The Diamond In The Rough
The previous chapters have considered the nature of commodity traps - how to identify and respond to differing competitive situations - and the present chapter means to discuss the methods by which a firm can predict changes in its market that could lead to commoditization. The ability to react in a crisis is necessary, but less effective than having the ability to predict when a crisis may arise.
Generally, it pertains to predicting changes in the marketplace: the price-benefit analysis from the perspective of the customer, who is ultimately the determinant of which will win. Some shifts happen slowly over a longer period of time, others seem to come out of nowhere and shake an entire industry - but even these can be anticipated.
The author uses the metaphor of an earthquake: it seems like a very sudden event, but science has gotten much better at predicting them. We now know the location of the fault lines and monitor even minor tremors that are harbingers of more dramatic events.
Most executives are very comfortable with the notion of being proactive when an opportunity or a threat arises, but few seem to understand quite how to recognize an opportunity or a threat, and still find themselves taken entirely by surprise. They do not know where to begin.
(EN: Calls to mind a lecture on SWOT analysis - how many textbooks teach strategists to do the analysis backward, considering the internal strengths and before looking to the environmental threats and opportunities, which reinforces "business as usual" and leaves them unprepared for those environmental factors that do not match the capabilities they already have. In that sense, it is likely not the lack of tools, but their misapplication that leaves strategists in the dark.)
Case Study: Restaurants
The author refers to a study he did for the hotel industry, chiefly in considering how to reposition the restaurants in hotels. In the present day, few hotel guests dine in the on-property restaurant but prefer to go to an independent one - and people who are not staying at a hotel very rarely come to a hotel restaurant to dine, which was once common. As such, hotel restaurants have become a highly unprofitable venture, and providing one as a convenience drains, rather than augments, profits.
To begin, he asked some basic questions: what drives a diner to choose a restaurant? The factors include its location, the price of a mean, the cuisine, the reputation of the chef and owner, etc.
He then looked to the Zagat guide, which included restaurants that varied from no-frills restaurants to highly expensive ones, and assembled a sample that included almost 1700 restaurants of various cuisines and in various locations. To this sample, he applied an instrument that created three scales on which customers rated their satisfaction with food, service, and decor, which would be cross-referenced to the price.
A primary finding was that the service experience was the primary driver of acceptance of higher prices - i.e., where prices were higher, customers who reported that the service was better were happier to pay the price. In this regard, service was 73% correlated, cuisine was only 2.5% correlated, and location was only 2.5% correlated.
Other factors such as an outdoor section on in-restaurant entertainment had only a 1% correlation to customer satisfaction, but a 21% correlation to variances in price. Clearly, restaurant management had this part of the equation entirely wrong.
To the hotel industry, the low correlation of location to satisfaction was surprising news: they clearly expected that the convenience of on-site dining was important to their customers, but it had only a 2.5% correlation. Couple this with the fact that a hotel restaurant charges a premium over non-hotel restaurants, and it becomes clear that hotel restaurant managers were faced with "some serious changes and soul-searching."
Ultimately, their decision was to refurnish some restaurants to make them look like stand-alone restaurants that happened to be located in the same building as a hotel (adding a street entrance and a secondary entrance from the hotel lobby).
(EN: No indication if this succeeded, but given that many hotels have followed this very same pattern, and even moved to more of a coo-op arrangement where on-property restaurants are independently managed and rent space from the hotel, there are strong indications that it was successful.)
Case Study: Real Estate
Identifying correlation between price and individual factors can help to identify hidden opportunities in other marketplaces: it gets beyond the vague notion of value and examines the specific qualities and features that cause a customer to be willing to pay a certain amount for it. Analyses similar to that which the author applied to restaurants has also been used for coin and stamp collectors, fine wines, and cigars, to determine the factors that lead a customer to value specific options.
(EN: And while this seems like a good idea on the surface, it seems to lead inexorably to commoditization: it is backward-facing and seeks to discover what customers valued in the past, not what they might value if it were offered; and second, if all firms do the same analysis, they draw the same conclusions and seek to make their product similar to everyone else who's making decisions according to the same numbers.)
The author mentions research done from a real estate developer, Affinity Neighborhoods, which took a similar approach. Residential real estate prices are highly differentiated according to size, features, location, and other factors pertaining to a home. A closer analysis gave the firm a general sense of what made a property appealing to buyers and establish better pricing - but more importantly, it helped them to identify unrecognized values in housing markets.
Because homes can be segmented by price, Affinity was able to develop its own analytics that would enable it to find "hidden gems in some of the poorest and least-attractive neighborhoods." In addition to features, the program considered factors such as crime statistics, school test scores, and even weather reports to establish an expected price for a given property.
Also, it showed overall trends, and identified neighborhoods that would be profitable to develop or gentrify based on favorable changes in these factors, as well as neighborhoods that were broadly declining because of changes in these same factors, and that should be liquidated before further deterioration occurred.
On a more granular level, the analysis of specific features (a deck, an upgraded kitchen, a fireplace, etc.) enabled the firm to determine what upgrades and repairs to make in properties that would be likely to increase its overall market value, and selected those that would provide 50% or greater return on investment.
During the downturn in the real estate market, this analysis helped to identify neighborhoods that would be least affected by price declines, and when the market recovered, the same analysis gave them a sense of which neighborhoods and properties would be the firs to recover.
And finally, the numbers generated by the system could be compared to asking prices to suggest whether the seller might be difficult to work with: comparing the price to the mortgage value (available in public records) identified the amount of profit (or loss) the seller would make at a given price point - some sellers would be very stubborn, others easier to crack.
Setting R&D Priorities
Creating an effective strategy to combat commoditization requires leveraging research to identify the customer's defined benefits in order that you might develop your product to be more appealing to them than the offerings of rivals.
This is especially true for new products and services. The author turns to another source (Cooper) who discovered that new products account for an average of 33% of sales - much higher in fast-moving industries - and yet failure rates for new products can be 50% or higher.
Another source (Ogawa and Piller) concludes that the reason for the failure rates is that many new products simply "have no market." That is, they provide benefits that customers are unwilling to pay for. The same study suggests that this is largely due to serious limitations in traditional market research that assess consumer preferences, chiefly that the research is geared to measure the customers' stated intentions, which are quite different than their actual purchasing behavior.
The research further finds that there is a distinct difference between introducing a new product and coming out with a me-too product that is new to the company, but not to the customer: new products have five times the success rate of me-too products. This is fairly intuitive, as a me-too product is moving into an already-crowded marketplace.
The author speaks of dysfunctional attitudes in his own interviewing with senior managers. There are tenacious in defending their own opinion of value when it is different to what consumers value. They are quick to deny the benefits of rival products. They ignore hard facts in favor of opinions and misperceptions. They look to their competitors rather than the customers for evidence. These are serious problems that keep them steadfastly pointed in the wrong direction in spite of all evidence to the contrary.
The author uses a sports metaphor "skate to where the puck will be" to suggest separation of roles: research should determine where the market is moving - an analyst is best qualified to make this determination, but is unlikely to know what he needs to do to exploit that data.
It's not enough to know where the puck will be - you still need skilled hands to take the right action to put it into the net - and this is where executives shine: while their gut feelings are poor indicators of the market's motion, their ability to take action when they are in the right place at the right time is unparalleled.
Firms look to undertake one initiative, pursue one goal, in order to win the market. But it's really not that simple. For any proposed benefit, you need to know the degree to which it influences buying behavior, and the best way to do this is to examine actual purchases rather than engage in speculative research.
The author also comments that "the market" is not homogeneous: one set of features does not serve all customers, and the features that a given customer wants will differ over time. Consider the market for cars: not all customers want the same thing that eighteen-year-old males desire, and even those customers will change what they want by the time they are age forty.
However, firms seem to wish things to be efficient: they seek to make a single product and sell it to all customers, use marketing to convince the driver at age forty that he should want the same product a teenager wants, and they will put great effort and resources into attempting to bend the market to their will. The ultimate result of such actions is failure - but the consequence to the market of this effort is commoditization.
Escape, Destroy, or Exploit
Ultimately, commoditization will never completely disappear. Soon after one firm takes an action to break away from the pack, others attempt to imitate their efforts to siphon away some of the profit. Markets go through cycles in this manner.
Since a firm cannot reasonably count on destroying commoditization, it must make a strategic decision how to respond. Escape the trap and move your business to greener pastures; destroy the trap and continue to fight for turf in a crowded pasture; or exploit the trap to make your competitors struggle to compete in a market you dominate.
The proper response to take depends largely on the conditions of the market and the capabilities of the firm - none of the three strategies is appropriate to all firms in all markets at all times. Success depends on understanding the situation, considering the options, and making the best choice.