How premium companies can cope when competitors pile it high and sell it cheap Adrian Ryans.
Sometimes consumers will put up with a lot to secure a good price. Just look at Ryanair, which is almost as famous for its tough, no-frills approach to customer service as for its cheap airfares. As a business model it’s one that works: for much of 2009 and 2010 its market capitalisation exceeded that of Lufthansa, despite the German airline’s revenues being more than seven times higher.
Other sectors have seen a similar rise in “good enough” businesses, from low-cost retailers such as Ald i and Lidl to “fashion” retailers like H&M and Zara. These companies do not offer a premium service — for example, Aldi offers shoppers little choice other than its own-brand products, while the fashions on sale at H&M are not generally made of high-end fabrics — but consumers do not mind. Who needs choice when the off-brand beans are cheap and tasty, and the checkout process fast? Who needs top-quality tailoring on a new shirt that will only be worn for one season?
Given the right market conditions, low-cost competitors can rise and challenge industry leaders very quickly. Vizio is a good example: in 2004 it was a small supplier of low-cost big-screen LCD televisions in the US, with sales in that year of $20 million. Over the next few years it exploited the emergence of new channels for its products at discount retailers such as Costco and Walmart; by 2007 it was the third-biggest manufacturer of large-screen LCD televisions in the US, and by 2009 it was the market leader, with a market share of almost 22 per cent — just ahead of Samsung, but well ahead of Sony.
Responding to the low-cost challenge
How, then, should premium companies facing competition from low-cost rivals react? The first step is to understand the three types of core value propositions:
- Price value. This is focused on providing “good enough” solutions and offering these standard products and services at an attractive price. This is the core value proposition of low-cost competitors such as Aldi, Ryanair and ING DIRECT Bank.
- Performance value. Companies that emphasise this offer their customers a combination of superior functionality, innovative features, an exceptional user experience, excellent quality and style, and fashion leadership. Examples include Apple and Bloomberg.
- Relational value. This tends to be particularly important to customers who have complex, diverse needs and see value in being able to buy an integrated solution from one supplier. Companies will try to provide customised offerings — if that is what the customer wants. Examples include GE Medical Systems, Cisco and IBM Global Services.
Executives can then use this framework to think through their options; many will choose to use a combination of two or more of them.
The first option is to directly challenge low-cost competitors by moving into the lower tiers of the market and offering a “good enough” product or service that is competitive on price. Advantages to this approach including meeting a real market need, gaining additional economies of scale, creating sell-up opportunities, and helping to control low-end competition.
However, while this approach seems quite simple in principle, it is difficult to implement successfully. Developing the core product or service is often the easy part — the real challenges are finding effective routes to market, pricing, manufacturing, and organisational structures. Other very real risks include the possibility that you will cannibalise your own higher margin business, damage your brand, and lose focus on your core business.
Another possibility is distancing your business from low-cost competitors by increasing performance value through superior quality, performance, and style. Companies as diverse as Intel, Research in Motion and Gillette have done this successfully for a period of time. However, in many cases it is increasingly difficult to get a good return on investment from this strategy, particularly as the product category starts to mature. It can cost a lot to make what are, from the customer’s perspective, only marginal improvements, while useful improvements are often quickly matched by competitors. To increase performance value in ways that customers will be willing to pay for it requires a deep understanding of their needs. The days when companies could simply try to “out-spec” a competitor and hope that the customer found something useful are long gone; R&D investments have to be much more focused if a company is to get a good return on these investments. In addition, more and more customers, particularly in B2B settings, are looking for proof that improved performance value will lead to improved financial results.
The third option, used by companies as diverse as P&G, Tesco and Cisco, is to increase relational value. For example, Orica Mining Services — originally ICI Explosives — built more intimate relationships with many of its customers by moving from selling explosives to providing blasting services. It recognised that what mines and quarries wanted was rock on the ground that would meet the customers’ size specifications and facilitate further processing. To meet this need, Orica would take over the customer’s blasting activities and charge them for the rock on the quarry or mine floor that met the size specifications. As Orica developed more sophisticated models for blasting, it was able to deliver more and more of the rock in the specified size range, thus reducing waste and the need for additional processing of rocks that were too large. This created value for both the customer and Orica, and substantial barriers to entry for low cost competitors.
Only the paranoid survive
But the journey to improved relational value is often long and difficult. Companies who take it have usually begun with a performance value proposition for their customers. In many cases, their emphasis has been on providing the best-performing, highest-quality, most reliable products. This is very different to focusing more on delivering truly integrated solutions, which requires deep and intimate relationships with customers.
In almost every market, there are, or soon will be, customers looking for “good enough” solutions that are attractively priced. The low-cost competitors that emerge to meet this demand will eventually challenge the premium brands in the market. This threat may not be immediately apparent, but companies should not be arrogant enough to ignore it simply because initial losses are small. The sooner companies make the tough choices and start grappling with the implementation issues, the better their position will be in the long run.
Adrian Ryans is Professor of Marketing and Strategy at IMD
