Benefits of Intense Competition: Lower Prices and Better Products

No segment of our economy has been under more intense pressure than the manufacturing sector.  Lower labor costs in many parts of the international economy have forced manufactured product prices down and shifted manufacturing jobs out of the United States.  Competition has indeed been intense.

Over the years, we have done in depth studies of more than fifty industries who have faced intense competitive markets.  We found both what you might expect and, also, what you wouldn’t expect.  You would expect that costs in a difficult industry would fall as companies work to make a profit despite the falling prices that accompany intense competition.  What you might not expect is that product quality and supporting service levels increase at the same time as costs and prices fall.  Customers simply will not buy a poor product even if its pricing declines. 

The broad measures of the manufacturing sector illustrate these same conclusions.  Manufacturing in the U.S. is finally growing again.  In 2010, manufacturing jobs increased for the first time since 1997.  Today manufacturing is growing at three times the rate of the domestic economy.  Consider, as well, the following facts as noted by Jerry Jasinowski, a former President of the National Association of Manufacturers:

• American exports of goods rose 21% in 2010.  Conclusion: the quality of our goods is rising.

• Manufacturing output in the U.S. today is twice that of the rate of the 1970s, in real terms.  Conclusion: we are more cost competitive today than we were in the 1970s.

• Between 1987 and 2008, manufacturing productivity grew by more than 100%, while the rest of the business sector’s productivity increased by less than 60%.  Conclusion: we get far more out of our workforce today than we did in 1987 and than many businesses do today.

• Between 1995 and 2008, manufacturing prices decreased by 3%, while the overall price level in the economy increased by 33%.  Conclusion:  while product quality has improved, and costs have fallen, prices have also declined.

The overall picture the manufacturing sector portrays, over the last twenty-five years, is that hostile market conditions produce better products and lower prices for customers, both at the same time.

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

Another Creative Pricing Scheme

It is not often that you see companies using really unusual pricing to build future business. Here is one that I like.


Every price has three and, usually four, components: the Benefit Package, the Basis of Charge, the List price and usually some Optional Components of price. The Benefit Package includes all of the Function, Reliability and Convenience benefits associated with the main product. The Basis of Charge is the way the company quantifies the unit of sale that it prices with the List Price, which is the stated price per unit of product sold. The Optional Components of price enable the company to leave the List Price unchanged, but to alter the value the company offers the customer by changing Functions, Reliability or Convenience benefits beyond those of the main product. The most creative pricing schemes usually involve the Optional Components of price.


Recently, we described one of these Optional Components of price, a Call, offered by Continental Airlines. In this blog, we will describe a “Put” offered by Best Buy. A Put is an Optional Component of price that enables the customer to sell back a product to the seller at a stated price in the future.


Best Buy recently introduced the Buy-Back program for various electronic gadgets it sells. This program adds a fee to the original List price of the product. In return for that fee, the customer gets the right to bring the product back for up to two years for a return value of a stated percentage of the original List price of the product. These percentages run from 20% to 50%, depending on the time of the return. The value of the return itself comes in the form of a Best Buy gift card. Best Buy hopes the customer will use this gift card to purchase an upgrade on the product that the consumer returns.


This Put may be attractive to consumers concerned about the speed of technological innovation in electronic gadgets. The Put effectively reduces the future price of purchasing a new electronic gadget. It leaves the current List prices and future List prices unchanged. It also increases the odds that Best Buy will be the retailer who delivers the new technologically-advanced product.

Apple Gets Crossways with App Developers

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

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

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

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

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

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

The iPhone Versus the iPhone

After nearly four years, AT&T has lost its exclusivity on Apple’s iPhone. It has been a great run. Now AT&T faces the formidable competition of Verizon, who started offering the iPhone in February of 2011. Market shares are about to shift. Let’s look at how they might change.

Market shares among established customers shift for one of two reasons. (See Audio Tip #40: The Components of Market Share Change" on StrategyStreet.com.) First, a competitor may “win” market share by offering a benefit that more than half of the market suppliers do not offer. On the other hand, market share may shift away from a competitor if it “fails” its customer relationship and opens that relationship to other competitors. A company “fails” a customer relationship when it refuses, or is unable, to offer something that half the other competitors in the market can or will offer.

AT&T garnered much of its share gain over the last four years with a “win.” That “win” was due to its exclusive offering of the Apple iPhone. While it won business with the iPhone, it developed a reputation for problems in the quality of its services. iPhone users tended to overwhelm the AT&T network and cause interruptions and dropped phone calls. AT&T’s customer service has been suspect as well. Still, its market share has grown with the iPhone, primarily at the expense of the smaller carriers. Its market share growth due to the exclusive on the iPhone offset its “failures” in its network and customer service.

Now Verizon enters with its own version of the iPhone. Today, any customer who wants an iPhone can choose either the largest competitor in the market, Verizon, or the second largest competitor, AT&T as his or her carrier. So, Verizon can “win” market share against the smaller competitors as well. These competitors, such as Sprint, Virgin Mobile and others like them, do not offer the iPhone and are unlikely to do so soon.

Verizon should also be able to gain share at the expense of AT&T. Here’s how. iPhone-using customers who are dissatisfied with their current service with AT&T now have a viable, high quality competitor offering an equivalent service with the same phone. Some of these customers will leave AT&T because they perceive that AT&T’s services are not up to the standard of the other competitors, especially Verizon’s, and migrate to Verizon. This is a phenomenon we call “flight to quality.” This “flight to quality” is also an example of a “weak win,” where a competitor gains share only after an incumbent supplier has “failed” the customer relationship.

This “flight to quality” is unlikely to be dramatic. A company can “win” share quickly with a unique Function. On the other hand, a “flight to quality” usually brings share gains in dribs and drabs. It produces share gains slowly, over time, because of inertia in the customer relationships. This inertia allows AT&T time to get its house in order before it suffers a great deal of customer immigration. (See Video #36: Probable Priorities for Innovation in Hostile Markets on StrategyStreet.com.)

Google at Risk

Google continues to dominate the search market. It commands about two-thirds of all the searches done on the internet. Its next closest rival is Microsoft’s Bing which, at 28% market share, includes its integration with Yahoo’s site. (See “Audio Tip #9: Introduction to Step 3 of the Basic Strategy Guide” on StrategyStreet.com.) Google’s dominance in this market has brought with it a disproportionate share of the spending on paid advertising. Google may be putting that premium position at risk.

Google has been investing heavily in developing its local search capability. It hopes to gain even more advertising dollars by making this investment. Now the problem. Some companies, who also specialize in local marketing have begun complaining that Google discriminates against their sites in favor of Google’s own local search results. This is a very dangerous development for Google. It risks its Reliability reputation.

Google’s competitors have had a difficult time gaining market share against Google. As competitors develop new Functions, Google simply copies them. Internet searchers have had little reason to shift from Google to other competitors, including Bing. In our terms, Google’s competitors are not able to take market share away from Google by “winning.” (See “Audio Tip #32: Introduction to Step 7 of the Basic Strategy Guide”) They have not been able to do anything unique that causes a substantial portion of customers to shift their searches to Google. Rather, most of the market share that shifts in this market today comes as the result of a “failure.” Google must fail to meet its searcher’s expectations in order for Bing and the other competitors to have a significant opportunity to gain market share.

Google may be creating this opportunity by risking a failure in Reliability. A searcher has to know that Google will provide the most relevant results. If Google offers up its own less relevant results ahead of other web sites’ more relevant results, Google will lose market share. (See “Audio Tip #72: Reliability Failures Among Outstanding Companies” on StrategyStreet.com.) Google’s actions in promoting its own results over more relevant results are equivalent to a retailer offering a customer a lower quality product over a higher quality product simply because the retailer makes more money with the lower quality product. After a while, customers catch on and defect to other retailers. A failure in Reliability is particularly troublesome because trust is so hard to rebuild.

Sometimes Smaller is Better

Retailers suffered through the last two years with low or declining sales as typical consumers struggled with an economy in the doldrums. Some of these retailers experimented with cost cutting and discovered an innovation for customers.

As retail demand fell, some retailers decided to reduce the size of their stores and cut their inventories to fit the smaller market they were facing. One company, Anchor Blue, put in temporary walls and cut its selling space in half. This certainly saved them money. It also provided a big surprise. Anchor Blue found that its foot traffic rose by 7% and sales increased by 23% after the remodel.

As other stores had the same experience, bigger chains began their own small-is-beautiful experiments. Bloomingdales and Nike are both trying smaller stores. Retailers are reducing their inventories by removing the slower moving items. These changes enable their customers to find, choose and pay for their products faster. In other words, the smaller stores are a Convenience innovation that customers seem to like.

We seem to be reaching a limit in the retail world. For the last generation, retailers grew by increasing Functions in ever-larger stores. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) They added categories and assortments to increase customer choices. These Function innovations demanded more space. More choices and space added to the time customers had to spend at a store. The Convenience innovation of the smaller stores suggests that customers have reached saturation points with the larger stores offering more choices. Sometimes smaller is better. (See the Perspective, “Is Bigger Really Better?” on StrategyStreet.com.)

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.

Microsoft Phone 7 - A Long Row to Hoe

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.

Mobile Hears Big Footsteps

A short while ago, we wrote a blog about Radio Shack’s rebranding itself (See Blog HERE) as primarily a mobile product carrier. At the time, we predicted that Radio Shack would have a difficult time competing on Function with Best Buy. Though, it would be more Convenient than the average Best Buy. (See “Video #26: Example of the Customer Buying Hierarchy at Work” on StrategyStreet.com.)

Best Buy is ramping up its mobile product investment now. The company has created 80 stand-alone mobile stores from a standing start in 2006. It may add as many as 100 new shops this year. In addition to these stand-alone shops, BestBuy Mobile operates as a separate store within all 1,000 of Best Buy full-sized stores.

The company has set itself up to be able to catch the mobile wave without committing itself to high costs over the long term. The BestBuy Mobile stand-alone stores average 1500 square feet of footprint. The stores within the regular Best Buy stores are only 600 square feet. These stores compare with an average of 40,000 square feet for a regular Best Buy store. (See “Audio Tip #188: The Efficiency of the Input” on StrategyStreet.com.) The small footprint allows the company to offer fast-growing products in Convenient mall locations near consumers, especially women consumers. In a few years, when growth slows, the company can withdraw from these small locations at relatively little cost and fold the mobile business back into its large regular stores.

BestBuy Mobile looks to be the Function leader in this market. It offers ninety different handsets and service plans from nine carriers. They offer products that work on the networks run by all four major wireless carriers: AT&T, Verizon Wireless, Sprint Nextel and T-Mobile USA.

BestBuy Mobile offers clear advantages over the stores run by the wireless carriers. Their prices are lower. Pricing is also clear and easy, with no mail-in rebates. And the company promises that the customer will leave the store knowing exactly how to use their phone in what the company brands as its “Walk Out Working” product promise. This promise is both a Reliability and Convenience benefit.

Everyone else in the industry must be hearing Best Buy’s big footsteps.

Wal-Mart and the Customer Buying Hierarchy

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

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

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

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

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

Reliability in Tough Markets

The stats for the light vehicle sales in the U.S. during the month of February are out. Of course, Toyota’s sales shrank by nearly 9%. The surprising big winner was Ford, whose sales increased 43%, far more than anyone else. Its nearest competitor, Nissan, had a sales increase of 29%. GM’s sales increased by 12%. What may be driving this superb performance from Ford?

We often use the Customer Buying Hierarchy to evaluate a company’s performance against its competitors. The Customer Buying Hierarchy argues that customers buy Function, Reliability, Convenience and Price, in that order. Customers continue to cycle through their alternatives until they have chosen one supplier who offers something important to the customer that no one else offers. As we have noted before, in tough marketplaces, high Reliability is a hallmark of the best industry performers. (See the Symptom & Implication, “Competitors are emphasizing reliability in product quality” on StrategyStreet.com.)

Ford’s reliability is impressive today. (See the Perspective, “Reliability: The Hard Road to Sustainable Advantage” on StrategyStreet.com.) The National Highway Traffic Safety Administration measures the complaints it receives about automakers and their products. Their measure is number of complaints per 100,000 vehicles sold. Honda is the leader here, with about 64 complaints. Ford follows at 81, then Toyota at 91 and GM at 104. So, Ford’s quality seems to be somewhat better than Toyota’s today. That is at least one reason why Ford is in the ascendant, and while Toyota is falling off the pace.

The Pre Looks to Go Post

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

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

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

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

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

Retailers as the Source of Creativity

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

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

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

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

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

Hit Them on Both Sides of the Head

One of our local newspapers is running a series on the problems of public transportation in the San Francisco Bay Area. The problem seems to be that ridership is well off of plan. The economy, and its attendant reduction in jobs and squeeze on commuter pocketbooks, has reduced demand.

Virtually all of the authorities in charge of the various modes of public transportation have found the same magic elixir for this sickness. They plan to reduce services and raise prices at the same time. Let’s see now. We find that demand is off and our answer is to reduce what people can get for their money (offer less) and to charge them more to get that “less.” How is this likely to work? This will work only if the authorities can raise the prices enough to offset the likely accelerated loss in commuter revenues that the Price increase and Performance decrease is likely to bring.

Let’s use a few simple concepts to express better what is taking place. Any business offers a Value to its customers. The Value is a combination of the Performance the business offers the customer plus the Price the business charges. The Performance includes Benefits such as Features, Reliability and Convenience of purchase. The company must beat its competition in offering this Value in order to grow market share. Right now customers are telling public transportation authorities that the current level of service for the price charged is not high enough to keep all of them using public transportation.

The business supports its Performance with its Cost Structure. The company’s Cost Structure must allow the business to make a margin on the sale of the product to the customer. Here again, the business must have a Cost Structure at least as productive as that of its competition or its margins will be lower than those of the competition. Most of these public transportation authorities are losing money. They may not be less productive than direct competitors because there are so few of those kinds of competitors. However, they are less competitive than the consumer’s alternative, perhaps even the consumer’s own automobile.

A business in a loss position has negative margins. Costs are greater than revenues. The business has two levers to pull in order to get out of this situation, other than stringent cost reduction on the current Cost Structure. First, it may raise Prices and hope that the additional revenues on the customers who stay will be greater than the revenues lost by customers who leave due to the higher price. Second, it may reduce the Performance it offers the customer as well as the costs that support that Performance. As costs come down, margins may increase, as long as customers do not defect. In extreme situations, a business may raise Prices and reduce Performance at the same time.

How extreme is this radical approach of raising Prices and reducing Performance at the same time (gutting the former Value proposition)? Over the years we have evaluated thousands of Price increases. We have found that companies are able to raise Price and reduce Performance at the same time in about 3% of the cases where Prices rise in an industry. When you see this kind of an action, you can usually assume that the industry has very strong pricing power. (See the Perspective, “Who Has Pricing Power?” on StrategyStreet.com.) For example, HP and Lexmark International launched lower capacity ink cartridges with smaller price tags to try and counter the growth of off-brand printer ink sellers. These cartridges had starting prices below $15 a cartridge but their cost per ounce of ink was higher than the predecessor products. In another case, the cable T.V. industry for years prospered by raising prices well in excess of inflation at the same time as forcing consumers to buy packages of channels, including many channels the customers did not want or ever use.

Occasionally, you also see the phenomenon of a raised Price and decreased Performance in an act of desperation to save the business. (See the Symptom & Implication, “New competition is entering a settled market” on StrategyStreet.com.) The airline industry has begun charging for previously free services, such as checking bags and serving onboard meals at the same time that its prices have gradually risen. The legacy airlines may have no choice. The difference, in this case, is that the airline industry is operating at higher levels of utilization and actually has a bit of pricing power today. Newspaper publishers have raised prices and reduced coverage in their print products to stay alive. The outlook for public transportation, and some other industries in desperate need, such as newspapers, is grim.

The Wrong Customer

CVS Caremark is struggling. The Caremark side, which is a pharmacy-benefit manager, is bleeding losses and major customers. The company picked the wrong customers.

CVS is one of the country’s premier retail drug store chains. The company has grown through acquisitions over the last several years. On the retail drugstore side, these acquisitions have been a great success. Not so, on the pharmacy benefit side. (See the Perspective, “Buying Share, Not Sand” on StrategyStreet.com.)

A couple of years ago, CVS beat out Express Scripts, a competing pharmacy-benefit manager, to win Caremark. The other competitors in pharmacy-benefit management are independent companies, focused strictly on the wholesaling of drugs to large companies and institutions.

CVS has trodden another path. As a retail druggist at heart, CVS developed innovations aimed at the retail, rather than the wholesale customer. For example, the company offers the Maintenance Choice plan that lets pharmacy-benefit management patients pick up 90 day prescriptions in its drug stores at the same low price they would pay through the mail. Of course, this helps CVS sell more products through its drug store chain. It does not, however, help the wholesale customer who makes the pharmacy-benefit management buying decision. (See “Video #34: Types of Product Innovations That Reduce Customer Costs” on StrategyStreet.com.) But there is even a downside for the retail customer, the employee of the wholesale customers. These retail customers must use a CVS drugstore to fill their prescriptions or see their drug co-pays rise to 50% rather than 25%. Hear loud protests off-stage.

Trouble started early in this acquisition. The wholesale customers have been unhappy for some time. In fact, last year CVS offered lower prices to more than half of its pharmacy-benefit management customers in order to keep them from defecting. A few other clients simply left,
discouraged by the fact that CVS seemed to be focused more on the retail, than on the wholesale, customers.

Of course, the Medco’s and Express Script’s are delighted to be picking up such easy share from the failures of CVS Caremark. (See “Audio Tip #35: How Does a Company “Fail” in a Market?” on StrategyStreet.com.)

The eBook Competition

Amazon and its Kindle products have had the eBook market to themselves since the market began taking off a couple of years ago. The eBook market is now starting to grow fairly fast. Sony has decided to grab some of that growth.

Sony is entering the market with three price points: a $199 entry product called the Reader Pocket Edition, the $299 Reader Touch Edition with a touch screen and the high-end Reader Daily Edition at $399 with both touch screen and wireless capability.

Very fast-growing markets see market share changes due to Function and Price innovations. Let’s use the Customer Buying Hierarchy (see Audio Tip #95: Customer Buying Hierarchy on StrategyStreet.com) to evaluate Sony’s prospects against Amazon.

The Customer Buying Hierarchy holds that customers buy using four major criteria: Function, Reliability, Convenience and Price. Customers go through the hierarchy in that specific order and purchase when there is one, and only one, competitor who can offer them a unique benefit.

Function refers to the way the customer uses the product. Function innovations in this eBook market are two types: hardware innovations and content. In hardware, Sony has two Price Points with a touch screen capability that Kindle does not offer. On the other hand, the regular Kindle 2 offers wireless downloads. The only Sony product that offers wireless is the high-end Reader Daily Edition at $399, compared to Kindles’ $299 Price Point. Without considering price, it is hard to call a winner when the Kindle 2 offers wireless connectivity while the Sony offers a touch screen.

Content is likely to be a different story. Sony has adopted the ePub format, which is an international format for digital books and publications. Amazon, on the other hand, offers eBooks which can be read only on Kindle 2 devices, a proprietary approach. Sony argues that its readers can download books from the local library using its format, saving costs. But libraries have only a limited number of digital copies of books available. And, if the market takes off, the authors and publishers are likely to severely limit the number of free library copies available to ereaders. Kindle, for its part, is the progeny of a book retailer. There are many books available through Amazon for the Kindle 2, far more than will be available for the Sony products. In addition, the Apple iPhone and the iPod Touch also allow their owners to read books in the Kindle 2 format. With its extensive experience and product platform already in the market, content providers are highly likely to choose the Kindle 2 format before choosing the Sony format, if they must make a choice. Certainly in the early going, the content, and thus the Function advantage, goes to Amazon and it’s Kindle 2.

Reliability refers to how a company keeps the promises it makes to its customers. For an end user customer, Reliability means that the product works and will be fixed promptly if it does not work. Amazon has a superb reputation for Reliability among consumers. Sony’s reputation is also good. However, since Sony produces mostly electronic gear, its reputation is unlikely to be as good as that of Amazon, who sells mostly digital products. I would guess Amazon gets a slight nod in Reliability.

Convenience refers to the ease with which a customer can buy and begin using the product. Sony’s products will be in 9,000 retail outlets, including all the leaders in the industry, this holiday season. Amazon sells its Kindle online. The customer can see and touch the Sony products in the many retail outlets. Seeing and touching a Kindle is much more difficult for the perspective Amazon customer. The nod in Convenience clearly goes to Sony.

Price is the last consideration. The Kindle 2 product has a price of $299. The Sony Reader Daily Edition has a price of $399. As we noted above, the Sony product offers a touch screen at this price. Kindle does not, at least not yet. The Sony product is a third more expensive than is the Kindle. This additional price is likely to make the Sony product a Performance Leader product (see Audio Tip #82: Performance Leader Products and Companies on StrategyStreet.com), rather than a true competitor for the leading Standard Leader position.

It is going to be difficult for Sony to make the $399 product the most common product in the market. Amazon’s Kindle has already established the industry standard for benefits and price. Sony would have been more successful offering its touch screen benefits at no price increase over the Kindle 2 Standard Leader product. Sony looks to be in a Leader’s Trap here. It will eventually have to reduce that price or see the product garner relatively little market share, likely well below 15% of the market.

Both Sony and Amazon would probably be better off if they responded to the content challenge each offers the other. Sony might try to license the Kindle software and offer that format, as well as the format. Then Sony could have competed on its strengths in making small electronic equipment. Amazon could add the ePub format to its software and open up a new world of content for its customers. This will become imperative for Amazon if a great deal of content comes available in the ePub format that is not also available in the Amazon proprietary format.

Sony in the Game Business

Sony has just introduced a new PlayStation3. This product comes in a new slim form factor. Its price is $299. This is a 25% reduction from the $399 price of the current model of the PlayStation3. The price cut comes as the PS3 has struggled against its competitors, whose products have carried lower prices. Sony was in a Leader’s Trap.

Not only is the PS3 struggling against lower-priced competitors, it is also facing the head winds of a badly depressed market. Industry sales of game hardware and software are down 29% from a year ago.

The problem? Even at the new price, the product is more expensive than the industry leader. Nintendo’s Wii console sells for $250. The wildly successful Wii sets the price bar for the heart of the market. Its total console sales have passed 20.7MM compared to just over 15.5MM for the Microsoft Xbox and about 7.9M for the PS3. A competing console price higher than $250 really focuses the customer’s attention on the value of the marginal benefits.

Sony justifies the fact that the PS3 will remain the more expensive console because it offers a Blu-Ray player. Customers may not see it that way (see the Perspective, “The Two Greatest Consultants in the World” on StrategyStreet.com). The new PS3 may end up as a high end, Performance Leader, product with limited market share.

Sony has climbed part way out of its Leader’s Trap (see Video #42: Leader’s Trap on StrategyStreet.com) but still has a way to go. You will see more of the same in our next blog.