The Kindle with Special Offers…not your typical low-end product

Amazon has introduced a low-end Kindle product, the Kindle with special offers. This Kindle sells for $114 compared to the standard $139 Kindle with Wi-Fi. This is not a typical low-end product. Low-end products offer fewer benefits than industry-leading products (we call these Standard Leader products) for either the buyer or the user of the product in return for a lower price. We call these low-end products Price Leaders. There are two kinds of Price Leaders. The first, called Strippers, strip out benefits for both the user and the buyer of the product in order to achieve a very low price. The second, Predators, offers the user equivalent benefits to the industry’s main product but fewer benefits for the buyer. On average, Price Leaders cost about 33% less than Standard Leader products.




You will note that the Kindle with special offers does not fit easily into either of these two Price Leader categories. It reduces the user benefits by delaying the use of the product until the customer has viewed advertisements. There is no change to the benefits offered the buyer of the product. The Kindle with special offers deviates from the norms of Price Leader products with its level of discount. The Kindle with special offers sells for about 18% less than the standard Kindle product.



The Kindle with special offers varies from the Price Leader pricing norm in another interesting and important dimension. Some of these “special offers” are really good deals for the average Amazon customer. In one particularly interesting offer, Amazon will sell an Amazon Gift Card worth $20 for just $10. So, an avid fan of the Amazon web site receives additional user benefits with this new low-end product. In many cases, these special offers may more than offset the disadvantage to the user of a delay in using the product while the user views an ad.



This new Kindle with special offers is a very creative product innovation. Congratulations to Amazon.

Evolution of the Smart Phone Market

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

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

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

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

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

Best Buy in a Leader's Trap

Few industry leaders believe their prices are too high. Often, they are right. They are usually less right in a market where prices fall. Consider GM in automobiles and IBM in personal computers in the past. At one time or another, most industry leaders will get caught in a Leader’s Trap, where they assume that customers will stay loyal to their products because the low-end products do not enjoy their quality and reputation. This assumption rarely, if ever, holds. Best Buy has been in a Leader’s Trap and its assumptions won’t hold this time either.

Through the third quarter of 2009, Best Buy was gaining market share in flat panel TVs and personal computers. However, in the most recent quarter of 2010, the company lost over 1% of its market share in televisions and computers to competitors who were discounting. (See the Perspective, “The Two Best Consultants in the World” on StrategyStreet.com.) Now, if it were just a simple low-end, low value competitor, Best Buy might not worry. But their discounting competition was Wal-Mart and Amazon. By any definition, these companies would count as peers of Best Buy in the television and personal computer retail market.

In the recent quarter, Best Buy emphasized high technology, and high margined, TV and personal computer products. Customers did not follow along. Best Buy noted that it had faced tough competition from off brand televisions at lower price points.

Best Buy could have offered private label products to compete with low-end, off brand, competitors. Its store brands include Dynex and Insignia. The company decided not to emphasize these lower-priced products in their promotions because they have low profit margins. Best Buy “failed” its customer by refusing to offer something that at least half the other competitors could and would offer. (See “Audio Tip #35: How Does a Company “Fail” in a Market?” on StrategyStreet.com.) Nor did competition “win” the customers who switched. Amazon and Wal-Mart simply took what Best Buy allowed them to take. (See “Audio Tip #34: How Does a Company “Win” in a Market?” on StrategyStreet.com.)

The result: Best Buy missed its targets and saw its stock price fall by 15%. The company lost market share to peer competitors. And its sales and profits fell in televisions and personal computers. Competitors gained strength.

Best Buy is a fine company with capable management. It won’t stay down for long. You may expect to see them leave the Leader’s Trap very soon.

Nokia Scores...and Fumbles

Nokia is an industry Standard Leader who struggles at the high end of the market.

Nokia demonstrates its grasp of the mass market with a recent pricing innovation in India. In that country, Nokia owns half the market. In order to encourage further growth in the market, Nokia plans to roll out new handsets in twelve rural Indian states. In these states, the company has allied itself with a microfinance organization that is buying the handsets from Nokia and selling them to women in rural areas on the installment plan for 100 rupees a week. 100 rupees is equivalent to about $2. These weekly installments continue for 25 weeks, for a total cost of $50 per phone. Nokia’s program makes phones more affordable to these new customers by providing them an extended payment option.

Nokia is not without its struggles, however. In the smart phone market, the company is beginning to lose share at a rapid rate. While still an industry leader, Nokia’s smart phone market share has fallen from 47.5% a year ago to 45% today. Apple and Research In Motion are the beneficiaries of Nokia’s share slippage.

This smart phone market is important to all industry participants. Smart phones are growing their share of the market. The Standard Leader phones are declining in sales, while smart phones continue to grow. They now account for 14% of the total handset market, up from 11% last year. These smart phones are Performance Leader products with substantial margins. They increase company profitability as well as growth.

One problem Nokia seems to be facing is that its applications don’t have the same ease of operation as do Apple’s offerings. Apple’s applications work better with one another than do Nokia’s. And Nokia has been slow to bring new functions to the market.

Nokia may be suffering from a phenomenon we call Price Point Bias. (See Audio Tip #89: Price Point Bias on StrategyStreet.com.) Price points, other than the Standard Leader price point, often cause Standard Leaders problems in an industry. Marketing oriented Standard Leaders dislike Price Leader products because they view them as trojan horses for lower market prices. Many also believe that low priced products depreciate the quality of the company’s brand name. At the opposite extreme, Standard Leaders dominated by an operations culture dislike Performance Leader products. They view these products as disruptive to the smooth flow of operations and to the low costs that smooth-running operations create.

For more information on this phenomenon, see StrategyStreet/Diagnose/Products and Services/Innovation for Customer Cost Reduction/Price Point Bias.

Competing Against Low-End Competition

The consumer food industry has both an opportunity and a challenge in today’s marketplace. The opportunity comes as consumers reduce their “eating out” occasions and, instead, eat at home more frequently. The challenge is the seemingly inexorable market share growth of the less-expensive private label products. Some of the responses of the packaged food industry to these opportunities and challenges give us some insight into how to compete with low-end competitors and offset the ravages of a tough economy.

Several of the branded food companies are instituting advertising programs emphasizing the value of their products compared to alternatives. They hope to increase their share of the growing eat-at-home market by emphasizing their good value. Oscar Mayer Deli Fresh Meats claims that they have deli fresh taste without the deli counter price. Lean Cuisine Frozen Foods claims that its products are good for the wallet. These companies are helping the consumer to see a cost advantage to the use of their branded foods in a difficult economy.

Competing with private labels is proving somewhat more difficult for the industry leaders, whom we call Standard Leaders. (See the Symptom and Implication, “The industry leaders are losing share” on StrategyStreet.com.) Some Standard Leaders argue that they offer better quality than cheaper alternatives. Others are responding directly to the low price challenge of private labels by discounting their products. Actually, relatively few branded food companies are discounting their products directly. Instead, several are offering discounts in kind. In this form of price discount, the company offers more product for the same price as the previous version of the product. Frito Lay is adding 20% more product to some of its snacks without increasing the prices. French’s is selling a 20 oz. bottle of French’s Classic Yellow mustard for less than a 14 oz. bottle.

Other companies assert the simple claim that their food is not expensive. A joint advertising venture between Chips Ahoy cookies and Capri Sun juice explains that a serving of the two snacks costs about a dollar. Del Monte argues that a consumer can stretch her food dollars because canned foods offer better value than frozen or fresh foods. Kraft Singles cheese slices claims that a Single’s cheeseburger costs less than a dollar.

Over the years, we have studied several hundred low-end competitors. We have analyzed how the industry Standard Leaders respond to these low-end challenges. We have concluded that there are four different types of low-end competitors: Strippers (some private label products), and Predators (most private label products) who are players who just offer low prices. The other two types of low-end competitor offer better performance as well as a lower price. The response to each of these types of low-end competitors depends on several factors in the marketplace.

In summary, we found that the Standard Leader responses to these low-end competitors fall into patterns. The ideal order of these responses would minimize the impact of the response on the company’s margins, as follows:

1. Ride out the challenge. The Standard Leader company does not change its own value proposition in response to the low-end challenge. Instead, it:

• Ignores the low-end competitor where the competitor cannot expand
• Blocks the low-end competitor by using legal challenges and control of information, among other means
• Acquires the low-end competitor

2. Improve the value proposition. The company strengthens its own value proposition to make itself more attractive to customers in the face of the low-price challenge. It:

• Adds a low price point in the marketplace
• Increases its current product’s benefits without increasing prices
• Reduces its prices, as a last resort

In order for a response to succeed, the Standard Leader company must ensure itself that its response will discourage future challenges and leave it better off than it would have been without the fight. (See the Perspective, “Turmoil Below: Confronting Low-End Competition” on StrategyStreet.com for much more detail on how to compete with low-end competitors.)

The Exceptional Growth of a Price Leader Product

In our terminology, a Price Leader product is a low-end competitor in the market place. It competes against both other Price Leader products and against Standard Leader products, which are the industry leading products.

There are two types of Price Leader products. They differ from one another in the benefits they offer the user and the buyer of the product. The user and the buyer may be the same person but the activities of each create different needs. The first type of Price Leader, a Stripper product, offers both the user and the buyer of the product fewer benefits than does the Standard Leader product. The second type of Price Leader product, the Predator product, offers the user the same benefits as the Standard Leader product but offers the buyer fewer benefits. Stripper products, as a group, usually have less than 15% of the total market’s unit sales. Predator products would also usually have a minority market share, though they may be on their way to becoming very powerful Standard Leader products as their buyer benefits increase.

Recently, the Deloitte’s Center for Health Solutions reported that 750M Americans traveled abroad for medical care in 2007. The same group predicts that, by 2010, nearly 6MM Americans will travel outside the U.S. seeking medical treatment. This is called “medical tourism.” It is a Predator product. Its Function benefits for the user are the same as those of the Standard Leader product, health care in the United States. The U.S. Standard Leader product is holding a high price umbrella over this new Price Point. This Predator’s buyer benefits, however, are considerably less than those of the Standard Leader product. The customer must travel in order to obtain the service, so its Convenience is lower. Also, because the services are provided in a foreign land, there are fewer Reliability benefits with the product than with the Standard Leader product.

The advantage that all Price Leader products have is their low price. In this example we can see that the low price is powerful indeed to produce such a growth rate in medical tourism.

Over time, the buyer disadvantages of medical tourism will decline due to the fact that many people will have tried it. These people will convince their peers that it is a safe and worthwhile product, reducing Reliability disadvantages.

Eventually, this Price Leader healthcare product will put pressure on both the pricing and the current business model for the Standard Leader’s equivalent services.

For more information, visit strategystreet.com.

Slowing a Price Decline with a Low-Priced Product

For the last several years, most landline telephone companies have offered special discount deals to customers who threaten to cut their landline service. But the trickle of customers leaving landline service, and depending solely on cell phones, has turned into a stream.

Verizon believes it has at least a partial answer to slow the customer defection from the landline business. The company is considering introducing a $5 monthly voice plan that would allow customers to receive unlimited calls, but dial out only to 911 and Verizon Customer Service. This is a new low price point in the market. This price point compares with the Verizon unlimited nation-wide home phone plans which start at $40 a month.

Verizon is pricing defensively, trying to keep customers from leaving the company for cheaper pastures. In order to develop this defensive pricing plan, Verizon made three choices: the approach to take, the segments to serve, and the components of price to use to serve those segments. For many more examples of these three choices and how they defend both market share and margins, see our new Perspective, “Meeting Falling Prices with Creativity” in the Perspectives section of StrategyStreet.com.

Market Share at the Low End of the Market

I was struck by a recent article about statins. A recent study has found that these cholesterol lowering drugs reduce the heart risk in even healthy patients. That fact was not what struck me, though. What jumped out at me was the size of the market share for generic statins. The generics in the statin market make up 49% of total prescriptions. The well-known Lipitor is the leading branded statin, at 27%, followed by Crestor at 9%, Vytorin at 7%, and Zetia at 6%. But the generics dominate all of those branded drugs. (See “Low-end products are gaining share of market” in the Symptoms and Implications on StrategyStreet.com.)

In our study of several hundred Price Leader products, those at the low end of a market, we found that there were two basic types of price leader competitors. Price Leader competitors distinguish themselves from the industry-leading Standard Leader products on the basis of offering different benefits to either, or both, of the buyer of the product and the user of the product. The buyer and the user may, in fact, be the same person, but their respective needs differ in each activity. (See “Turmoil Below: Confronting Low-End Competition” in the Perspectives on StrategyStreet.com.)

The first type of Price Leader we call a Predator. Predator products offer the user the same benefits as the industry-leading Standard Leader product, but offer fewer benefits for the buyer. For example, the product may have the same ingredients but have a lesser known brand name or be more difficult to find in the stores. Private label suppliers, PC clone makers, Advanced Micro Devices, semiconductors and Drypers disposable diapers are examples of Predator competitors.

The second type of Price Leader product is a Stripper. This low-end competitor reduces benefits for both the buyer and the user. These companies reduce the Functions and Features available to the user. They offer the buyer less well-known brand names, low marketing budgets and often inconvenient locations for purchase. Jet Blue Airways, Motel 6 and Costco Wholesale Corp are examples of Stripper competitors.

It is rare for these low-end competitors to garner more than 15% of a market’s unit sales. It does happen, but not often. When it does happen, it is most likely to be a Predator competitor who will do it.

Generic statins are Predator products, but their market share is astonishing. It serves as eloquent witness to the power of institutional buyers over corporate marketing. The big buyers of statin drugs, corporations and insurance companies, have forced the growth of the generic drugs. The drug companies’ marketing programs have ceded market share to the generics in order to hold the branded product’s prices high. My guess is that the calculus behind this decision by the drug companies is a good one, though the trade-off between a high market share and lower price, compared to a higher price and much lower market share, are probably pretty close.

A Standard Leader Blocks the Price Leader Competitor

Enterprise Rent-A-Car is an astute, well managed company. They have grown to the number one position in automobile rental by using their management skills to beat the likes of Hertz, Avis and National. Now they are starting to close the door on a growing low-end, Price Leader, set of competitors. A Price Leader is a competitor or product that offers below industry-standard performance for a very low price. More than 50% of a Price Leader competitor's total unit volume is usually sold at price points below the Standard Leader product.

This low-end, Price Leader, part of the business is car sharing. This is a club-like service where members join and then rent cars by the hour in locations close to their home or business. The leader in this industry is Zip Car Inc. This company has 250,000 members and 8500 corporate clients. Zip Car, as well as most of the industry, exists only in the larger cities in the United States.

So what has Enterprise done to stunt the growth of Zip Car? It has gone after the largest customers in the industry, in big geographic markets, with a comparable product. (See the Symptom & Implication, “Low end products are gaining share of the market” on StrategyStreet.com.) Enterprise has created WeCar branches at several partner businesses around the country. It plans to deal only with the largest customers, businesses. By contrast, Zip Car gets most of its business from consumers, a costlier market segment to serve. It currently has WeCar locations at Google’s office in San Francisco, Washington University in downtown St. Louis and at sporting goods retailer, REI’s offices in Kent, Washington. The company has been attracted to this car sharing price point because it is a booming business in an otherwise slow-growth industry.

In the long term, it is likely that the industry’s Standard Leaders, including Enterprise and Hertz, will be the leaders in this low-end price point. (See the Perspective, “When Product Mix Matters”, on StrategyStreet.com.)

How the High End Company is Vulnerable

The housing market is in a shambles, especially the new home construction market. In partial response to this horrible market, some of the home building industry’s largest competitors, including Toll Brothers and Hovnanian Enterprises, have entered the custom home market. Their entry illustrates the strengths of companies at the high end and exposes their vulnerability.

In the custom home market, small builders design and build homes for customers who own their own lots. These customers go to these high end builders because of Function. The builders will design and build exactly what the customer wants. The Features and Functions of the home are precisely built to the customer’s specifications. (See “How Customers Buy” in StrategyStreet.com/Tools/Perspectives.) We call companies at the high end of the product spectrum Performance Leaders. These companies usually offer Functions that the industry’s largest competitors, whom we call Standard Leaders, do not offer. (See “Success Under Fire: Policies to Prosper in Hostile Times” in StrategyStreet.com/Tools/Perspectives.)

There is not much of a market for the Standard Leaders in home building today. New home construction rates are near historic lows. In search of some market, then, these Standard Leader builders have begun offering custom-built homes. There are two types of these homes: semi-custom homes, which are developed from the builders’ pre-drawn plans; and custom homes, which are built to the buyer’s specific specifications. The Standard Leaders are entering the Performance Leader’s territory with both semi-custom and custom homes.

Why would a custom home customer buy a Performance Leader product, such as a custom home, from a Standard Leader company? There are three answers to this question. The first answer is that the customer wants Reliability. These customers want to be sure that the project will be finished as promised. These Standard Leader builders have more resources available to them and have a proven capability to complete a project, where sometimes Performance Leader builders might falter. Second, the customers for the custom home buy on Convenience. Some of these customers have found that the Standard Leader builders can produce a custom home in half the time it takes for the Performance Leader builder to complete the project. Finally, these custom home customers also buy on Price. The economies of scale that the Standard Leader builders can bring to the Performance Leader product category enable them to offer lower prices, per square foot of home. In fact, these prices can be as much as 25% below those of the Performance Leader custom home prices.

Performance Leaders are usually strong on Function. But Standard Leaders can attack their market, offering better Reliability, Convenience and Price. The Standard Leaders’ high end product is “almost as good as” that of the Performance Leader company’s product, but it is much cheaper.

This Standard Leader attack from below pattern has recurred many times. Another example is the Lexus line of automobiles offered by Toyota. In the early years of Lexus’ debut, Toyota priced the Lexus at a breathtakingly low price compared to its competition from Mercedes and BMW, among others. This price advantage shot Lexus into the market. Today, the Lexus enjoys a much higher price level but it is still less expensive than BMW or Mercedes.

RV Market in Hostility

The RV market is in hostility. A hostile market sees low returns on investment, even for the industry leaders. One of the largest players in the market, Fleetwood Enterprises, has seen five straight years of losses. Another leader, Winnebago Industries, while still profitable, has seen four consecutive years of falling sales. This hostility has been caused by a rapid and deep fall-off in demand.

Once an industry enters hostility, it will usually witness a “flight to quality” where customers migrate away from weaker competitors toward those offering a better value proposition. (See the Perspective “Success Under Fire: The Policies to Prosper in Hostile Times” in StrategyStreet.com/Tools/Perspectives).

Few companies, even the largest, perform well in hostile markets. For every Toyota there are several companies like GM, Ford and Chrysler. Many of the policies that make a company successful in normal times get in the way during hostility. In fact, some of the rules for success seem downright counter-intuitive. Briefly, there are five rules that seem to be patterns for companies who succeed in hostile markets:

1. Strive for a good mix of both large and medium-sized customers. Ignore demands of small customers.
2. Cover a broad spectrum of price points. Avoid over-reliance on the high or low price points.
3. Differentiate your product and company on the basis of Reliability. Unique product Features are less valuable.
4. Turn price into a commodity. Seek payback in sales volume, not in price.
5. Emphasize productivity and economies of scale in the cost structure, but remember that good value for the customer comes first. You can’t cut unit costs without customers buying the units.

For more description of these patterns and their implications, see “Staying Alive in a Hostile Market” in the Tools/Perspectives section of StrategyStreet.com.

Microsoft Office Versus Google Apps

Microsoft has problems getting its stock price up where it thinks it belongs. Some analysts believe that the reason, in part, is that Google has introduced free substitutes for the Microsoft Office products. These substitutes are called Google Apps and include spreadsheet and word processing applications. The fear is that Google’s advertising-supported free applications will force Microsoft to reduce prices on Office products where it enjoys a 70% gross margin. These fears are premature and probably overblown.

Google Apps is a long way from offering a true challenge to the Microsoft Office programs. They do now, and probably will for the long-term future, appeal only to small customers. By small customers, we mean customers who buy in very small quantities and account for less than 10% of the total market. (See Basic Strategy Guide Step 2 on StrategyStreet.com.) The big buyers are likely to stay with Microsoft for a long time. If history is any guide, Microsoft will have to suffer reliability problems with its Office programs, failing its customers, before a low-end competitor is likely to gain much market share. (See Basic Strategy Guide Step 7 on StrategyStreet.com.)

When, and if, it must respond, Microsoft has a number of options (see “Turmoil Below: Confronting Low End Competition” in the StrategyStreet/Tools/Perspectives section of StrategyStreet.com). One option is to duplicate exactly the Google business model. Microsoft would introduce a product with the same features as the Google Apps product. It would offer the product for free and rely on advertising to pay for the product. Given Microsoft’s much longer experience with Office-type products, their features and reliability are likely to be easily as good as, and more likely much better than, Google Apps. If “free” is what the customer wants, and in return the customer is willing to put up with advertising and somewhat stripped features, reliability and convenience, Microsoft should be able to match Google with little problem. This would effectively end the Google challenge to Microsoft.

Will this hurt Microsoft’s margins? It is unlikely, providing Microsoft does this soon. Microsoft could design a product specifically for smaller customers and use advertising to support it. These are customers that are not likely to buy the Microsoft Office product anyway. Or at least they wouldn’t buy it for themselves. They may already use Office at work. Microsoft is probably on pretty sure footing, as long as it acts expeditiously.

Discounters at the High End

Even high-end brands can offer lower-end products. We call the high-end companies and products Performance Leaders. These companies and products offer better performance than the Standard Leader products in an industry for prices starting at least 10% over the Standard Leader product prices. Price Leader competitors are those companies who offer less performance than the Standard Leaders products for prices generally starting about 25% below those of the Standard Leader.

Even Performance Leader brands can offer Price Leader type of products. These Price Leader products are high-end products with significant discounts to the normal high-end prices. This concept developed years ago with the emergence of off-price retailers and the Performance Leaders brands’ own outlet stores. The concept has evolved today to where these stores have their own distinctive merchandise and independent lives.

In today’s stressed economy, many of the higher-end brands are putting more emphasis on their factory outlet stores in order to keep their growth going. Cole Haan, the shoe company, plans to renovate or open 40 total outlet stores over the next two years, as it seeks high-end customers looking for bargains. Other companies doing the same include Liz Claiborne and Talbots.

These companies have to walk a tightrope. They want to protect their high-end, Performance Leader, brand and at the same time offer a lower-end product to keep growing in the marketplace. Most of these companies manage that tightrope walk by limiting the number of factory stores and by ensuring that these stores are at some distance from the locations of its main branded stores.

Some companies may prefer not to walk this particular tightrope. But if competitors will walk that tightrope, you may have little choice but to follow in their footsteps or see them gain market share at your expense.

For more on this subject, visit http://www.strategystreet.com/

The Picture of a Predator

Heico Corporation is a Predator. In our research, we have found that there are four types of low-end competitors. They differ from one another in the benefits they offer, compared to the industry-leading products, to either the user or the buyer of the product. We call the industry-leading companies and products Standard Leaders.

Heico Corporation is a Predator type low-end competitor. Compared to the industry Standard Leader product, it offers the same benefits to the user of the product with lower benefits to the buyer. Its products work the same but the company is not well known. Heico becomes a low-end competitor by way of the substantial discounts it offers on its products.

A bit more information about Heico and its industry. Heico supplies replacement parts to airlines, who use these parts to overhaul and maintain their airliners. Not everyone can make these parts. Before a company can make and sell these parts, the plans and prototypes for each product must be specifically approved by the FAA. Once approved, they then may be used as replacement parts. There are about 125,000 parts in the airline industry. Heico has approval from the FAA to produce 6,000 of those parts, and it adds 400 new parts each year. The company is highly profitable. For the last three years, profits have climbed by at least 14% annually. Heico is fast-growing as well. Sales are growing at the rate of 18% a year.

You might imagine that Heico is up against some relatively weak competition. Not so. Its main rivals are companies like General Electric and Pratt & Whitney. Heico controls only 2% of the total market for component replacement parts. The company gained that 2% by offering airlines prices that averaged 25 to 30% less than those offered by the largest competitors.

Heico is taking advantage of the price umbrella of the large name-brand parts makers. These companies price replacement parts very high in order to raise the profitability of their relationships with the airframe manufacturers. The big competitors hold these price umbrellas very high and this, in turn, has allowed Heico to offer discounts of 25 to 30%, despite enormous disadvantages in potential economies of scale.

The large parts manufacturers are in a Leader’s Trap, where they assume that their customers will stay loyal despite the low cost offerings of a low-end competitor. Over the long term this never works.

The Leader’s Trap is almost certainly going to be costly to the larger competitors because Heico has one very important wild card in its hand. Since 1997, the company has had a strategic alliance with Lufthansa, which is the world’s largest independent provider of engineering and maintenance services for aircraft components and jet engines. This is a very large customer endorsement of Heico and its products. With this Lufthansa implied assurance of Heico’s quality, the company’s 2% share will turn into 4, the 4 will turn into 8 and the 8 will continue to grow until the larger competitors decide that it is time to confront Heico. That confrontation will be bloody.
To learn more about low-end competitors and the way they operate in an industry, go to StrategyStreet.com and review Step 15 of the Basic Strategy Guide and the page Diagnose/Products and Services/Innovation for Customer Cost Reduction/Value Proposition using the navigation bar.