COMMODITIES AND HOSTILE MARKETS
by Donald V. Potter
Conventional wisdom tells us that a commodity market is one in which the products are virtually indistinguishable and buying decisions are made on price.
Conventional wisdom is wrong. A commodity market's prices are indistinguishable and buying decisions are made on product. No product is a commodity.
When Prices Converge
The importance of price is overestimated. When customers buy, they consider first product function, then reliability and convenience, and finally price.
On average, across all markets, price is the deciding factor in less than 15% of all sales.
Price can be even less important in hostile markets. As hostility intensifies, each player matches others' price cuts. Eventually, prices converge. Yet customers are still making choices. When prices are virtually identical, how are those buying decisions actually being made?
"Business Class to Chicago"
An example illustrates how the buying process is really working. Suppose a customer wants to fly from San Francisco to Chicago. He is buying an airline seat, which — in this time of intense competition among carriers — is often considered a commodity.
Using his buying hierarchy, our flier first satisfies his requirements for product function ("a business-class seat"), reliability ("on a major, reputable carrier") and convenience ("arriving in time for my 1:00 meeting"). Very likely two or more carriers will meet those requirements. If one carrier were to offer a uniquely low price, our flier could make his decision then and there. But almost certainly the carriers will offer their seats for the same price.
Our buyer then recycles through his hierarchy to make his choice on some other basis. He may prefer one type of airplane over another. More likely, the choice will be based on some aspect of service: a more convenient arrival time, better on-time performance, more convenient gate locations, good food, friendly flight crews, or a preferred frequent flier program.
Beyond the Physical Dimension
"Price is the deciding factor in relatively few sales."
In hostile markets, most buying decisions are based not on price but on some aspect of the product offering. In mature markets, however, products are usually close to identical on the physical dimension. Airlines are flying the same planes, equipped with the same seats. Suppliers of beer, color televisions and personal computers offer products that might be difficult to distinguish from those of competitors when the products sit side by side.
These "softer" aspects of service, in turn, forge surprisingly durable bonds between supplier and buyer. As customers choose an airline again and again, they begin to accumulate frequent flier miles with that airline, which encourages the buying pattern. Suppliers of traditionally defined "commodities" such as steel and paper develop customer relationships based on consistency and trust.
In hostile markets, these service-based patterns and relationships underlie the majority of buying decisions.
Winners Invest in Service
Unfortunately, service isn't easy. Building a reputation for reliability and convenience takes effort, money, and time. Generally, it requires working with the people within the organization, getting them to perform differently and better – which is far more difficult than simply adding a product feature or changing a price.
"A railroad is 95 percent men and 5 percent iron".
When a market becomes hostile and price competition intensifies, more managers instinctively cut costs even if that means service must slip. In contrast, companies who win in hostile markets are those who maintain, or even invest to improve, their service. They know that keeping customers allows them to spread costs over greater volume, preserving their economies of scale. They know that service, not price, is really driving most buying decisions. They know that if they fail on service they may lose a customer who, once having gone to another supplier, will be hard to recapture.
In short, they know that – especially in hostile markets – conventional wisdom is wrong. Products do differ, especially in service.
In very tough markets, companies who compete primarily by offering the lowest prices tend to be weak. They also usually attract a high share of the weakest customers. Weak serves weak.
(Note: This Perspective was written in the context of the economy in 1993. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)
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Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis.