6 Tips to De-Commoditization

May 10, 2012
Companies make choices to avoid competing on price alone, and you can, too

A commodity is a product whose buyers base their purchase decisions on price and availability. Commodity market segments return substandard profits to most of their vendors, as the lion’s share of the business goes to the lowest-cost supplier. In most business-to-business markets, buyers pressure vendors to offer higher discounts, lower prices, and extra services. One tactic is to threaten taking the order to a competitor, who often will offer a lower price. The drum beat of downward pricing pressure convinces salespeople, sales managers and even some chief executives that low price is the major, or even the only, decision driver for their buyers. They gradually come to perceive their market segment as ‘commoditized.’

But, most markets are not commoditized. Very few markets are dominated by the low-cost supplier. In fact, it is often noted (with surprise!) that the dominant player in a given market is able to maintain its dominance even with higher prices. The classic example of this is Starbucks, which de-commoditized the coffee market. Starbucks replaced the fifty-cent cup of Joe with a $2.00 “low end” product, and successful offerings as high as $4.95.

But Starbucks is a consumer product, and examples abound in the business-to-business world as well. Intel is routinely underpriced by AMD in the business of microprocessors, but the company had 80.2% of the microprocessor market in the last quarter of 2010. VMWare confronts both Citrix and Microsoft in the virtualization software market, and commands more than 80% of that market. Microsoft’s Hyper-V and Citrix’s Xenserver are both offered for free. Microsoft, AMD, and Citrix are all credible companies with histories of quality, reliability, and world-class support. Nonetheless, like Starbucks, Intel and VMW are are able to hold commanding shares of that market, along with higher prices.

Are you a commodity? This would mean that your management team has failed to establish differentiators that are meaningful in your market sector. You are a commodity when your market views you as nothing special, and decides to buy from you primarily because of your price. Feeling this pressure, you probably feel forced to cut prices and to add more and more value to what you offer. You feel pressure to win your customers by providing even “more for less.”

But there is another way. Starbucks does it, Apple does it, Intel does it, VMWare does it, John Deere does it. Zantac came into the market deliberately with prices 10% higher than the established leader. The list goes on and on. In nearly every industry, there are companies that have found ways to differentiate themselves from their cheaper competitors, to compete on bases other than price. They have escaped the commodity trap, and you can, too. These are some of the methods they have used:

1.DECIDE — The most important leap you need to take if you want to decommoditize your business is a willingness to say no to a portion of your market. You can’t sell to everybody, and you can’t sell to the portion of the market that views price as its most important decision driver. If the guiding principle of the company is “we will never lose on price,” the company is admitting that it has failed to establish differentiators that its customers will pay for, and in which it has confidence.

When netbooks emerged they appeared to be an exciting new segment of the laptop PC market — a category defined by its low price point and low-powered processors. Industry analysts pressed Apple CEO Steve Jobs to introduce a netbook. Jobs’ answer was “I don’t know how we could bring out a quality product for $300.00.” In one sentence, he reaffirmed Apple’s strong willingness to lose on price. Apple said ‘no’ to the very large number of customers looking for cheap computers. If customers wanted a $300 computer, they would have to go elsewhere. In that statement, Jobs also defined his market segment: customers looking for quality and other differentiators. And, he had confidence in his differentiators’ value to that segment, and the customers’ willingness to pay for them.

2. SEGMENT — The Decide step is a matter of attitude. It’s a matter of will. It’s a matter of confidence. The Segment step is a matter of research and analytics. Its importance cannot be overstated. A McKinsey and Company study of the 100 largest American corporations found that the decision of where to compete accounted for a full 80% of their differences in growth. If these companies competed in segments that were growing, they would grow. The segment step is the very difficult, soul-wrenching process of deciding which segments you can serve most profitably, what segments you should say no to, and dedicating product development, partnering strategies, marketing resources, go-to-market strategies, and sales resources to serving those segments better than anyone else.

3. PRICE — Choose a pricing strategy and stick with it. Your pricing strategy is largely a function of the maturity of your market segment. A revolutionary product with an entirely new value proposition should command a premium price. In part, this is a simple recognition that most prospects won’t buy it; they need to be educated. The ones who will buy it are typically willing to pay premium prices, and the high price is itself a statement of the value being offered. An evolutionary product that only modestly improves on what is on the market should command a neutral price – one that reflects the value perceptions of the buyers, adjusted for the brand value of your company vis--vis those of your competitors. If the market ment is declining, and the technology has been superseded, you can at some point resume pricing at a premium.

This somewhat counter-intuitive finding arises from the fact that there will be instances where there are complex systems relying on older technology, and rather than replacing the system, it becomes cheaper and simpler to continue to rely on that older technology. Typically these customers will be willing to pay premium prices for it. We see this today in the markets for vacuum tubes and vintage data storage systems for mainframe computers.

4. DRIVE CUSTOMER VALUE — This direction has been a staple of management seminars for nearly 50 years, but it rarely achieves the prominence that it deserves in day-to-day management. Monitor customers’ circumstances as they change constantly. This means you need to be constantly monitoring your value-creation landscape, continually finding new ways to improve customer value. Drive Customer Value dovetails with Segment, as different market segments will benefit from very different parts of your offerings, and when changes apply to your target segment this can create singular opportunities for you to improve your perception of value.

5. BUNDLE — Bundles are versions of your products – often several products grouped together – that solve a specific customer problem or give you access to a desired customer segment. When you identify a customer problem and present a commitment to solve it, this improves your perception of value in the eyes of the customer, enables you to close sales more readily, and often earns higher prices as well. Bundles typically do not need new product development; design them according to the ways that your customers use your products. These use cases can be turned into usage notes, case studies, pre-installed configuration options, and combinations with other products – yours as well as complementary products from other vendors.

6. UNBUNDLE — Unbundles are offerings with specific attributes removed in order to offer a lower-price alternative. Well-designed unbundles can serve a segment unwilling to pay your standard prices, enabling you to earn profits from customers who otherwise would buy from competitors. They also give your sales channel a way to respond to customers’ demands for lower prices, forcing them to recognize the value of the attributes and decide whether or not to pay for them.

Commoditization is more often the perception than the reality. It is the natural result of customers constantly pressuring suppliers to lower their prices. When suppliers lack the structures and the sales skills to resist those demands, they give in to the pressure and compete mostly on price, making them … commoditized.

Per Sjofors is the founder and CEO of Atenga, Inc. He has more than 20 years of executive management experience and has built a number of successful sales and marketing companies in Europe and in the US. Atenga Inc. (www.atenga.com) is offers pricing strategies (price training, targeted market research, and price optimization services) to commercial and industrial firms worldwide. Contact Atenga at tel. 818 887 4970, or [email protected]