by Donald V. Potter

A staple theme in science fiction is the voyager who passes through some barrier to emerge in an alien universe. Words have no meaning, nothing is familiar, and “universal” laws no longer apply. Always, the voyager is disoriented, even afraid. Sometimes, the voyager learns quickly and survives.

Leaders of companies going into hostility have the same experience as a voyager stepping into a new dimension. Reasonably comfortable conditions that have existed for a few years suddenly end. The new world is foreign, and certainly not friendly. Hostility comes on quickly – usually in two years or less. Then suddenly, the old rules no longer apply.

Understanding key differences between hostile and non-hostile markets can help leaders make the transition.

Who Controls Price?

In a non-hostile market, the strongest competitors exercise price leadership. Generally, they lead prices up at least as fast as their costs grow. All competitors follow the upward trend.

When hostility sets in, low-cost, low-priced competition pulls prices downward. Eventually everyone must follow. Market leaders experience this shift as a loss of power, but that isn’t really true. In any market, hostile or not, it is the competitor who can lead prices downward that always has true pricing control. Market leaders have this power, but seldom choose to exercise it.

What Is The Pricing Structure?

Before hostility begins, product price differences between suppliers are fairly great. In the personal computer market during the late 1980s, for example, comparable products were available at prices that varied by thirty percent from the low-priced to the high-priced supplier. At the same time, price differences among the customers of any supplier are slight. A supplier charges all its customers prices that fall within a five to ten percent range.

The onset of hostility reverses that pricing structure. Product price differences between suppliers narrow considerably, to about five percent. At the same time, the prices that a supplier offers to its range of customers diverge a great deal, sometimes by twenty percent or more. This occurs because some customer groups (often the largest) can negotiate hard for favorable prices. Price management at the individual customer level becomes essential.

What Moves Share?

When a market is not hostile, considerable share can move when a supplier introduces a successful new feature. One example is Citibank’s introduction of its massively successful Advantage credit card, which gave the user frequent flier mileage credit for charges on a Citibank card and resulted in a multiple point share gain for Citibank. New features move share because often they are not copied. Competing suppliers may resist duplicating the feature on the basis of pride or style (“That’s not what we do at Acme,”) or contractual constraints, or because their attention and energy is focused elsewhere – perhaps on introducing their own new feature.

Hostility changes the game. With prices among suppliers virtually identical, no supplier can give competitors the advantage of an attractive product feature. New features must be duplicated quickly – and they too lose their ability to shift share. In a hostile market, share shifts on the basis of convenience and reliability. A respected brand name, high service levels, and broad product availability become key. These benefits are hard to develop, and they move share slowly.

How Should We Track Profitability?

In a non-hostile market, management control systems trace product profitability. Most revenue and costs can be readily allocated to individual products.

Once hostility takes hold, product profitability becomes meaningless. Customers want to save money by consolidating their purchases, and suppliers want to bind those customers by covering more of the customers’ product requirements. So, product lines and price points proliferate. Additional services and special pricing deals are offered for major customers. Suddenly the costs of overhead, distribution, and even manufacturing cannot be cleanly allocated to individual products, and products cannot be separated from their roles in the package offered to key customers. The management control system must track individual customer profitability.

What Drives High Returns?

Before hostility, high returns are based on revenue. High ROI can result from high unit prices (often for brand name leaders) or high growth (often for smaller firms that introduce unique features).

Hostility removes those unique revenue drivers. Brand leaders have to drop prices, and new features are quickly duplicated. The key to high returns becomes low unit costs. Large producers have the advantage of spreading their costs over more units, but smaller companies can remain competitive by avoiding costs that will not bring them revenue. In either situation, cost becomes a factor to be aggressively managed.

Closing Thought

The majority of companies do not survive hostility. Part of the reason for this high occurrence of failure is that many of the management rules from non-hostile days are not only ineffective, but wrong, for hostile times.

(Note: This Perspective was written in the context of the economy in 1994. 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.