn to distrust the answer when they search for the price of airline tickets. Many customers have learned that the quoted fare will not be the final price they must pay. (See the Symptom & Implication, “Customers are more price sensitive” on StrategyStreet.com.)

Abhorring a vacuum, several companies have rushed to offer information to the consumer about these often hidden fees. Today, companies such as TripAdvisor.com and FlyingFees.com, offer tools to calculate fees for various options a customer may choose while flying. These current tools have limitations. But the travel industry heavy hitters are about to join the battle. The giant, Sabre Travel Network, is about to introduce a broad-based suite of products that will enable travel agents and consumers to specify the services the consumer anticipates using and then see the full price of the ticket, plus the fees, the customer will incur. Further, travel companies are working to standardize the way that airlines include fees in their reservation systems. Some people expect these pricing benefits to be available within the next year. This is very similar to what has happened in the automobile rental industry. An auto renter can easily determine the total cost of the rental before signing on the dotted line.

Until now the airline industry has been able to charge different fees for the same service. For example, a consumer sending an unaccompanied minor on Southwest Airlines pays no additional fee. The same service on Air Tran brings a fee of $39. The service at Continental, Jet Blue and Alaska Airlines costs $75. If you want to fly an unaccompanied minor on the legacy airlines, Delta, American, United and U.S. Airways, the fee is $100.

Much of this pricing freedom is likely to erode as the travel companies bring more pricing information to the consumer. Most consumers will continue to operate the way they have in the past. They will ignore the fees and search for the lowest fare. However, enough consumers will pay attention to the full cost of the airline trip. These people will move their business if prices seem too high for the extra benefits they prefer to buy. This is likely to commoditize the price of these extra benefits.

The airline industry has done the consumer a service with its fee-based pricing innovations. Those customers who wish to fly for the lowest possible price can chose options that have few benefits. Those who want more benefits can chose those and pay for them accordingly. This is a sensible and helpful pricing strategy in a hostile market, for both the airline industry and the consumer.

The Flexibility of a Great Retailer

Many people in the United States have heard little of Tesco, but it is a great retailer. In fact, it is the fourth largest retailer in the world, following Wal-Mart, Carrefour and Home Depot.

Tesco has about 30% of the total grocery sales in the U.K. There it operates with several different formats and price points. It has been very successful, both in the U.K. and in the several other countries in which it has operated.

In late 2007, the company opened its first U.S. stores, called Fresh & Easy. There are now 114 of these stores spread out through California, Arizona and Nevada. The Fresh & Easy format calls for small stores of about 10,000 square feet, focused on food, with an “Every Day Low Price” pricing scheme where prices were 10 to 25% below those at regular grocery stores.

The economy immediately presented Tesco with big problems. The Western U.S. has been hard hit by the recession. Customers have grown accustom to “Every Day Low Prices.” As a result, while Fresh & Easy generates more sales per square foot than the industry average, the company has not been able to open as many stores as it had hoped.

The company has responded quickly and creatively. Since customers began to take “Every Day Low Prices” for granted, the company began emphasizing extra low prices on individual items. They promoted low-priced special items, using radio commercials. As an example, the company offered $9.99 Valentines Day bouquets through radio commercials. The company also began emphasizing its Buxted brands in its stores. In the meat isle, these private label products are trimmed less well than the standard Fresh & Easy products and cost as much as 40% less.

These pricing moves are impressive. Most low-end competitors, such as Fresh & Easy in the U.S. market, could not afford to emphasize even lower priced products and expensive mass media advertising. (See the Perspective, “Turmoil Below: Confronting Low-End Competition” on StrategyStreet.com.) Few, if any, low-end retailers would do this, but Tesco did.

The company also has made changes in the look of its stores. The company repainted the walls in pastels and added a warmer color to the concrete floors after customers reported that they thought the stores were too sterile. Remember, most of these stores are less than a year old. The maintenance schedule did not call for a new paint job. But the customer did.

I am not sure whether the current Tesco concept will succeed. It is likely, however, that Tesco will find a format that works well in the United States. Their moves to date demonstrate that they are a flexible and creative company, determined to succeed.

National Costs in a Global Economy

Dell Inc., the American computer manufacturer, is moving nearly half the jobs it has in Ireland to Poland. The move reduces Dell’s costs. It also sends a powerful message to the Irish and to other nations.

Ireland initially attracted Dell to manufacture in Ireland in 1990. Dell built a manufacturing facility in Limerick. Over the last few years, it has become the second biggest foreign employer in Ireland. Ireland’s low corporate tax rate and well educated workforce originally attracted Dell. Things have changed since 1990.

Ireland has now become a much costlier place to do business. (See the Symptom & Implication, “Some competitors seek price increases more aggressively than others” on StrategyStreet.com.) Yes, its corporate tax rate remains low, at 12.5%, but labor costs have increased and productivity has fallen. Energy costs have risen as well. The quality of the country’s infrastructure has slipped. And, very importantly, there is now more business regulation. All of these changes have reduced Ireland’s competitive position compared to other countries.

The result: more jobs in Poland and fewer jobs in Ireland. The Poles offer a lower cost structure than the Irish. In an international market, jobs can and do move. (See the Perspective, “Can We Raise Margins with a Price Increase” on StrategyStreet.com.)

As the U.S. contemplates changes in its labor regulations, it should heed the warning of this Irish situation. If labor prices go up faster than labor productivity, national jobs inevitably evaporate into the global ether.

The New Schwab Credit Card and What it Tells Us

Charles Schwab Corporation is introducing the Schwab Bank Invest First Visa Signature credit card. This no-annual-fee card offers an unusual set of benefits. First, it returns a 2% cash rebate on all purchases, one of the highest rebate promises around, and it has no pre-set spending limits. Most other cards impose minimum spending hurdles before the rebates kick in. Next, there are no category (e.g. type of retail) restrictions on the spending with the card in order to earn the 2%. This benefit contrasts with most rebate card programs that require spending at certain locations to get the highest rebate. Finally, Schwab charges no foreign exchange fees if the card is used overseas.

You see from the name of the credit card, the “Visa Signature” brand, that the card is targeted for big spenders. It is likely to succeed in attracting them. The benefits are very attractive in today’s market.

You may recall that the rewards credit card started back with the Citibank American Advantage card. This card offered one airline mile for every dollar spent on the credit card. And the card itself carried a fee. Until a few years ago, the value of the mileage rewards on credit cards was around 2%. Today, it is more likely to be 1%, if that, and the miles can be very difficult to redeem. It is no wonder that the largest growth in reward cards is in non-airline reward cards. This new Schwab card offers benefits worth at least twice what the airline cards offer and it charges no fees to boot.

Schwab is introducing this card in order to accomplish two goals with these very attractive large customers. First, they expect that new high net worth customers will open accounts with Schwab. Second, Schwab expects that many customers will consolidate their other credit card relationships with Schwab in order to take advantage of Schwab’s generous terms. Once the customer opens an account with Schwab, and begins using the new credit card, Schwab will credit the 2% of spending to the customer’s Schwab account. The customer, in turn, will use either a check or a debit card to withdraw the reward money.

This new Schwab product illustrates two patterns of market evolution. First, industry profits are high. You will read about the credit losses that the companies are incurring. They are, indeed, rising. Still, credit card issuing is a very profitable business. In fact, profits are so high that new entrants, like Schwab, are continuing to enter the market. The market is very attractive, no matter the anguished cries, as long as it has new entrants. (See the Symptom and Implication, “New competition is entering a settled market” on StrategyStreet.com.) Second, companies who sell several related products tend to dominate industries. Each new product may stand on its own base of profits, but it may also complement other products in the customer relationship. (See the Perspective, “Achieving the Low Cost Position” on StrategyStreet.com.) Industry leaders can afford to subsidize new products, if they have to, if they can gain new revenues and profits, either from selling a new customer other products or the new product to current customers. As long as the customer opens a new account, or consolidates balances with Schwab, Schwab will gain more than just the credit card profits from this new credit card.

This is not an uncommon pattern. You may recall the Netscape story. Netscape introduced a very profitable browser. Microsoft, as the industry leader, felt threatened by Netscape’s browser and introduced Internet Explorer in answer to it. However, rather than selling the Internet Explorer, Microsoft included it free in its Windows package and wiped out Netscape’s market. Microsoft figured that it made more sense to have the browser customer stay in the Windows family than to let that customer loose where someone else might offer him another operating system or office tools.

The Schwab move is consistent with the way the company has approached the market since Charles Schwab’s return as CEO. Before his return, the company was stumbling. It had raised its prices well above its peers. Customers were defecting. The company was losing market share and Schwab’s returns were dropping. Schwab returned as CEO, immediately reduced prices and the company became much more aggressive in the market place. The company’s returns grew apace. Nice job by Charles Schwab and the company.

This new Schwab credit card will threaten a lot of people, especially the legacy airlines. More on that in our next blog.

Cost Standards Come to the Service Industry

For many years, managers manufacturing have measured activities to a farthing using methods developed over a hundred years ago with the time and motion theories of Frederick Taylor. But throughout most of these last hundred years, the service industries have managed to elude this management approach. That may be changing.

The major consulting firm, Accenture Ltd., has a unit named Operations Workforce Optimization (OWO). This consulting group has created labor standards for several retail chains. These labor standards create the equivalent of standard costs for service employees, such as cashiers and stock people.

These new standard cost measurements, along with ubiquitous electronic technology, enable retailers to measure precisely the productivity of some service employees. A clock on the cash register starts as soon as a cashier rings out the previous customer. The clock continues to run until the current customer has paid and received a receipt. This measure of time compares to standards established by OWO and the company. The company then counsels low-performing cashiers to improve their times. OWO maintains that its methods can cut labor costs by 5 to 15%.

The question is, how do retailers best use this cost innovation? Certainly, they should be able to reduce costs by bringing poor performing employees up to a reasonable standard. At least some of the cost savings originate here. But they also should be able to improve customer service by reducing the time the customer must spend in the check-out line. Of course, reducing a customer’s time and reducing workforce at the same time can quickly work at cross purposes. There is where management must balance conflicting opportunities. In some cases, the cashiers, who are under the measurement system, have told customers they cannot talk to them, or do anything extra, because they are “on the clock.” In other cases, customers have found that they do, in fact, spend less time checking out. It will take an astute management team to make these trade-offs properly so that costs go down and customer service goes up at the same time. If the customer sees no benefit, the cost reduction can become self defeating. (See “Costs: The Last Consideration” in the Perspectives on StrategyStreet.com.)

These cost management innovations by OWO and its client retailers are examples of efforts companies make to reduce the units of input, in this case employees, not producing output, in this case customer transactions. The simple measurement of employee productivity is one major approach to reducing lost or wasted input. There are several other approaches producing the same effect. You can shift demand from high demand to low demand locations or times. You can improve the accuracy of the forecast in order to staff more appropriately. You may use short-term sources of help to shave the peak of demand with stretched capacity. And you can speed the process so employees spend less time waiting. (See the cost reduction ideas in the Improve/Costs/Reduce Units of Input Available but not Producing Output on StrategyStreet.com.)

Each of these approaches improve productivity if the company implements them right. If they are done poorly, however, they can actually reduce margins.

Masters of the Cost Cutting Universe

General Mills is a $13.7 billion food company. In 2007, the company increased its profits by 13% on a 10% increase in sales. It enjoys higher margins than either Kraft or ConAgra.

The company reaches these margin heights by a constant and unrelenting focus on improving the efficiency of its operations. The attention to cost containment emanates from the very top of the company.

Here are some of the cost savings the company has implemented in the recent past:

* Get rid of some of the fourteen different pretzel shapes in its Hot’n Spicy Chex Mix.

* Eliminating half of the more than fifty versions of its Hamburger Helper product.

* Eliminate unimportant spice and cheese pouches in the Hamburger Helper product.

* Shrink the size of the product box, while keeping the product serving size the same in order to reduce shipping costs.

* Eliminating multi-colored lids on Yoplait yogurt.

We have studied patterns of cost reduction for a number of years. Costs are Inputs of people, purchases or capital. These Inputs produce product Outputs. The cost reduction objective is to reduce the ratio of Inputs to Outputs. We have observed that there are four separate approaches to reducing costs:

* Reduce the rates the company pays for the use of an Input

* Reduce the number of units of Input that are wasted or idle in the production of the Output

* Redesign the product or the process to avoid activities or steps that are currently undertaken in the production of the Output

* Find new customers and sales volume, i.e. more Output, for fixed cost Inputs

The examples of the real-world cost reductions at General Mills all fall under the third category redesign the product and the process in order to reduce activities. In this case, the company eliminated components of the product that brought little value to the customer. The components the company eliminated may have generated some revenues, but the revenues they generated were far lower than the costs they caused the company to incur. (See the Perspective, “Cutting the Right Cost”, on StrategyStreet.com.)

The Improve/Cost section of StrategyStreet contains several hundred brainstorming ideas to control costs in even the best of markets.

Avoiding Wastage of Resources

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

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

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

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

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

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

Union Negotiations During Good Times

Boeing and its key union, the International Association of Machinists and Aerospace Workers, are clashing over negotiations for a new contract. The company is enjoying some of the best of times. As a result, the union has unprecedented leverage. So, what do these negotiations tell us?

The odds seem stacked on the union side. Boeing is in one of its most prosperous periods. Customers are lined up to buy almost 900 planes, and its current order book is being delayed because outside suppliers have been overwhelmed by the amount of work Boeing has sent them. This is partially the result of the struggles of the outside suppliers and partially the result of growth in the business. Boeing has hired nearly 12,000 employees over the last several years to bring the union’s ranks to nearly 27,000 workers. Boeing believes it cannot take a strike because it would anger customers who are already upset with delays. The union has unusual leverage to make strong demands. Almost a year ago, the union began urging its members to set aside money in case of a strike.

Boeing has learned from the troubles of many other U.S. manufacturers. The company has three objectives in its negotiations. First, it wants to limit its pension and healthcare liability by limiting the employees covered by the plans and by asking employees to pay part of the costs of health insurance. Second, the company wants to limit future retiree benefits. And third, the company wants changes in job security language that would permit the company to farm out work or bring in outside non-union employees to save costs.

One thing is clear from the outset. The union employees’ long term outlook for job security is already poor. Boeing is paying today more than it would need to pay in order to attract qualified employees The union has set a price for its product that is higher than the current open market price. Sooner or later, the market corrects these unbalances. Often, the correction takes the form of a new, lower-cost competitor. For examples other than domestic autos, see color TVs, airlines, trucking, railroads, steel and machine tools, among others.

The two sides spin these negotiations differently. The union argues that Boeing is negotiating like it’s in bankruptcy. The company says that it wants to stay off a course that would make it look like the three domestic automobile manufacturers in a few years.

The company is right here. (See “What Makes Returns High?” on StrategyStreet.com.) If they do not negotiate in a tough-minded way, they are almost certain to end up looking like the “Big Three” automakers in the long run. It is in the interest of all stakeholders, and especially of the current unionized workforce at Boeing, that the company hold down the rate of increase of cost for a work force that already exceeds what the company could purchase on the open market today.

This is the best, rather than the worst, time for Boeing to take a strike. Its profits are high and its products are the most popular in the marketplace. A few more weeks of delays are a small price to pay for long term safety of an employment contract that will enable the company to continue growing years into the future. The people who really cannot take a strike are those who let opportunities to hold down excessive employee cost increases slip away from them. Ask Ford, GM and Chrysler whether they could take a strike today.

Schlitz, Lessons From the Past

“Schlitz, the beer that made Milwaukee famous.” The older baby-boomers among us may remember that advertising slogan. It was all over the media in the 50s and the 60s. Schlitz, after leading the domestic beer industry for most of the first half of the 20th century, disappeared. It has been gone now for a long time. Recently, though, its current owner resuscitated the old brand and formula and re-introduced it to the market. Schlitz is in test phase now, mostly in selected mid-west markets, and its popularity sounds an echo of its former prominence. The story of the rise and fall of Schlitz offers lessons for us, even today.

The Joseph Schlitz Brewing Company was just one of many brewers in Milwaukee in the late nineteenth century. It became a top seller only after the great Chicago fire of 1871 wiped out its Chicago competition. The failure of other brewers gave Schlitz its opening to become a leader in the market. Here is the first lesson. It didn’t “win” its market. It gained its top billing because it was one of the last brewers standing at the time. The failure of a competitor is the source of most share gain in many of the markets that exist today. (See “Failure Shifts More Share Than Success” on StrategyStreet.com.)

In the early years of the 20th century, Schlitz entered its halcyon days. It was the world’s best selling beer for most of the first fifty years of the 20th century. Then, in the mid-1950s, the Milwaukee brewery’s workers interrupted production with a strike. The Schlitz product was scarce on the shelves and other competitors, such as Anheuser-Busch with its Budweiser brand, filled the gap. Budweiser and Anheuser-Busch have held the leading position in the U.S. market since that time.

Here we have a second example of the observation that failure is more likely to move share than is a “win”. Budweiser could not take share from Schlitz as long as Schlitz was readily available on the market. When Schlitz was not available, Budweiser gained share. Then Schlitz had to wait for Budweiser to “fail” before it would gain that share back. Budweiser didn’t fail.

In today’s market, the pilot’s union at United Airlines could learn from this lesson. Their occasional work actions to interrupt service for their employer, United Airlines, has caused that company to cancel several hundred flights. Great idea. Create failure for your employer in the marketplace. Allow others to pick up share that United would have held. Create a smaller airline with lower profits. Have fewer pilots and less revenue available to pay all employees, including the remaining pilots. Where do these pilots learn their economic history?

On with the Schlitz story. Schlitz remained a vibrant and profitable competitor, even after losing its leading share position to Budweiser. In 1970, it still had 12% of th market, compared to Anheuser-Busch’s 18%. Later, in the 1970s, new owners took over the business with the intention of expanding it. In order to do so with little investment, the owners shortened the fermenting process. They also had quality control problems with some of their ingredients that caused the beer to lose its taste. There was a lot of that poor quality beer out in the marketplace. But rather than recall it and correct the situation, the owners decided to weather the storm and sell the defective product in order to create more near-term profits. With this Reliability failure, customers abandoned the brand. By 1981, the Schlitz brewery closed and the Stroh’s Brewing Company from Detroit bought the brand. Stroh’s also struggled and became part of Pabst Brewing Company in 1999.

So we have another lesson from the history of Schlitz. If you fail in Reliability you are in real trouble. The first success of Schlitz came from others’ failure in Convenience. Schlitz had product when others did not. The first failure in the 1950s also came as a result of a failure in Convenience. The product was not available to meet demand. But the most devastating failure was the last one. That was a failure in Reliability. The company delivered a very poor product to customers that had long trusted it to be consistently tasteful. Things like that can be unforgivable. In this case, the Reliability failure was fatal.

So, good luck to the new Schlitz. Let’s hope it learns the lessons of its past and consistently delivers good quality beer in the future.