Strategies to Fight Low-Cost Rivals - Harvard Business Review

A successful two-pronged approach requires the low-cost business to use a unique brand name such as HSBC's First Direct or at least a sub-brand such as ING ... Youhave1freearticlesleftthismonth. Youarereadingyourlastfreearticleforthismonth. Subscribeforunlimitedaccess. Createanaccounttoread2more. Competitivestrategy StrategiestoFightLow-CostRivals Companieshaveonlythreeoptions:attack,coexistuneasily,orbecomelow-costplayersthemselves.Noneofthemiseasy,buttherightframeworkcanhelpyoulearnwhichstrategyismostlikelytowork. by NirmalyaKumar by NirmalyaKumar FromtheMagazine(December2006) Tweet Post Share Save GetPDF BuyCopies Print Summary.    Reprint:R0612F Companiesfinditchallengingandyetstrangelyreassuringtotakeonopponentswhosestrategies,strengths,andweaknessesresembletheirown.Theirobsessionwithfamiliarrivals,however,hasblindedthemtothreatsfromdisruptive,low-costcompetitors. Successfulpricewarriors,suchastheGermanretailerAldi,arechangingthenatureofcompetitionbyemployingseveraltactics:focusingonjustoneorafewconsumersegments,deliveringthebasicproductorprovidingonebenefitbetterthanrivalsdo,andbackinglowpriceswithsuperefficientoperations.Ignoringcut-pricerivalsisamistakebecausetheyeventuallyforcecompaniestovacateentiremarketsegments.Pricewarsarenottheanswer,either:Slashingpricesusuallylowersprofitsforincumbentswithoutdrivingthelow-costentrantsoutofbusiness. Companiestakevariousapproachestocompetingagainstcut-priceplayers.Somedifferentiatetheirproducts—astrategythatworksonlyincertaincircumstances.Otherslaunchlow-costbusinessesoftheirown,asmanyairlinesdidinthe1990s—aso-calleddualstrategythatsucceedsonlyifcompaniescangeneratesynergiesbetweentheexistingbusinessesandthenewventures,asthefinancialserviceprovidersHSBCandINGdid.Withoutsynergies,corporationsarebetterofftryingtotransformthemselvesintolow-costplayers,adifficultfeatthatRyanairaccomplishedinthe1990s,orintosolutionproviders. Therewillalwaysberoomforbothlow-costandvalue-addedplayers.Howmuchroomeachwillhavedependsnotonlyontheindustryandcustomers’preferences,butalsoonthestrategiestraditionalbusinessesdeploy. Tweet Post Share Save GetPDF BuyCopies Print TheIdeainBrief Formidablepricewarriors—suchasGermany’sAldisupermarkets,India’sAravindEyeHospital,China’sHuaweitelecommunications—havegobbledupestablishedplayers’lunches.Yetmanyincumbentsignoretheserivals,assuming—mistakenly—thatextremediscountingwilldrivethemoutofbusiness.Otherestablishedplayersmountpricewars,whichonlyslashestheirprofitswithoutdisruptinglowcostcontenders’leanbusinessmodels. Howtofightlowcostrivals?Kumardescribesfouralternativestrategies:1)Differentiateyourofferings,2)augmentyourtraditionaloperationswithlowcostventures,3)switchtocross-sellingproductsandservicesasintegratedpackages,and4)becomealowcostprovideryourself. Choosethestrategythatbestfitsyourcompany’ssituation.Forexample,whenIrishairlineRyanairrealizeditcouldn’tcompetewithAerLingususingmodestpricediscounts,ittransformeditselffromahighcost,traditionalcarrierintoalowcostprovider.Itsrevenuesjumped28%injustoneyear,anditboastedthehighestpunctualityrateofalltheEuropeanairlines. TheIdeainPractice Kumaroffersfourstrategiesforbattlinglowcostrivals: Differentiateyourofferings#•Youcancombinenumerousdifferentiatingfactors(e.g.,coolproductsandcontinuousinnovation).•Consumerswantthebenefitsyournewofferingswouldprovide.•Youcanreducethecostsofthebenefitsyouwouldoffer.#ComputermakerHP’srestructuringhasshrunkrivalDell’scostadvantagefrom20%to10%.AndconsumersappreciatetheaddedbenefitsHPoffers,suchasinstantdeliveryandtheabilitytosee,feel,andtouchcomputersproductsinstores.Addalowcostbusiness#Yourtraditionaloperationwillbecomemorecompetitiveasaresult.•Yourlowcostventurewillmakemoremoneythanitwouldhaveasanindependententity.•Youcanallocateadequateresourcestothelowcostunit.#DowCorning’sXiameterunit—alowcostproviderofsiliconeproducts—sellsonly350ofDow’s7,000offerings,soXiameterdoesn’tcannibalizeitsparent’ssales.ItschedulesmanufacturingwhenDow’sfactoriesareidle,sellsonlylargeorders,andoffersnotechnicalservices.AfterlaunchingXiameter,Dowturneda$28millionlossin2001intoa$500millionprofitin2005.Switchtosellingsolutions#Therearenosynergiespossiblebetweenyourexistingenterpriseandalowcostbusiness.•Theintegrationofyourproductsandservicesprovidesuniquevaluetoconsumers.#AustralianminingcompanyOricasoldexplosivestostonequarries.Whenlowcostplayersemerged,Oricabeganprovidinganewservice:laserprofilingrockfacestoidentifythebestplacestodrillholesforexplosives.Theserviceimprovedcustomers’rockyields,reducingdownstreamprocessingcosts—andmakingcustomersdependentonthecompany.Orica’saveragesalesarebiggerthanwhenitsoldonlyexplosives.Becomeexclusivelyalowcostprovider#Therearenosynergiespossiblebetweenyourexistingenterpriseandalowcostbusiness.•Asignificantsegmentofyourconsumermarketbuysbasedonprice.•Youarewillingtoacquiresignificantnewbusinesscapabilities.#Ryanairchangedeveryaspectofitsbusinessmodeltobecomealowcostplayer.Itreplaceditsentirediversefleetwithjustonetypeofplane,beganoperatingfromsecondaryairports,andmovedfromtravelagencybookingstodirectbookingthroughcallcentersandtheInternet.Italsoeliminatedbusinessclass,freemeals,seatassignments,andcargocarrying. Leerenespañol Leremportuguês It’seasiertofighttheenemyyouknowthanoneyoudon’t.Withgale-forcewindsofcompetitionlashingeveryindustry,companiesmustinvestalotofmoney,people,andtimetofightarchrivals.Theyfindittough,challenging,andyetstrangelyreassuringtotakeonfamiliaropponents,whoseambitions,strategies,weaknesses,andevenstrengthsresembletheirown.CEOscaneasilycomparetheirgameplansandprowesswiththeirdoppelgängers’bytrackingstockpricesbytheminute,iftheydesire.Thus,CokeduelsPepsi,SonybattlesPhilipsandMatsushita,AviscombatsHertz,Procter&GambletakesonUnilever,CaterpillarclasheswithKomatsu,AmazonsparswitheBay,TweedledumfightsTweedledee. However,thisobsessionwithtraditionalrivalshasblindedcompaniestothethreatfromdisruptive,low-costcompetitors.Allovertheworld,especiallyinEuropeandNorthAmerica,organizationsthathavebusinessmodelsandtechnologiesdifferentfromthoseofmarketleadersaremushrooming.Suchcompaniesofferproductsandservicesatpricesdramaticallylowerthanthepricesestablishedbusinessescharge,oftenbyharnessingtheforcesofderegulation,globalization,andtechnologicalinnovation.Bytheearly1990s,thefirstpricewarriors,suchasCostcoWholesale,Dell,SouthwestAirlines,andWal-Mart,hadgobbledupthelunchesofseveralincumbents.Now,onbothsidesoftheAtlantic,asecondwaveisrollingin:Germany’sAldisupermarkets,India’sAra-vindEyeHospitals,Britain’sDirectLineInsurance,theonlinestockbrokerageE*Trade,China’sHuaweiintelecommunicationsequipment,Sweden’sIKEAfurniture,Ireland’sRyanair,Israel’sTevaPharmaceuticals,andtheUnitedStates’VanguardGroupinassetmanagement.Theseandotherlow-costcombatantsarechangingthenatureofcompetitionasexecutivesknewitinthetwentiethcentury. Whatshouldleadersdo?I’mnotthefirstacademic(nor,Idaresay,willIbethelast)toposethatquestion.Severalstrategyexperts,ledbyHarvardBusinessSchool’sMichaelPorterinhisworkoncompetitivestrategyandClaytonChristenseninhisresearchondisruptiveinnovations,andTuckSchool’sRichardD’Aveniinhiswritingsonhypercompetition,havedescribedthestrategiescompaniescanusetofightlow-costrivals.Butthatbodyofworkdoesn’tmakethephenomenonlessinteresting—orrenderthethreatanylessformidable.For,despitethebucketsofinkthatacademicshavespilledonthetopic,mostcompaniesbehaveasthoughlow-costcompetitorsarenodifferentfromtraditionalrivalsorasthoughtheydon’tmatter. Overthepastfiveyears,I’vestudiedaround50incumbentsand25low-costbusinesses.Myresearchshowsthatignoringcut-pricerivalsisamistakebecauseiteventuallyforcescompaniestovacateentiremarketsegments.Whenmarketleadersdorespond,theyoftensetoffpricewars,hurtingthemselvesmorethanthechallengers.Companiesthatwakeuptothatfactusuallychangecourseinoneoftwoways.Somebecomemoredefensiveandtrytodifferentiatetheirproducts—astrategythatworksonlyiftheycanmeetastringentsetofconditions,whichIdescribelater.Otherstaketheoffensivebylaunchinglow-costbusinessesoftheirown.Thisso-calleddualstrategysucceedsonlyifcompaniescangeneratesynergiesbetweentheexistingbusinessesandthenewventures.Iftheycannot,companiesarebetterofftryingtotransformthemselvesintosolutionprovidersor,difficultthoughitis,intolow-costplayers.BeforeIanalyzethevariousstrategyoptions,however,Imustdispelsomemythsaboutlow-costbusinesses. TheSustainabilityofLow-CostBusinesses Beitintheclassroomortheboardroom,executivesinvariablyaskmethesamequestion:Arelow-costbusinessesapermanent,enduringthreat?Mostmanagersbelievetheyaren’t;they’reconvincedthatabusinessthatsellsatpricesdramaticallylowerthanthoseincumbentschargemustgobankrupt.TheycitetheexperienceofU.S.airlines,which,aftertheindustry’sderegulationinthe1980s,succeededinbeatingoffcut-priceproviderssuchasPeopleExpress.Whattheyforgetisthatlow-costairlinessoonreemerged.Byslashingfaresandcuttingfrills,entrantslikeSouthwestAirlinesandJetBluehavegrabbedachunkofAmerica’sdomesticairtravelmarket.Unliketheirpredecessors,they’remakingmoneyhandoverfist,too. Successfulpricewarriorsstayaheadofbiggerrivalsbyusingseveraltactics:Theyfocusonjustoneorafewconsumersegments;theydeliverthebasicproductorprovideonebenefitbetterthanrivalsdo;andtheybackeverydaylowpriceswithsuperefficientoperationstokeepcostsdown.That’showAldi,theEssen-headquarteredretailerthatownsTraderJoe’sintheU.S.,hasthrivedinthebrutallycompetitiveGermanmarket.Aldi’sadvantagesstartwiththesizeofitsproductrange.AtypicalAldioutletisarelativelysmall,15,000-square-footstorethatcarriesonlyabout700products—95%ofwhicharestorebrands—comparedwiththe25,000-plusproductsthattraditionalsupermarketscarry.Thechainsellsmoreofeachproductthanrivalsdo,whichenablesittonegotiatelowerpricesandbetterqualitywithsuppliers.Infact,manyofAldi’sprivate-labelproductshavebestedbrandedproductsincompetitionsandtastetests.Thesmallnumberofproductsalsokeepsthecompany’ssupplychainagile.AnotherefficiencystemsfromthefactthatAldisetsupoutletsonsidestreetsindowntownareasandinsuburbs,whererealestateisrelativelyinexpensive.Sinceitusessmallspaces,thecompany’sstart-upcostsarelow,whichenablesittoblanketmarkets:Aldinowowns4,100storesinGermanyand7,500worldwide. Aldidoesn’tpampercustomers.Itsstoresdisplayproductsonpalletsratherthanshelvesinordertocutrestockingtimeandsavemoney.Customersbringtheirownshoppingbagsorbuytheminthestore.Aldiwasoneofthefirstretailerstorequirecustomerstopayrefundabledepositsforgrocerycarts.Shoppersreturnthecartstodesignatedareas,sparingemployeesthetimeandenergyneededtoroundthemup.Atthesametime,Aldigetsthebasicsright.Thereareseveralcheckoutlines,sowaittimesareshortevenduringpeakshoppinghours.Itsscanningmachinesarelightningfast,whichallowsclerkstodealquicklywitheachshopper.Mostretailersfollowlocalpricing,buteveryAldistoreinacountrychargesthesameprice,whichreinforcesthechain’simageasaconsumerchampion.In2006,GermansvotedAldithecountry’sthirdmost-trustedbrand,behindonlySiemensandBMW.Aldisellsproductsfarcheaperthanrivalsdo.Tosuppliers’prices,thecompanyaddsabout8%tocovertransportation,rent,marketing,andotheroverheadcosts,andabout5%forstaffcosts.Thus,Aldi’saveragemarkupis13%whilethatofmostEuropeanretailersis28%to30%.Notsurprisingly,89%ofallGermanhouseholdsmadeatleastonetriptoanAldiin2005,andaccordingtoEuropeanmarketresearchfirms,thechainhada20%shareofGermany’ssupermarketbusiness. AsAldi’sstorysuggests,thefinancialcalculationsoflow-costplayersaredifferentfromthoseofestablishedcompanies.Theyearnsmallergrossmarginsthantraditionalplayersdo,buttheirbusinessmodelsturnthoseintohigheroperatingmargins.Thoseoperatingmarginsaremagnifiedbythebusinesses’higher-than-averageassetturnoverratios,whichresultinimpressivereturnsonassets.Becauseofthosereturnsandhighgrowthrates,themarketcapitalizationsofmanyupstartsarehigherthanthoseofindustryleaders,despitethelargerequitybasesofthelatter.Forinstance,oneofEurope’sleadinglow-costairlines,Ryanair,isone-sevenththesizeofBritishAirwaysintermsofrevenues—$2.1billionversus$15.5billionin2006—butitsoperatingmargins,at22.7%,arethreetimesaslargeasBA’s7.35%.Notsurprisingly,Ryanair’smarketcapitalizationof$7.6billion(onMay28,2006)washigherthanBA’s$7.3billion. Manypricewarriorsdon’tfigureinlistingsofthebiggestcompanies,buttheyhavecreatedwealth—andpotsofit.LookatForbes’slistoftheworld’srichestpeoplein2006,forinstance,andyouwilldiscoverthat12ofthetop25billionairesmadetheirfortunesbycreating(orinheriting)low-costbusinesses.TheyincludeSamWalton’sfiveheirs,whosecombinednetworthwasestimatedat$80billion,Aldi’sTheoandKarlAlbrechtwith$32billion,IKEA’sIngvarKampradwith$28billion,MittalSteel’sLakshmiMittalwith$23.5billion,Dell’sMichaelDellwith$17billion,Zara’sAmancioOrtegawith$14.8billion,andWipro’sAzimPremjiwith$13billion. Interestingly,low-costcompaniesstayaheadofmarketleadersbecauseconsumerbehaviorworksintheirfavor.Myresearchsuggeststhatifabusinessgetsacustomertobuyitsproductsorservicesonthebasisofprice,itwilllosethecustomeronlyifarivaloffersalowerprice.Sincethediscounterswinalltheircustomersbecauseofthepricestheyoffer,theydon’thavetoworryabouttraditionalrivalsthatalwayschargepremiums.Onlynewentrantswithevenlowercoststructurescancompetewiththepricewarriors.Forinstance,until2000,SouthwestAirlines’costswerethelowestintheU.S.airlineindustry.Asitsemployeesgrewolder,thosecosts(excludingfuelcosts)rose:By2004,theywere6.2centsperavailableseat-mile,whichwasstillnearly25%lowerthanthe8centsperavailableseat-milethatDelta,Northwest,andUnitedincurred.However,JetBlue,whichstartedflyingin2000,spentonly4.7centsperavailableseat-milein2004—25%lowerthanSouthwest’scosts.Clearly,JetBlueposesastifferchallengetoSouthwestthanthetraditionalairlinesdo. TheFutilityofPriceWars Themomentacompanyspotsalow-costcompetitor,itwoulddowelltoaskitselfthisquestion:Isournewrivaltargetingasegmentwedon’twanttoserveorwilliteatintooursales?(Theexhibit“AFrameworkforRespondingtoLow-CostRivals”showscompanies’optionsinvarioussituations.)Ifthenewentranthassetitssightsoncustomersnootherbusinessserves,incumbentsneedn’tworry—forthemoment.Theycanobservewithoutengagingthecompetitor.Thatwait-and-watchstrategyoftenworksforcompaniesthatmarketproductsforpeopleattheverytopofthepyramid,suchaswines,perfumes,andcosmetics.Forinstance,whenEurope’ssupermarketchainslaunchedprivate-labelwater,ithadlittleimpactonmarketleaderssuchasEvian,Perrier,andSanPellegrino.Bottledwaterisasuperpremiumproduct,andstorebrandsserveconsumerswhorarelybuyit. AFrameworkforRespondingtoLow-CostRivals Sometimes,entrantsatlowpricepointscanprovideafilliptoincumbents’business.TakethecaseofeasyCruise,setupbytheLondon-basedserialentrepreneurSirSteliosHaji-Ioannou,whichhasboostedEuropeans’interestincruises.Theline’sshipsserveasfloatinghotelsthatdockintheafternoonandleavelateatnight,whichallowspassengerstoentertainthemselvesattheportsofcall.SinceeasyCruisedoesn’tofferlavishmealsandexpensiveshows,itisabletochargelowprices.Itscustomersaretypicallypeopleintheirtwentiesandthirties,manyofwhomcannotaffordtheall-inclusivepackagesothercruiselinesoffer.AlthougheasyCruiseisdoingwell,incumbentssuchasRoyalCaribbeanandCunardhaveleftthisnewcompetitoraloneratherthandivertingresourcestoattackit.TheybelievethatwheneasyCruise’spassengersareolderandricher,theywillturntotheestablishedlinesfortraditionalcruisevacations. Thatmaybeanexceptiontotherule.Mostlow-costplayersaltercustomerbehaviorpermanently,gettingpeopletoacceptfewerbenefitsatlowerprices.EasyCruise’spassengersmayneverswitchtothehigher-pricedcruiselines.Moreover,low-pricewarriorsareaidedbythefactthatconsumersarebecomingcynicalaboutbrands,betterinformedbecauseoftheInternet,andmoreopentovalue-for-moneyoffers. Whenmarketleadersfinallyacknowledgethethreatfromlow-costrivals,theyusuallytrytomatchorbeattheirprices.Alltheavailableevidence,however,showsthatpricewarsdon’tworkinincumbents’favor.Notonlyispricingbelowcostillegalinmanycountries,includingtheUnitedStates,butalsolow-costbusinessmodelsaredesignedtomakemoneyatlowprices—afactthatexecutivestendtoforget.Inaracetothebottom,thechallengersalwayscomeoutaheadoftheincumbents.Forinstance,inthelate1980s,Aldi,Dell,E*Trade,andSouthwestAirlinesmorethanheldtheirownwhenCarrefour,Compaq,Fidelity,andUnited,respectively,triggeredpricewarsthatweresupposedtodrivethechallengersoutofbusiness. Evenwhenmarketleaderscopythecriticalelementsoflow-costplayers’businessmodels,theyareunabletomatchtheirprices.That’sbecausetheindividualelementsofthemodeldon’tmatterasmuchastheinteractionsamongthem.ConsiderInternetbookingsforairlinetickets,whichdon’tdeliverthekindofcostreductionstotraditionalairlinesthattheydotolow-costcarriers.First,low-costplayersgenerate98%oftheirbookingsthroughtheirWebsites,whileonly20%ofincumbents’customersusetheInternettomakereservations.Internetbookingsaremoreattractivetotheleisuretravelerswhouselow-costcarriersthantobusinesstravelers,whooftenflytomultipledestinations.Consequently,whentraditionalairlinessetupInternet-basedbookingsystems,theimpactontheircostsislimited.Second,anInternet-basedreservationsystemisinexpensivetodevelopandmaintainwhenalltheaircraftinafleetareidentical,thereisonlyonecabinclass,ticketsarenotrefundable,andpassengerscan’treserveseats.However,thetraditionalairlines’systemsmustprovideformultiplecabinclasses,handleseveralkindsoftickets,provideseverallevelsofrefunds,andreserveseats,makingthemexpensiveinvestments.Third,mostincumbentsparticipateinindustry-widereservationsystemssuchasSabre,whichrobsthemofcontroloversomeseats.Finally,thetraditionalairlineshavesetupnetworksoftravelagents,whichwouldrebelifthecarriersmadeacompleteshifttodirectbookings.Forallthosereasons,traditionalcarriersareunabletoreducetheirbookingcoststothelevelsthediscountairlineshaveachieved. Slashingpricesusuallylowersprofitsforallincumbentswithoutdrivingthelow-costentrantoutofbusiness.IlearnedthatfirsthandwhileservingasaconsultanttoaEuropeantelecom-equipmentproviderthatwascompetingagainsttraditionalrivalsaswellasalow-costAsiancompetitorforamultimillion-dollarcontractinAfrica.AllthebidderskeptcuttingpricesinordertobesttheAsianrival’soffer,whichprovedtobethelowestaftereveryroundofbidding.Eventually,thetelecomgiantsdiscoveredthattheAsiancompanyhadoffereda40%discountonthelowestpricethecustomercouldnegotiatewithitsrivals!Notsurprisingly,thelow-costcompanywonthecontract.Inaddition,althoughthetelecomgiantswouldnothavemadeprofitsontheirlowestbids,theAsiancontenderseemedlikelytodoso. WhenDifferentiationWorks Whenbusinessesfinallyrealizetheycan’twinapricewarwithlow-costplayers,theytrytodifferentiatetheirproductsinalast-ditchattemptatcoexistence.Thisstrategy,theconsultant’sfavoriteantidote,takesmanyforms.Companies,we’retold,shouldadoptthefollowingapproaches: Designcoolproducts,as,say,AppleandBang&Olufsendo. ContinuallyinnovateinthetraditionofGilletteand3M. Offerauniqueproductmix,likethatofSharperImageandWholeFoods. BrandacommunityàlaHarley-DavidsonandRedBull. Sellexperiences,asFourSeasons,Nordstrom,andStarbucksdo. SincethetacticsI’vementionedarewell-known,Iwillnotdiscussthemindetail.Myresearchshows,however,thatthreeconditionsdeterminetheirefficacy.First,smartbusinessesdon’tusethesetacticsinisolation.Forinstance,Bang&Olufsenisabletocompeteeffectivelyagainstlow-costelectronicsmanufacturerswithitsdesigncapabilities.ThatapproachworkswellbecausetheDanishcompanyalsokeepsintroducingnewproducts,cultivatesanupscalebrandimage,andinveststimeandmoneyincreatingcool-lookingretailoutlets. Second,companiesmustbeabletopersuadeconsumerstopayforbenefits.Theabilitytodosousuallydependsontheproductstheysell.Forinstance,Gillette,findingthatitcanpushthe“closershave”envelopeformen,haslaunchedtheAtra,AtraPlus,Sensor,SensorExcel,Mach3,Mach3Turbo,andCentroshavingsystemsateverhigherpricesoverthepast20years.However,whenthecompanydeployedasimilarstrategyforDuracellbatteriesbyemphasizinglongerlife,manyconsumersbalkedatpayinghigherpricesafteracertainpoint.That’sbecausetheyfounditalmostimpossibletonoticethebetterperformanceandlongerlifeofDuracellUltrabatteries.EnergizerandRayovacfoughtbackbyofferingmorebatteriesforthesameprice,whichnegatedDuracellUltra’slong-lifeadvantage.Eventually,Gillettehadtobackawayfromthisdifferentiationgambit. Manycompaniesfindittoughtopersuadeconsumerstopayforadditionalbenefits.Asmallpremiumforgreaterservicesorbenefitsisapowerfuldefense,asTargetandWalgreenshaveshown.Targetstocksinexpensivekitchenwareandclothesdevelopedbywell-knowndesignerssuchasMichaelGravesandIsaacMizrahi.ItchargesabitmoreforproductsofbetterqualityanddesignthanthoseWal-Martsells.Inlikevein,Walgreensemphasizesconveniencebysettingupitsstoresclosetoshoppingcentersandprovidingdrive-throughwindowsforpickups,promisingshortcheckoutlines,andofferingeasynavigationbecauseofsmartstorelayouts.BothTargetandWalgreenshavethereforemanagedtoholdtheirownagainstWal-Mart.Alltoooften,though,incumbentsincurhugecostsinordertodeliverbenefits,forcingthemtoaskforpricepremiumssolargethattheydriveawayconsumers. Thethirdconditionnecessaryforasuccessfuldifferentiationstrategyissimple:Companiesmustbringcostsandbenefitsinlinebeforeimplementingit.Thattakestime.Afteryearsofrestructuring,Hewlett-PackardmayfinallybecatchingupwithDellinthepersonalcomputerbusiness.HPhasshrunkDell’scostadvantagefrom20%to10%,andsinceaveragePCpriceshavefallen,theabsolutedifferenceinpricesisrelativelysmall.ConsumersareshoppingforHPcomputersonceagainbecauseofsuchbenefitsasinstantdeliveryandtheabilitytosee,feel,andtouchproductsinstores. Unlesssizablenumbersofconsumersdemandadditionalbenefits,however,companiesmayhavetoyieldsomemarketstothepricewarriors.TakethecaseofBritishAirways,whichinitiallyignoredlow-costrivalssuchaseasyJetandRyanair;thensetupalow-costcarriercalledGo,whichitsoldin2002toeasyJet;andfinallydifferentiateditsservicesinseveralways.BAnowconcentratesonlong-haulflights,forwhichtherearenolow-costcarriers.Intheshort-haulmarket,thecarrierhasheldontosomemarketsharebyemulatingthebestpracticesoflow-costrivals,suchaspersuadingcustomerstouseelectronictickets.Oneveryflight,BAoffersasmallnumberofeconomyclassseatsatpricesclosetothosethatlow-costcarrierscharge.BecauseofitsstrangleholdonlandingslotsatHeathrow,aconvenientandpopularairport,itstillattractssomeshort-haulcustomers.Evenso,BAhasreducedcapacityonseveralflightstodestinationsinEurope,effectivelyconcedingvictorytolow-costcarriers. Strategiesthathelpanestablishedplayercoexistwithlow-costrivalscanworkinitially,butasconsumersbecomemorefamiliarwithlow-costoptions,theytendtomigratetothem.Intheairline,PC,andretailindustries,thesegmentchoosingtopaylessforfewerbenefitshasgrownrapidly—andI’mnottalkingaboutWal-Martshoppers.Dell’sandSouthwestAirlines’sharesoftheirindustries,forinstance,rosefromaround3%intheearly1990sto30%by2006.Thathasleftthetraditionalplayersscrappingwithoneanotherforashrinkingmarket,chargingeverhigherpricestofewerandfewercustomers.Thesecompanieshavetocopewithsmallertoplineseventhoughtheystillhavehighoverheadcosts.Thatwreakshavocontheirbottomlines.Theycanstopthemselvesfromgoingunderbymergingwithoracquiringrivals,but,asexecutiveswellknow,M&Aisn’tapanacea. DealingwithDualStrategies Whencompaniesdiscoverthatthelow-pricecustomersegmentislarge,theyoftensetuplow-costventuresthemselves.Becauseoftheiryearsofindustryexperienceaswellastheirabundantresources,incumbentsareoftenseducedintobelievingthattheycaneasilyreplicatecut-priceoperations.Moreover,thebusinessmodelsofsuchrivalsappeartobesimplerthantheirown.Inthe1990s,forinstance,allthemajorairlineslaunchedno-frillssecondcarriers—ContinentalLite,DeltaExpress,KLM’sBuzz,SAS’sSnowflake,USAirways’MetroJet,United’sShuttle—totakeonlow-costcompetition.Allthesesecondcarriershavesincebeenshutdownorsoldoff,showinghowtoughitisforcompaniestousethedualstrategy. Althoughmostexecutivesdon’trealizeit,companiesshouldsetuplow-costoperationsonlyifthetraditionaloperationwillbecomemorecompetitiveasaresultandthenewbusinesswillderivesomeadvantagesthatitwouldnothavegainedasanindependententity.Forexample,inthefinancialservicesindustry,HSBC,ING,MerrillLynch,andRoyalBankofScotlandhavesetuplow-costoperationsintheformofFirstDirect,INGDirect,MLDirect,andDirectLineInsurance,respectively,becausethenewandoldoperationsgenerateseveralsynergies.Thelow-costoperationsoffercustomersasmallnumberofproducts—termdeposits,savingsaccounts,andinsurance—throughcost-efficientdistributionchannelssuchastheInternet.Sincetheyreachouttoconsumerstheflagshipbankscannotaffordtoserve,theno-frillsbusinessesprotecttheparents.Theflagshipoperationscombinethefundsthesubsidiariesraisewiththeirown,whichallowsthemtomakeinvestmentscost-effectively.Thatapproachhelpsbothparentandsubsidiary. Asuccessfultwo-prongedapproachrequiresthelow-costbusinesstouseauniquebrandnamesuchasHSBC’sFirstDirectoratleastasub-brandsuchasINGDirect.Adistinctbrandhelpscommunicatethatfewerservicesgoalongwithlowerprices.Italsoallowscustomers’expectationstoformaroundthelow-costbusinessmodelratherthanthetraditionaloperation.FirstDirectcustomers,forexample,aremoresatisfiedwiththeirATMnetworkthanHSBCcustomersareeventhoughbothusethesamemachines.WhereasHSBCcustomersdemandATMsateverycorner,FirstDirectcustomers,whodon’texpectsomanymachines,aredelightedtoseethem. Conventionalwisdomsuggeststhatbecausealow-costoperation’ssourcesofcompetitiveadvantagearen’tthesameasthoseoftheparent,thesubsidiaryshouldbehousedseparately.Bysettingupanindependentunit,anestablishedcompanycancreateastart-upoperationwithstructures,systems,staff,andvaluesthataredifferentfromitsown.Becauseitisindependent,thelow-costoperationwillbemoreaccountableandislesslikelytobesmotheredbytheparentbusiness’sworrythatthesubsidiarywillcannibalizeitssales.However,asthecaseoftheairlinesshows,independentunitsarenecessarybutnotsufficientforthesuccessofadualstrategy.That’sbecausecommonownershipoftenimposesconstraintsonlow-costoperations.Forinstance,thetradeunionsdidn’tallowU.S.airlinestopayemployeesoftheirlow-costsubsidiarieswagesaslowasthoseatSouthwestAirlinesandJetBlue.Unsurprisingly,thosesubsidiariesfailedtotakeoff. Anotherfactorthataffectsincumbents’low-costbusinessesistheallocationofresources.Whendisruptorsarenewventures,theyfacemarkettestsoftheircapitalneeds.Subsidiariesfaceinternalresource-allocationprocessesthatoptimizedifferentcriteria—bothforlegitimatereasons,suchashighermarginsandlowerrisk,aswellasillegitimateones,suchaspowerandpolitics.Consequently,theparentmayendupstarvingthenewunit.RememberhowBausch&Lombdidn’tprovideabuddingbusinesswithenoughresourcestolaunchthedisposablecontactlensesithaddeveloped?ThenewlenseswerecheaperthanthepermanentlensesB&Lthenmarketed.Theyalsodidn’tneedtobestoredinsolutions,whichcontributedtotheparent’sprofits.Therefore,B&LleftthefieldopenforJohnson&Johnsontolaunchaprofitablenewbusiness. Atwo-prongedstrategydeliversresultsonlywhenthelow-costoperationislaunchedoffensivelytomakemoney—notasapurelydefensiveploytohurtlow-costrivals.Companiesshouldlettheiroldandnewbusinessescompetewithoneanotherandincorporatecannibalizationestimatesintobusinessmodelsandfinancialprojections.DowCorning’screationofXiameterisanexcellentillustrationofhowcompaniesshouldusethetwo-prongedapproach.Despiteenjoyinga40%shareoftheglobalsiliconesmarketin2000,DowCorningfoundlow-costcompetitorsenteringtheindustry.Ratherthanslashingprices,itdecidedtosetupalow-costbusiness.Twoyearslater,aftersegmentingthemarketandidentifyingpotentialcustomers,DowCorningcreatedXiameter.ComparedwithDowCorning,whichsells7,000products,thesubsidiarysellsonly350,allofwhichfaceintensecompetitionfromlow-costplayersaswellasfromtheparent.Xiameter’slimitedrangepreventsitfromeatingupitsparent’ssales. Atwo-prongedstrategydeliversresultsonlywhenthelow-costoperationislaunchedoffensivelytomakemoney—notasapurelydefensiveploytohurtlow-costrivals. Xiameterfoundthatithadtoofferproductsatprices20%lowerthanDowCorning’sinordertotakeonotherlow-costplayers.Ituseseverytacticinthebooktodoso.Insteadofquickdeliveries,Xiameterpromisesashippingdatesevento20daysfromtheorderdatesothatitcanschedulethemanufactureofitsproductswhenDowCorning’sfactoriesareidle.Itdoesn’tofferanytechnicalservices,soithasn’tinvestedinaservicefacility.Tokeepitssupplychainefficient,Xiametersellsonlyfulltruck,tank,orpalletloadsofproducts.CustomerseitherenterordersonaWebsiteorpayanextra$250toorderbye-mailorphone.Onceset,ashippingdatecannotbechangedunlessthecustomerpaysa5%fee;arushorderincursa10%premium;andanordercancellationfeeis5%.Suchrulesmakeproductionplanningeasier.Xiameteroffersonly30-daysupplier’scredit,whichhelpsreduceworkingcapitalneeds,anditpricesproductsinjustsixcurrenciestolimitcurrencyrisk.In2001,DowCorningpostedsalesof$2.4billion;in2005,thecombinedsalesofDowCorningandXiameterwere$3.9billion.Thatincreasehelpedtheparentcompanyturnalossof$28millionin2001intoprofitsof$500millionin2005.ThestrategyhasalsohelpedcustomersbetterappreciatetheadditionalbenefitsthatDowCorningprovides,enablingittochargepremiumprices. SwitchingtoConquer Iftherearenosynergiesbetweentraditionalandlow-costbusinesses,companiesshouldconsidertwootheroptions:Theycanswitchfromsellingproductstosellingsolutionsor,radicalthoughitmaysound,convertthemselvesintolow-costplayers. Switchtosolutions. Sincelow-costplayersturnincumbents’basicproductsorservicesintocommodities,existingcompaniesmaybeabletosucceedbysellingsolutions.Byofferingproductsandservicesasanintegratedpackage,companiescanexpandthesegmentofthemarketthatiswillingtopaymoreforadditionalbenefits.Solutionsofferseveraladvantages:Theyincludealargeservicecomponent,soit’shardtoevaluatethequalityofthesolutionsvariouscompaniesprovide.Overtime,thesellerdevelopsadeepunderstandingofthecustomer’sbusinessprocesses,sothecustomerfindsitdifficultandcostlytochangesuppliers.Furthermore,sincelow-costplayershavelimitedproductrangesandservicecapabilities,theycannotoffersolutions. Despitethepopularityofthisstrategy,makingthechangeoverisdifficult.Manycompanies,suchasBoots,Compaq,Xerox,andUnisys,didn’tsucceedbecausetheyassumedthatsellingsolutionsrequiredmodifyingtheirexistingbusinessmodelsratherthantransformingthem.Mostcompaniesseesellingsolutionsasawaytohawkmoreproductsathigherprices.Theydevelopcombinationsofproductsandservicesthatworkmoreorlessseamlessly,andcallthemsolutions.Thentheylookforcustomerswithproblemstofitthesolutions.Thatneverworks.Agoodsolutionproviderstartsbyworkingwithcustomerstounderstandtheirproblemsbeforedesigningsolutions. Sellingsolutionsrequiresacompanytomanagecustomers’processesandincreasetheirrevenuesorlowertheircostsandrisks.TakethecaseofAustraliangiantOrica’sminingservicesdivision(theerstwhileICIAustralia’sexplosivesbusiness),whichsellsexplosivestostonequarries.Tosetupablast,expertsdrillholesinrockfacesoverthecourseofseveraldays.Theholesarefilledwithpackagedexplosivesonthedayoftheblast,ataskthatcantakeuptofivehours.Loadingtheexplosivesisoftenaraceagainsttheclocksinceblastingtimesarerestricted.Drillingandblastingcostsareasignificantcomponentofaquarry’soperatingcosts.Becauseofstrictcontrolsonthestorageandhandlingofexplosives,companiesusedtoorderjustenoughexplosivesforoneblast,whichOricawoulddeliverontheappointedday. Whennewcompetitorsenteredthemarket,startingapricewarthatshowednosignofabating,Oricatransformeditselfintoasolutionprovider.Itstartedoutbysupplyingemulsionexplosivesinbulk.Afterthecustomerplacedanorder,amobilemanufacturingunitcontainingintermediatechemicalsarrivedatthequarry,mixedchemicalson-site,anddeliveredtheexplosivedownpredrilledblastingholes.Oricadrewprofilesofrockfaceswithlaserstoidentifythebestplacesfordrilling,convertingblastingfromanuncertainarttoaprecisescience.Thegreaterconsistencyofemulsionexplosivesandbetter-placedholesrequiredquarriestodrillfewerblastholes,whichreducedcosts.Becauseofbetterblasts,rockyieldsalsoimproved,reducingdownstreamprocessingcosts.Overtime,Oricaofferedtoprovidebrokenrocktocustomersinsteadofexplosives.Itnowbillscustomersaccordingtothequantitiesofbrokenrockitdelivers. Becomingasolutionproviderhasyieldedsignificantbenefitsforthecompany.SinceOricasellsexplosivesaspartofaservice,theproduct’spriceislesstransparent.Furthermore,blastingsolutionsrequirethecompanytointegrateseveralproductsandservices,soitsaveragesalesarebiggerthanwhenitsoldonlyexplosives.SinceOricamanagesblastsatseveralcustomersites,ithasenhanceditscompetenceandknowledge.Customersinthemeantimehavebecomemoredependentonthecompany’sblastingsolutionsbecausetheyhavestoppedinvestingintheprocess. Switchtolow-costmodels. Intheory,acompanycanconsiderswitchingfromahigh-costtoalow-costbusinessmodel.Inpractice,suchatransformationisunlikelybecausetheincumbentwillhaveaprofitablealbeitshrinkingbusinesstomaintain.Moreover,switchingtoalow-costbusinessmodelmeansacquiringcapabilitiesthataredifferentfromthecompany’sexistingcompetencies.It’shardtoimaginemanymarketleadershavingthestomachforthat. Neverdoubtthepowerofexample,though.Onecompanyhassuccessfullyachievedsuchatransformation,andyourorganizationcouldbethesecond.In1991,MichaelO’LearywastappedtoturnaroundRyanair,anunprofitable,high-cost,traditionalairline.TheairlinehadbeenpursuingastrategyofadvertisingpricessomewhatlowerthanthoseofIreland’sflagshipcarrier,AerLingus.O’Learyrealizedthatsuccessdependednotonbeing10%cheaperbutonbeing80%to90%cheaper,andhebelievedthatwaspossibleonlyifRyanairtransformeditself.O’LearymadeseveraltoughdecisionstoconvertRyanairintooneofEurope’sleadinglow-costairlines.Hereplacedtheentirefleet,whichcomprised14typesofplanes,withafleetofBoeing737s.Ratherthanoperatingoutofsecondaryairports,Ryanairstartedoperatingfromsecondarycities,suchasTorp,65milesfromOslo;Char-leroi,37milesfromBrussels;andBeauvais,35milesfromParis.Inadditiontocharginglowerfees,someoftheseairportsalsopaidRyanairtoflyintothem.AtO’Leary’sprompting,Ryanairstoppedacceptingbookingsthroughtravelagentsandmovedtodirectbookings,atfirstthroughcallcentersandlaterovertheInternet. Theairlinetookseveralotherstepstoremakeitself.Iteliminatedbusinessclasstoconcentrateoneconomyclassandleisurecustomers.Itstoppedservingfreemealsandbeveragesonflights,insteadmakingthemavailableforpurchase—amovethatallowedtheairlinetoreducethenumberofattendantsoneachflightfromfivetotwo.Ryanaireliminatedseatassignmentstospeedupboardingandstoppedcarryingcargo,whichreducedaircraftturnaroundtimesfrom45minutesto25minutes.Italsosimplifiedgroundservices,developedextensiveguidelinesformaintenanceservices,andoutsourcedboth.Atpresent,Ryanairoperates103aircraftandfliesmorethan300routesfrom15Europeanbases.In2005,theairlinehad,at90%,thehigheston-timerateofallEuropeanairlines,lostthefewestbags,andhadthefewestcancellations.Inthe12monthsthatendedMarch31,2006,Ryanairflew35millionpassengers—up26%overthepreviousyear.Itsrevenues,at$2.1billion,were28%higherthanthepreviousyear’sandgeneratedanafter-taxprofitof$387million.Importantly,Ryanaircutcosts(excludingfuelcosts)by6%in2005–2006,showingthatO’Learyisstillworkinghislow-costmagic.••• Low-costplayerswillcontinuetomushroom,andsomewillsucceed.However,therewillalwaysbetwokindsofconsumers:thosewhobuyonthebasisofpriceandthosewhoarepartialtovalue.Therefore,therewillalwaysberoomforbothlow-costplayersandvalue-addedbusinesses.Howmuchroomeachwillhavedependsnotonlyontheindustryandcustomers’preferences,butalsoonthestrategiestraditionalbusinessesdeploy.Ifincumbentsdon’ttakeonlow-costrivalsquicklyandeffectively,theycanblamenoonefortheirfailurebutthemselves. AversionofthisarticleappearedintheDecember2006issueofHarvardBusinessReview. ReadmoreonCompetitivestrategy orrelatedtopics Businessmodels, Strategyformulation andPricingstrategy NK NirmalyaKumaristheLeeKongChianProfessorofMarketingatSingaporeManagementUniversityandaDistinguishedAcademicFellowatINSEADEmergingMarketsInstitute. Tweet Post Share Save GetPDF BuyCopies Print ReadmoreonCompetitivestrategy orrelatedtopics Businessmodels, Strategyformulation andPricingstrategy PartnerCenter Diversity Latest Magazine Ascend Topics Podcasts Video Store TheBigIdea Data&Visuals CaseSelections