While it may seem entirely intuitive today, the concept of the “experience curve” was first offered in a Harvard Business Review article in 1964. The thesis was that as the number of units produced goes up, the cost per unit should come down.  Within the service economy, there are similar expectations. The bigger you are, the easier it should be to apply overheads and bring costs down.

Almost every industry is more competitive than it was 10 years ago.  Customers are more demanding than ever, expecting Nordstrom’s service at WalMart pricing. We have one client whose customers actually have efficiency gains written into their contracts (i.e. their customer EXPECT prices to go down, and not up). In things such as budgets and sales productivity, the entrepreneur must demand incremental improvements every year because that is what customers expect.

In order to survive the experience curve, the entrepreneur must seek out business model innovation.  In a world of reverse engineering, where your product can be mimicked around the world in a matter of days, sustainable advantage is more readily maintained through creating entirely new business platforms.

Amazon earns about a 5% markup and turns its inventory 25 times per year, compared to a discounter that might earn a 20% mark up and turn its inventory 5 times.  Unlike a typical retailer that is dependent on vendors and cash flow to fund inventory, Amazon’s model is “buyer financed”, creating a float of 41 days between the time a customer buys a book and the time the publisher is paid[i]. Thus Amazon has a distinctive cost and cash flow advantage, even over other internet retailers. In today’s environment, a two percent cost advantage can be material, and allow a competitor to undercut a market.

The quickest way to garner the experience curve is through technology.  Organizations can easily benchmark technology spending within their industry through the statements of public companies and the like.  If you are spending 2% of revenue on technology, and others are spending 4%, it is likely that some will outpace you in terms of efficiency, speed and cost.

Another experience curve gambit can be found in quality initiatives such as Total Quality Management, Lean Manufacturing and Six Sigma, all derived from a thirst for quality improvement, efficiency and cost cutting.  Becoming leaner is not a choice as much as a necessity, and the race is underway in manufacturing environments to be the leanest.  The race never ends.

In a bold move this month, Amazon doubled royalties paid to authors for electronic books. Given the surging popularity of book readers and the release of the iPad, Amazon is attempting to lock in its position as the distributor of e-books. The segment tripled in volume in 2009.

As an author, what is of particular interest to me is that this transition represents a seismic shift in the control of a distribution channel. For years, publishers controlled the shelf at popular book sellers such as Borders and Barnes and Noble. Thus authors are highly incented to push distribution through publishers, even though they hog all the profit.

The advent of the electronic distribution channel (which dilutes the value of media through lower pricing) will now offer the originator volume and margin, if they have the gumption to self distribute. What are the ramifications of this trend in other industries?

The golden rule is that for physical products, the last mile of distribution is always the most expensive. This is why home delivery of groceries (Webvan seems so far away) has never succeeded. The grocer can move product in mass more efficiently than the consumer can.

But what about categories of products that are traditionally moved through distributors that will no longer require a middle man or special handling? Could we buy automobiles direct, or water for that matter? Could television be streamed straight to our TV’s without the need for cable or a dish?

If your business is reliant on distributors, or you are one yourself, it may be time to consider if your model could be disrupted and by whom. Do distributors in your space add value to the product or diminish from it? As internet applications continue to proliferate, it is time to think provocatively about what radical changes may take place in the way your products and services move through the value chain.

Part 1 of a two-part post

One of my fondest memories of the 90’s was my weekly trek to the local independent book store to sip espresso while previewing the latest business books (I had no life back then either).  With the emergence of Internet booksellers, independent book stores are on the verge of extinction.   

The book business is braced for another watershed moment.  Last week, Walmart announced their intent to be the low cost leader for books online, and sent the first salvo with the announcement of a cut on the top 10 hardcover titles to the bare bones price of $10.  Not to be outdone, Amazon matched the price within hours.  Later that day, Walmart cut the price again to $9, only to be matched by Amazon, as an entire industry gasped, “holy commoditization”!

Walmart is not only sending a shot over the bow for the book business, but for the future of Internet retailing. Amazon, already positioning the Kindle as the next killer app, will need to redefine how books are sold and downloaded to maintain competitive advantage.

Welcome to the slippery slope of competing on price.  Walmart is the “category killer” on everything from baby formula to tires. Walmart and Amazon are built from the ground up to support the business discipline of low cost leadership. One salesman tells of a time he called on a Vice President of Purchasing at WalMart who had lawn chairs set up as his office furniture.  A scarcity mindset is part of WalMart’s DNA and its daily decision making.

Walmart can afford to cut prices, every time a competitor enters the fray.  The annoying Walmart smiley face has become a caricature of low pricing and a message that Walmart will not be undersold. The problem with being a low cost leader is that there is a low cost of entry as upstarts attempt to buy business with lower margins.  Lower margin businesses also have more risk, as one or two bad quarters can put the low cost operator out of business.

 The only way that low cost leadership can be sustained is through scale, or technological advantage (often a function of scale).  When scale can be achieved, the bottom end can make money on purchasing power and operating efficiencies. Only a few companies in any space can create enough volume to remain competitive.  The complex combination of attributes that combine into a unique selling proposition must continuously be shaped and prodded to create more value.

Part II of this post will focus more on how to price in the competitive marketplace.