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.

Amongst my favorite Seinfeld episodes was that of “The Soup Nazi”.  As you may remember the story line, The Soup Nazi banished Elaine from his soup kitchen with his announcement “No Soup for You!” While the Seinfeld clan’s attraction to the Soup Nazi may have been soup of extraordinary flavor, the episode offers marketers a more compelling recipe.

In her brilliant book “Different”, Youngme Moon points out that in a mature market, added features that are not highly relevant to the customer offer little incremental value.  She offers the concept of differentiating strategies through “reverse and hostile brands.”

While the Soup Nazi’s fare was surprising good, the service was shockingly bad. I am not suggesting that our clients start insulting customers anytime soon, but there is lesson to be learned from the Soup Nazi.  Disrupters understand the need to find separation, even if it means not offering services and benefits offered by the competition. Southwest Air offers no amenities, but does offer free baggage.  Where United and Delta says yes, Southwest says no and vice versa.

Menchies and similar self serve yogurt shops have exploded on the scene.  Eat all the yogurt you want and we are not going to serve you.  By the way, you are going to spend about a third more than you would otherwise. The model is distressing to our waist line but stimulating to our business sensibilities.  Tart yogurt flavors are particularly hot as they offer the opposite of what we have been conditioned to expect; as sweet is ying, tart is yang.

For a good laugh with clients, I have occasionally handed out calendars from despair.com.  A spoof of the overused motivational posters, they have similar imagery that says things like “Consulting: Why find a solution when you can prolong the problem?” The calendars are popular because they are funny, but also because they are a shock to our senses.  When ordering such a calendar you get an email to the effect of don’t bother calling us. 

To be different may require the marketer to be entirely counter to the marketplace.  The iPad is revolutionary but lacks USB ports and other goodies.  Apple is unapologetic, as consumers intuitively understand the tradeoff.

We are drawn to things we can’t have, and thus one potential strategy in value creation is “the take away”.  To suggest that your product or service is only available to a select group of customers increases its value. When clients ask us to do Executive Coaching we say no (it is not in our core competency) which makes our Strategic Planning services worth more.  Customers know that to get something really good, they may have to give up something in return.

While I am not encouraging anyone reading this to go negative, I am suggesting we need to think more provocatively about creating products and brands that are not only innovative and different but counter to our thinking.  That may include cutting out benefits that we naturally assume are necessary, but may just be redundant. I wonder if George would go for the vanilla tart or caramel latte?

Fighting off Commoditization

The authors of a recent HBR article (How to Stop Customers from Fixating on Price by, Bertini and Wathieu) reached a rather shocking conclusion; “the best tool for getting people to see beyond price may be the price itself”. 

Most executives I run across complain about the bloodletting occurring in almost every industry.  Buyers have become skeptical that there is any distinguishable difference between the vendors who serve them in terms of quality, service and price.

The fastest way to grab the attention of the buyer is to price radically. This requires that you either have a service model that allows you to provide the lowest cost, or one that is dramatically higher. It may be counter-intuitive, but the highest price products attract the most attention.

When comparing like products, we are instantly drawn to the most expensive models (even if we do not intend to buy them) so that we can benchmark why they are better than the others.  In other words, we naturally perceive a higher price product as superior. If you were shopping for a watch and looked at one with diamonds that was $2,000; you would assume it to be a better time piece than one that is $500, even if there was no distinguishable difference in its functionality.

While we always advocate for bundling, the customer must perceive a value in the incremental features in the bundle, or they will not be willing to pay for it. If a provider is in a rush to discount, they desensitize the customer to the very benefits that they are touting.  If your service is priced 20% higher because you only used licensed or certified professionals, and you then provide them at the same cost, you have diluted the perceived value of the certification (which you probably paid handsomely for in the first place).

Perhaps the most innovative pricing response to hyper-competition is to restructure your pricing model so that it is completely alien to the market place. Bertina and Watheiu point out Norwhich Union, a U.K. insurance carrier who charges car insurance premiums by “miles driven” instead of annual premiums, providing a significant point of difference to traditional pricing models.  This is clearly more clever than appliance makers offering one model number at Costco and another at Best Buy as if we are too dumb to tell the difference. To create a new pricing model requires enough differentiation that the customer can distinguish more value in the way that they use the service. Pay as you go is a more efficient application of resources (which is the premise of cloud computing-using only the computer resources and memory you actually need). I am not saying pay as you go is better, I am saying it is different and therefore not comparable.

How can you position your pricing to be completely counter to the marketplace?

Part 2 of a two-part post on pricing strategy

Our last post spoke to the difficulty of sustaining competitive advantage as the low cost leader, a temptation for many in this sluggish economy.   Globalization has opened the market to big box retailers and up starts that can create a virtual offer overnight. Discounting is rampant in almost every industry, and the sluggish economy has reinforced  the  trend towards consumer thrift and a “treasuring hunting” mentality.

Consumers are trading down on some goods so that they can trade up on the luxury goods that they desire. Go into any suburban Walmart, and you will see a representation of Mercedes Benz in the parking lot. Upon boarding a Southwest Airlines flight, the business man in the next seat is apt to be sporting a Rolex watch.  The consumer (as well as the professional buyer) will vary their purchase triggers (quality, service and price), based on the use of the product they are acquiring. Customers find middle priced offers confusing because they are not sure if the product or service stands for quality and service (which they perceive as higher priced) or for value.

Now that the bar has been lowered on many goods and services, it will be hard to raise it again. Consider the plight of U.S restaurant chains.  Earlier this year, Bennigan’s and Steak and Ale skipped Chapter 7 and went straight to liquidation, (because their business was so bad). At around that time, operating margins by  segment were as follows:

• White Table Cloth (Ruth Chris 6%, Morton’s 4%)
• Casual Specialty (Cheesecake Factory 6%, Olive Garden/Red Lobster 9%)
• Casual (Bennigans, Steak and Ale–Chapter 7, Ruby Tuesday’s 5%)
• Fast Casual (Panera 9%, Corner Bakery/Chili’s 6%)
• Fast (McDonald’s 27%,  KFC/Taco Bell/Pizza Hut 12%)

White table cloth restaurants, operating on high margins were able to introduce an occasional special and remain solvent during the downturn.  Themed restaurants such as Olive Garden and Cheesecake Factory eked out a small profit. McDonald’s with its massive scale and zeal for consistency was able to capitalize on its dollar menu and build market share (McDonald’s and Walmart were the only Dow components to increase in value in 2008). The companies in the middle such as TGIF, and Ruby Tuesday struggle because they lack any differentiation and only create marginal economies of scale.

If restaurants are not proof positive that the middle had eroded, consider the department store industry. While Nordstrom’s and Walmart continue to thrive, Montgomery Ward’s and Mervyn’s shuttered their stores. The merger of Sears and Kmart was like two guys who didn’t know how to swim, grabbing for each other in the deep end.  Only differentiated Target is able to price in the middle (Target is priced 5-10% higher than Walmart).

Clearly, the highly differentiated brand that commands higher price points supports higher margins and less risk.  Many are asking, how can a company preserve premium pricing in this economy? Any company can discount, but to cut prices on more lucrative goods only commoditizes a brand.

One approach is to create a separate offering. Ultra luxury brand Coach has developed the “Poppy” line of handbags sold at a lower price point. By marketing a secondary line, Coach can maintain its leadership as a premium brand, while providing the consumer a lower price alternative.  Others are creating Internet offers which different products, case packs and terms (cash).

Marketers must make short term profit decisions within the context of long term brand positioning.  Customers equate higher prices to higher quality and lower prices to…well, lower quality.  A strategic view of pricing dictates that the value of the brand be preserved so that companies can take advantage of the real profit, to be made during the upturn.  While one may feel compelled to cut prices to fend off competition, consider the attributes of the customer you are acquiring…..a price buyer who does not value brands or quality. If you are unable to play on any field but price, it is an indication that more investment is required in creating a differentiated offer and unique bundle of services.