Rare Mettle: Gold and Silver Strategies To Succeed in Hostile Markets
by Donald V. Potter
Hostile markets are the ultimate tests of management ability. As the economic version of scorched-earth warfare, a hostile market demands that its competitors have the ferocity of a prizefighter and the endurance of a marathon runner.
In a hostile market, too many companies compete for the same customer base. Returns are low, sometimes abysmally low. The industry is plagued with excess capacity either because of a fall-off in demand or due to aggressive expansion by competition. No situation or customer relationship is safe. Pricing seems irrational and self-destructive to an outsider – and even to some insiders.
The odds of surviving a hostile market are low. Hostility is a chronic condition, often lasting twenty years or more. And only a few survive its full term. In 1967 there were more than 30 American manufacturers of televisions; 25 years later, only one had survived. Of the top 50 less-than truckload firms operating in 1967, fewer than 10 remained in 1990. U.S. wholesale grocers numbered 1,500 in 1975, but in the early 1990's there were only 250. Most of the departing companies had been withered by a hostile market and swallowed by surviving firms.
A survivor wins when it both increases market share and earns an ROI above its industry's average. Our research shows that managements of winning companies have common themes for success in hostile markets, although at first glance they seem to be a widely disparate group of competitors: American Airlines and McDonald's, Marriott and Whirlpool, E&J Gallo and Owens/Corning Fiberglas.
Yet these winning firms fall into two broad classifications that we refer to as Gold and Silver. These Gold and Silver companies follow five basic themes to survive hostility:
Focus on large customers (but accept others)
Differentiate the company on reliability
Cover a broad spectrum of price points
Turn price in to a commodity for the customer
Emphasize resource utilization in the cost structure
Of course, the lessons of our research are more subtle than this list suggests. While virtually all successful companies are aware of these themes, their implementation differs according to their market position at the onset of hostility.
CHARACTERISTICS OF GOLD AND SILVER COMPANIES
Gold competitors are the largest, most successful companies in their industries, such as Federal Express, Owens/Corning Fiberglas, and Paccar. While most industries have only one Gold, a few (such as meatpacking with ConAgra and IBP, and trucking with Yellow Freight and Roadway) have two. Gold firms hold the highest or second highest market shares and often have a powerful brand-name franchise. They grow faster than their industries and have above-average returns on investment.
Silver competitors are smaller and face longer odds of survival than Golds. While they too, have above average sales growth and ROI, their names are less well-known, except within their industries, and they are third or lower in market share. Examples of Silver companies are Airborne Express, Tamko (residential roofing), and Freightliner (truck manufacturing).
Gold and Silver competitors are neither numerous nor certain to exist in every industry. A typical hostile market might have one Gold company, with a market share of 20%-40%, and one Silver, with a market share less than half that of the Gold. The rest of the market belongs to several companies of varying size that have slow growth, low returns, or both. Some industries lack a Gold or a Silver competitor, and some have neither. For example, the farm equipment industry during the 1980's had a Gold company (John Deere), but no Silver company. The lodging industry had a Silver (Marriott), but no gold. The domestic integrated steel industry had neither a Gold nor a Silver. A Gold or a Silver will exist only where a management follows a very disciplined strategy in its market.
Golds and Silvers differ in how they implement the five basic themes, but each is like its counterpart in other industries. Golds win like other Golds, Silvers like other Silvers. Exhibit 1 compares some of the important characteristics of Gold and Silver competitors.
Exhibit 1. Gold vs. Silver Competitors
|Market Share Ranking||#1 or #2||#3 or below|
|Growth||Above industry average||Above industry average|
|Profitability/Returns||Above industry average||Above industry average|
|Key Customers||Industry's largest||Large second tier, selected medium|
For channel customers:
For end users:
| Cost reduction programs
| Revenue enhancement programs
Above standard service
|Price Point Coverage||All with significant volume||As dictated by key customers|
|Pricing Policy||Level with peers||Low early, then level with Golds|
|Cost Management Thrust||Economies in overhead||Focus overhead on key customers only|
Our research indicates that Gold and Silver firms concentrate relentlessly on the strategies consistent with their position. Hybrid approaches – trying to blend elements of both Gold and Silver- seem to lead to customer resistance and failure of one degree or another.
Managers in industries that are not yet hostile can be better prepared for the trials ahead by studying the patterns of successful companies in hostility. For companies in hostile markets that do not have Gold or Silver positions, the decision becomes whether they should consider using more of the approaches of these winning firms.
FOCUS ON LARGE CUSTOMERS (BUT ACCEPT OTHERS)
Companies that survive a hostile market usually go into the period of hostility serving the "heart of the market." That is, they generally are mid-priced suppliers, such as Procter and Gamble in disposable diapers, Canon in copiers, and Michelin in the tire industry. These companies have sufficient volume and margin to be able to survive the inevitable price wars. A few survivors also straggle in from the high end of the market. Intel, in the semiconductor industry, is one example. These firms tend to specialize in special, feature-rich products that command a minority of the total market's unit share. Margins, for these companies, stay high as long as their products are not duplicated. Low-end specialists, with little room to cut margin as prices fall, almost always fail. People Express Airlines and Laker Air are examples of noble, low-priced ventures that could not survive market hostility.
Volume is crucial. A company that would succeed from an initial position in the middle price range of the market needs unit volume for success. Unit volume drives a cost structure. Unit market share is important in a hostile marketplace in order to maintain a cost structure that will allow a medium-priced specialist to make an attractive return on investment.
In most industries, this volume comes from a relatively small set of customers. In industries with channels of distribution, the 80/20 rule usually holds where 20% of the customers buy 80% of the industry's volume. A channel of distribution is a customer who has the option of buying from more than one supplier and who then resells the product to another customer. A channel of distribution would include distributors and wholesalers who sell to dealers and dealers who sell to retail customers. Value-added resellers would be channels, as would brokers, though the latter rarely assume ownership of the product. Some industries operate largely without channels of distribution. Examples would include the fast food and credit card issuing industries. These industries sell most of their product direct to the end user. In industries without distribution channels, volume is less concentrated in the top tier of customers. Here we have observed more of a 70/30 rule, where 30% of the end users account for 70% of industry unit volume. However, in both hostile and non-hostile markets, some version of the Pareto rule applies: a relatively small minority of customers in a market buys a very large percentage of the market's unit volume. These are the industry's large customers.
Whenever an industry has both channels of distribution and end-user customers, and the majority of industries seem to have both, there can arise a question as to who is the key customer. In each case we have studied, both the Gold and the Silver companies view the channel customer as most important in setting strategic policies.
But serving only large, high-volume customers will not ensure success. In the few cases we have seen where a leading company will serve only large customers, that company's profitability levels are below what we would have expected. In hostile markets, the profitability of a customer relationship is usually inversely related to size. Large customers use their volumes to negotiate for the lowest possible prices, so they offer smaller margins, whereas medium-sized and smaller customers cannot negotiate so effectively and can be served at better margins. Using common accounting practices, smaller customers are more profitable. Margins, then, are also important. Medium-sized customers help sustain margins because they offer both volume and profitability. A company in hostility needs these customers.
But medium-sized customers are the most difficult to serve. These customers, especially if they are channels of distribution, are often feeling price pressure from their larger peers and service pressure from their smaller competitors. As a result, they send inconsistent messages to their suppliers, vacillating from price sensitivity to high service demands. A company in a hostile market must find some way to attract medium-sized customers while at the same time concentrating its efforts on large customers.
Gold: Get The Largest Customers (Medium Customers Will Follow)
Most Golds focus their energies on the industry's very large customers. Their weapon is their strong brand identity with end users, which they have developed over the years. End-user pull allows Golds to avoid, for the most part, channel conflicts. Companies with consumer brand franchises and customer pulling power (Owens/Corning Fiberglas in insulation and Procter and Gamble in disposable diapers) are largely immune to volume losses from members of their channels who compete with other members of the channel who are "too close"- channel conflict. The majority of large and medium distributors feel compelled to carry the Gold product because their customers demand they do so. To the extent that the distribution channel is the customer, Golds can attract the largest volume distribution channel customers.
If end-user volume shifts channels, Golds can evolve their distribution tactics to match the volume shift. For example, the residential roofing industry saw a significant growth in roofing shingle volume sold through retail channels during the 1980s. As this shift took place, the Gold competitor, Owens/Corning Fiberglas, added a strong retail distribution marketing program to complement its major position with wholesale distributors. Owens/Corning Fiberglas took the vast majority of this fast growing retail business and became the unquestioned market share leader as the industry's channels evolved.
Golds treat the industry's medium-sized customers as marginal volume. They will accept any medium-sized customer who will buy on terms and conditions set primarily for the industry's largest customers. Golds seem to get this profitable mid-sized customer volume by right of position. Many medium-sized customers buy from the largest suppliers because they believe these suppliers' large size makes them the best supplier in the industry or because their own customers demand that they carry the products of the largest companies.
In industries without channels of distribution, or with end users as important direct customers, Gold companies will attempt to create a large customer from a group of medium-sized customers. Using this pattern, Federal Express created the "parts bank program" which centralized companies' national parts warehousing systems. Shippers who were medium-sized customers when moving some critical parts to their own customers became large customers when Federal Express offered to manage their critical parts warehousing and distribution for them. Similarly, American Airlines introduced the first frequent flier program. This program encouraged business travelers who spread their purchases over several airlines to concentrate their ticket purchases on American. Yellow Freight introduced a customer shipment aggregation discount program to increase the size of its average shipment for its customer. And discount broker Charles Schwab instituted a program devoted exclusively to financial advisors to encourage these buyers to do most of their business with Schwab.
Silver: Seek Second Tier Large Customers;
Woo Service-Oriented Medium-Sized Customers
It is rare that a Silver competitor can win a major position with many of the industry's largest customers. If the Silver could win a major position with the industry's very large customers, it would quickly become a Gold company. However, Silvers rarely possess the infrastructure to serve these customers as well as can the Golds. Instead, Silver competitors focus on the second tier of the industry's largest customers – that is, the industry's large, but not the largest, customers. In the truck manufacturing industry, small fleet owners fit this description. Freightliner focused on small fleet owners to sell its trucks. Tamko stressed the large roofing-oriented distributors over the very large retail channels in residential roofing. These second tier customers tend to emphasize "good service for a reasonable (i.e., not the lowest) price" to their own end-use customers. These second tier customers cannot negotiate prices as low as those of the very largest customers. Silvers will usually have revenues per unit sold that exceed Golds because their average customer is smaller and pays a higher price.
To attract these customers, many Silvers adopt industry specialties. Ball became the major supplier of wide-mouth food jars to the food industry while others sought the beverage market. Hewlett Packard piggy-backed on its stellar reputation in the manufacturing and test equipment markets and tailored its minicomputers for these industries while competitors sought larger volume purchasers
And, in contrast to Golds, Silvers seek out medium-sized customers, who are important customers to them and definitely not marginal volume. Silvers are far more solicitous of medium-sized customers than are Golds. These medium-sized customers are an important part of the Silvers' marketing and sales programs.
Not just any medium-sized customer makes the grade with a Silver though, only those who are service-oriented in their purchasing and in their own marketplace. As one executive put it, "We wanted customers who did business the way we did." The best of the Silvers describe their ideal medium-sized customers the same way: the customer is growing faster than his market, so his customers like him, and his credit rating is better than average in his industry, so he makes a good profit. Silvers avoid price buyers in the medium customer category.
DIFFERENTIATE ON RELIABILITY
In times of market hostility, customers tend to have multiple suppliers. The need for several suppliers starts before hostility begins. In non-hostile times, industries often see product shortages, so customers add suppliers to assure themselves of product availability. For example, the building insulation market saw several shortages during the 1970's as demand surged around rapidly rising energy costs. In response, insulation distributors added secondary suppliers. During non-hostile times, a customer may also have to add a supplier to fill out its product needs, especially at the high or low end of the industry's product price range. In the early 1980's, lift truck distributors had to turn to smaller industry competitors to supply them with small volume, high-end, narrow aisle lift trucks. The need for several suppliers is often compounded with the onset of hostility as customers seek to achieve lower prices or just to be certain they are receiving a good price from their major suppliers. As one customer put it, "I need at least two suppliers to keep both of them honest on the prices they charge me."
A customer will assign each of his suppliers a specific role to play for him. For example, the primary role will go to his major supplier, who meets most of his needs. The secondary supplier might provide product availability insurance and the tertiary supplier might provide him with his specialized product needs.
The key role for a supplier is that of primary supplier to the customer. This role can bring with it two to four times the volume of all the other roles combined. A primary supplier wins this role with the customer on the basis of a relationship of trust, something we term reliability.
Reliability commands far more market share than does any other factor differentiating one company from others in the market. Other factors do not remain unique. Feature differences that move significant share remain unique less than twelve months, on average. Price differences become quite small during hostility. Differences in convenience of purchase depend largely on which company has the most outlets. This, we have also found, depends on reliability. A company cannot hold its position in outlets unless it maintains high reliability.
Gold and Silver companies stress innovation for their largest direct customers. Where channels of distribution exist, both Golds and Silvers will develop two to three product and service improvements, as well as new marketing programs, for their largest direct customers, the channels, for every one developed for the end-user.
Golds and Silvers will both add product features defensively, especially where share is likely to move as a result of these features. Gold competitor Michelin copied Goodyear's all-weather tire and Federal Express matched UPS's COD potion when those features began to move share. Silvers do much the same. For example, Quick and Reilly copied features introduced by Charles Schwab that proved successful in attracting customers of full-service firms to discount brokerages. And, Overnite introduced electronic data interchange once their largest customers began to request it.
Golds and Silvers will both add product features defensively, especially where share is likely to move as a result of these features. Gold competitor Michelin copied Goodyear's all-weather tire and Federal Express matched UPS's COD option when those features began to move share. Silvers do much the same. For example, Quich and Reilly copied features introduced by Charles Schwab that proved successful in attracting customers of full-service firms to discount brokerages. And, Overnite introduced electronic data interchange once their largest customers began to request it.
Golds and Silvers both stress consistency – a key form of reliability – in their products and services. Both believe strongly that their key customers should get the same performance over both time and geography. Alumax, a Silver company in the aluminum industry, carried special inventories for its largest customers so they would never feel a shortage and order cycle times would remain predictable. And the program succeeded as one very satisfied Alumax customer reflected: "We never knew there was a shortage. We just called and the metal was there."
Reliability has different meanings for end-use customers than for distribution customers. For an end-user customer, reliability means that the product or service works consistently and that it will be fixed promptly if it stops working. On the other hand, for a channel customer, reliability means the product or service will be delivered where and when promised and that the supplier will be consistently responsive to the channel customer's problems.
Golds and Silvers also have important differences in how they innovate on reliability. These differences exist whether they innovate for end-users or for channel customers.
Gold: Develop Presence for End-Users and Cost Reduction Programs for Channels
Gold competitors stress presence with end-users. For the largest end-users, the Golds emphasize a wide-spread physical presence. Alcoa put a sales office in every region where one of its largest customers was headquartered. This ensured those customers a fast response to their problems. Golds also develop presence by seeing that their products are carried by the biggest members of the channels. These channel members are often national in scope, offering the many locations needed to serve a very large end-user with requirements in several places in the country. In most industries, end-users tend to assume that the best companies associate with one another. One large corporate personal computer buyer put it succinctly: "I buy from IBM not just because they are a good company, but because I know they will pick the best dealers. And I rely as much on my dealer as I do on IBM."
With medium-sized end-users in all markets and with markets that have no channels, the Gold competitors rely on advertising to create a strong brand identity. This advertising creates a large "share of mind" presence for the Gold with the end-user. The advertising usually emphasizes reliability rather than any particular feature or price. The themes stress that the company will "take care of" its customer. McDonalds "You deserve a break today" and Citibank's credit card advertisements on protection from theft are examples.
This brand advertising is important to channel customers as well. It increases customer demand, especially from medium and small customers. This smaller customer demand increases the sales per square foot of the channel for the branded product over that of a less well known product. With channel customers, Golds innovate to reduce the costs their customers incur in buying from them. They do this primarily through investments in information systems and automation. They frequently provide channel customers with extensive market information and with sophisticated data-based programs to help their customers manage their purchases and inventories more effectively.
These innovations demonstrate Golds' long-term commitment to their customers and remain unique a long time. Brand advertising implicitly assures an end-user of quality in a product. While investments in systems to reduce the costs to channel customers to buy and sell a Gold supplier's products increase the number and level of personal relationships between the Gold company and its customer. These presence and cost reduction innovations remain uncopied because the very large initial cost of creating them requires a substantial volume base over which to recover that cost.
Silver: Beat Service Standards for End-Users
and Protect Revenue for Channels
Silvers are not naturally as well positioned as Golds. Their average customer is smaller and they have far less infrastructure and overall market presence. They win by offering, consistently, service levels to end-users that other competitors achieve sporadically. Where channels exist, the Silvers rely almost solely on them to carry their message to the end-user and, in return, they protect the revenue base of the channel.
Silvers are not large enough to set the industry standard for services, including the service of correcting problems. Instead, they use the industry standard as the platform on which to build their consistently higher level of service. Alaska Airlines put one more flight attendant on its flights than did its competitors. The extra attendant solved passenger problems faster. Pitney Bowes guaranteed a four-hour response time on a plain paper copier service call, no matter where the customer was located. No one else could meet that standard for the customers Pitney Bowes chose to service. Silvers will also typically achieve higher service levels for their channel customers. For example, Cooper Tire had the tire industry's highest order fulfillment level for its dealers.
The channel is the key to Silvers' success with end-users. Where distribution channels exist in an industry, end users of Silver products tend to look to the channel to recommend a brand and to ensure its quality. Silvers believe that the best way to serve the ultimate customer well is to pick the right channels of distribution and then to serve those channels well. The channels, in turn, would tell the companies what the end-users really needed. As one executive explained it: "We used our distributor customers as our real sales force. If we didn't have what they needed for their customers, it didn't take long for us to find that out."
However, the primary emphasis of Silvers with their channel customers comes in revenue protection. Silvers work hard to see that their channels increase their revenues. To protect the channel, many Silver competitors offer exclusivity of territories. Silvers often develop joint sales calling programs with their key channel customers. In the residential roofing business, the Silver competitor, Tamko, developed comprehensive programs to make joint sales calls with their key roofing-oriented distributors. The targets for these calls were building contractors that were the key customers of the distributors. The objective was to enhance the distributors' relationships, and business, with their key customers. Tamko then expected to grow as their distributors' business grew. Silvers also invest in extensive sales and service training programs to help their customers' sales and repair programs prosper. These programs make the Silvers' channel customers more reliable suppliers to the end users.
COVER BROAD SPECTRUM OF PRICE POINTS
In every hostile market, a company must decide not only how to improve the product and service packages that it already offers, but whether to offer additional price points.
The typical hostile market has three characteristic groupings of price points: high end, medium, and low end of the market. The medium price points – the "heart of the market"- set the standard for product performance and unit price in the industry. Products here command 60-80 percent of an industry's unit volume. The high end of a market seems to start at a premium of 10-15 percent over the standard price. High-end price points typically command 5-15 percent of an industry's unit volume, though they can have as much as the low 30s. The low end of the market typically sees price points at 25-50 percent off standard, with unit shares again in the 5-15 percent range.
The air express industry during the 1980s offers an example of these price point groupings and unit shares. Standard service was the overnight letter with morning delivery, priced around $15.50. This service had nearly 80 percent of the market. The high-end price point service delivered the letter the same day, for several times the price of an overnight letter. This service commanded less than 1 percent of the market. Low-end service offered second-day delivery for a price only 40 percent of that of a standard letter, a proposition that was attractive enough to garner nearly 20 percent of the unit market share.
In a hostile market, winners offer products at a range of price points. To understand why, we should describe part of the evolution of market hostility.
In hostile markets, products proliferate as competitors seek niches with offerings tailored to the needs of ever-smaller groups of customers. Companies that enter hostility as mid-range price specialists (that is, those with the bulk of their unit volume in the "heart of the market") drive this proliferation. They expand their shares by offering products at the other price points. As they expand their their offerings, they put financial pressure on competitors at the high and low ends of the market range. High-end competitors feel pressure as the large players from the "heart of the market" introduce products with better features, more convenience, and prices that match or only slightly exceed those of the low-end specialists. In the auto industry, Toyota, one of the key "heart of the market" competitors, put enormous pressure on both high and low-end specialists by following this pattern.
At the same time, competitors copy one another, so the differences in the physical features of the products offered by various companies decline. As product functionality converges, the largest competitors in the market gain share by appealing to customers' growing interest in consolidating purchases in a form of "one stop shopping." This consolidation of purchases serves to reduce the effective prices paid by the customer and to ease the customer's logistical problems.
The addition of product price points supports both the growth and profitability of the "heart of the market" competitors. Unit growth rates over the longer term favor the middle price points. However, for periods of several years, a low or high price point may grow notably faster than the standard price point. For example, during the 1980's, the high-end price points grew far faster than the mid-price range in the plain paper copier industry and the low-end range grew fastest in the lodging industry. Product price point profitability usually is proportional to price – the higher the price point, the more contribution margin per unit the price point generates. Winners will introduce new price points, then, but Golds and Silvers will do so in ways that differ from one another.
Gold: Seek Volume Everywhere
Golds are companies in search of volume. They will happily introduce new products if they believe these products can generate marginal volume. Golds are not concerned with adding only products that appeal primarily to their current customer mix; they are willing to go after new customers. Anheuser Busch's introduction of non-alcoholic beer is an example of this phenomenon, as is Canon's introduction of the personal copier in the plain paper copier industry.
This approach generally leaves Golds with a product mix that mirrors the market. They will have market shares at all major price points that roughly approximate the composition of the market overall.
Silver: Respond Only to Needs of Large Customers
Silvers are much more constrained than are Golds in the introduction of additional product price points. They have less money for product development.
As a result, Silver's prefer to introduce product price points only when they are certain that the price points will appeal to their large, current, and potential customers. In a real sense, their product price point offerings are dictated by their largest customers. Several Silver companies executives described their attitude toward price point coverage in words like "making what customers wanted rather than selling what we made."
This policy of responsiveness to large customers leaves Silvers with a product mix different from that of the market as a whole. Since Silvers target large customers who emphasize service over the lowest prices in the market and therefore buy higher-end products, Silvers' product mix is skewed toward the higher end. This mix is important to Silvers' profit position. Higher-priced products usually are more profitable than medium-priced products, so a company with a mix skewed toward the high end will have higher margin levels. However, this product mix results from the decision to seek customers who emphasize service, rather than being a result of the introduction of more high-end products.
TURN PRICE INTO A COMMODITY
In the years immediately preceding hostility, price differences among competitors can be quite large – from 10-30 percent for comparable products. However, within two or three years of the onset of hostility, prices will converge. By then, the typical customer will see competitors' unit price quotes falling within a 5 percent range of one another.
Some price differences may remain a result of performance differences. Certain companies may seek modest 2-3 percent premiums over the average market price because the company can either increase its customer's sales, or decrease the customer's cost more than can competition. In other instances, companies may find that they have, in effect, been handed a price premium by weaker competitors who need to cut price below market to hold any share at all. These "price shaver" suppliers offer discounts to offset some performance weakness in their product, such as a missing feature, lack of brand name, below-average quality, or poor product availability. Price shavers do not perform well long-term.
For all practical purposes, the hostile market turns price into a commodity. That is, any remaining price differences are so slight or unimportant that most customers can not, or will not, change suppliers on the basis of price differences that exist in the hostile market. Ironically, price has little long-term impact on share movement once hostility is underway.
If hostility causes prices to converge and become a commodity, how do Golds and Silvers change their pricing strategies with the onset of hostility?
Gold: Price With Peers
In many industries not yet in hostility, Golds hold up a pricing umbrella that allows smaller competitors to grow. Federal Express in air express, Roadway in less-than truckload trucking, and IBM in the personal computer industry were among the many leading companies who held price umbrellas over smaller competitors as hostility began in their industries.
Golds always drop this umbrella. Once the umbrella has dropped, Golds decide to price "at the market", meaning that Golds' prices are virtually the same as those of 2-5 other companies that customers treat as "peers" in the market. These "peers" are other, relatively large, competitors who also solicit the business of the customer. These other companies are rarely "peers" of the Gold company in true quality of product or service, but customers use the prices quoted by these "peers" to hold the Golds' prices at the same level. Most Golds accept this situation and adopt pricing policies that say that the company "will not lose business on price." One Gold CEO's policy is stated simply, "You can lose a deal on price, but never a customer." Such a policy removes price from the customer's buying criteria. It makes price a commodity.
Golds do reap rewards for their better performance, though. They argue to the customer that their superior performance merits a greater volume position in the customer's relationship. And this argument often prevails.
Silver: Match Price to Falling Market Levels
Silver competitors seem to be major beneficiaries of the price umbrella the larger competitors often set immediately preceding hostility. Many Silvers – including Airborne Express, Overnite Trucking, Shintech in PVC, and Toyota in lift trucks – have garnered share by discounting against the price levels supported by their industries' largest competitors. Few Silvers begin hostility with prices above those of the largest companies.
As the hostile industry's largest companies react to share loss by dropping their prices, the Silvers, who were discounting prices against the largest competitors, then gradually reduce their levels of discounts. As market prices continue to fall, Silvers eliminate their discounting entirely and come to match the general industry price level. At this point, the Silvers, too, have commoditized price.
Silvers then grow on the basis of their superior performance for their carefully chosen customers. After three to five years of hostility, the Silvers usually are part of the industry's market pricing structure. They meet industry prices whenever and wherever prices move. On rare occasions, Silvers maintain small discounts. Cooper Tire, for instance, continued to price its products about 2 percent below the market price set by the larger tire companies for several years after hostility established itself in the industry. However, most Silvers match the prices of the larger firms and continue their share growth on their superior performance alone.
EMPHASIZE RESOURCE UTILIZATION FOR RETURNS
The best companies in hostile markets beat their industry's average return on investment. They may not beat the returns of the average large company in other non-hostile industries. The trauma of hostility challenges an entire industry, so that even the leading companies may have returns below the average for all industries. For example, American Airlines is a Gold competitor in the airline industry but because of hostility in that industry during the 1980s, American's return on equity was below the average for large U.S. companies during that decade.
Returns that are high for an industry are proof of an effective cost structure. With competitors pricing within a very narrow band, the best returns go to those companies with the lowest unit cost structures. Generally, the highest returns go to the Gold competitors, who have the advantage of volume. Gold companies such as Owens/Corning Fiberglas in the insulation industry, McDonalds in fast food, E&J Gallo in table wine, and John Deere in farm equipment, annually produce returns far above their industry averages.
But Golds are not always on top in returns. Some Silver competitors overcome their size disadvantages to lead their industry in returns. During the 1980's, Tamko, a Silver, was the most profitable residential roofing company while another Silver, Quick and Reilly, led the discount brokerage industry. Two other examples are Alumax in aluminum and Pitney Bowes in plain paper copiers, both of which topped their industries in returns.
In a hostile market, what is key to a low-cost structure? Usually it is high productivity. There are at least three ways to achieve a low-cost structure. The building blocks of any cost structure are the costs of people, capital, and outside purchases. A company's cost structure can produce high returns by having low rates of cost for these building block resources, by having a unique approach to the management of one or more of the functions that use these building blocks, or by having high productivity of the building block resources.
Market hostility diminishes the capability of two of these three ways to achieve low cost. Differences in rates of cost usually disappear quickly. High purchase rates for raw materials, such as energy, would destroy a company and so are factored out as far as possible. For example, when relative energy source costs changed during the 1970's, the aluminum industry required only a few years to restructure its energy-intensive smelting configuration. Other rates of cost appear less important – in fact, some successful competitors even have higher rates of pay for their work forces. Differences in approaches to managing functional costs do exist, but are of secondary importance because they are so easily copied throughout the industry. For example, Ball was the first domestic glass container manufacturer to run two lines rather than one off its furnaces, but within three years all major competitors had copied that configuration.
Most winners have high returns because they have high productivity in their resource base. High productivity means that the company produces more units of product per unit of resource used than does competition. One path to high productivity is high revenue growth. A company that increases its sales much faster than its industry seems to add costs at a slower rate than its unit sales grow – increasing its productivity of resources. And both internal and acquired growth offer this opportunity to increase resource utilization. The Silver airline industry competitor, Alaska Airlines, is an example of increasing productivity with internal growth. During the 1980's, Alaska's return on equity beat its industry's by a wide margin, in part because its unit growth rate was more than twice the average for its industry. Acquisitions work as well if they are accompanied with overhead reduction. The Gold glass container industry competitor, Anchor Glass, acquired its way to the second ranking in its industry. With each acquisition, it cut overhead dramatically. In purchasing Midland Glass, for example, Anchor cut Midland's selling, general and administrative expenses by 80%.
Eventually, though, most companies must find paths to high resource productivity other than high growth. And Golds and Silvers do so. But not the same way. Golds achieve productivity through using their size while Silvers reach it with focus.
Gold: Invest for Economies in Overhead
Golds achieve high productivity by investing to create low costs, especially in selling, general and administrative expenses. These investments and the low costs they create can be traced to the Golds' advantage of size.
Golds have a natural overhead cost advantage over most of their competitors. Golds have more and larger customers. These advantages give the low overhead costs because of their greater relative size. They sell more units of output per unit of work done. For example, the average order a Gold receives has more units per order than does the order of a competitor. So a Gold overhead employee, such as an order handling clerk, will handle more units per order than will a similar clerk at a smaller company – resource productivity is higher with the Gold company due to its market position.
Golds will invest to increase these advantages of market position. They invest by accepting, even seeking out, marginal volume, even at relatively low returns. In the large appliance industry, for instance, both Whirlpool and General Electric build private label products for other companies who will market them under other brand names. These private label programs reduce their overhead costs by increasing unit sales per unit of overhead employee.
Golds also invest to increase their overhead efficiency, which is the units of work an employee can complete in a day. For example, the Golds will invest in automation and information systems to increase the number of orders an order handling employee can process in a day. The large size of the Golds allows them the potential savings to make these investments economic before their smaller competitors can.
Silver: Focus All Costs on Target Customers
Silver companies achieve their productivity entirely differently than do Golds. They must focus their resources very tightly to prosper. But they get some help from their marketing focus along the way.
Silvers target large second tier companies and some medium-sized companies. These companies pay higher price than do Golds' customers, and they tend to buy a higher-margin mix of products, where returns are better. By having a richer customer and product mix, Silvers are able to realize unit revenues several percentage points over those of the average Gold. In the less-than-truckload trucking industry, for instance, the Silver competitor, Overnite, enjoyed an average return per ton mile about 15 percent over that of Gold competitor, Yellow Freight. This 15 percent advantage was due entirely to a better customer and product mix, not to higher product prices.
Silvers need all of this unit revenue advantage since their unit cost structures are also higher than those of Golds. Because their customers are smaller and more demanding, Silvers usually spend more per unit to make and service their products. Silvers offset their cost disadvantage with an extremely disciplined approach to R&D, marketing, and sales. Silvers know who is – and who is not – a target customer, and they focus on meeting the needs of only those target customers. For example, target customers do not demand that Silvers lead the industry with new features. As a result, Silvers spend below the industry average on R&D; instead, they are fast followers. Silvers also stretch their marketing and sales budgets by refusing to spend resources on potential customers who do not meet their disciplined criteria. Few will undertake large advertising programs. Silvers also have a smaller sales force per unit of sale because they do not require salespeople to call on low-potential customers outside the target profile.
There are few secrets to survival in hostile markets. There are, however, policies that can improve a company's chances of emerging from hostility with its customers and profitability intact. These actions include focusing company policies on the largest customers that the company stands a good chance of winning. The company should create programs to build a relationship of trust with these chosen customers. These programs include not only the commitment to be the most reliable supplier but also to offer a broad spectrum of product price points at market prices. Once the company has succeeded with its customers, only then should it turn to its cost structure. Management must design and build a cost structure that ensures that all resources, but especially, sales, general and administrative costs have high levels of utilization. While these policies are the same for both Gold and Silver companies, they are implemented differently by each type.
For a Gold company, the challenge is to build volume and then exploit the advantages of size. A Gold firm wins the largest industry customers by building massive presence and driving down the customer's costs of doing business with it. Golds add product price points rapidly – whenever, in fact, they see a volume-building opportunity. They price their products at the market, and achieve higher penetration levels with their customers. In addition, they invest in their cost structures with the specific intent of enhancing overhead productivity through systems and automation.
For Silvers, the policy implementation is different. They succeed by being the industry's most focused companies. Their first priority is to choose the "right" customers. In the words of a Silver executive, "We avoid the strategic interests of the largest competitors in the market." Silvers have as customers large firms (although not many of the industry's largest customers) who emphasize or appreciate service. Silvers grow with these customers by consistently exceeding industry service standards for end-users, and by protecting and developing the revenue base of their channel customers. In addition, Silvers cover only the product price points that their chosen customers demand, and they follow and meet the prices set by the largest competitors for those products. Silvers tend to have high manufacturing and service cost structures, due to both their average customer size and their high service orientation. To offset this disadvantage, Silvers achieve low costs in design and sales by avoiding spending that does not support their chosen customers.
There's plenty of bad news when competing in a hostile market. The good news is that, inevitably, hostility ends. Managers who pass the severe tests imposed by hostile markets will find a changed competitive arena when hostility subsides- one marked by new opportunities for growth at high returns. And those who will cash in on these opportunities will indeed possess rare mettle.
APPENDIX. ABOUT THE RESEARCH
In 1985, we began a long-term study of successful performance in hostile market conditions. We undertook this work in the belief that all industries are fundamentally alike. The economic and psychological pressures of hostility are the same across industries. Companies in a hostile industry will respond to these pressures in patterns determined largely by where they are positioned as hostility commences. The company response patterns, in turn, seem to have similar probabilities of success or failure, regardless of the industry in which they are employed.
To date, we have studied the characteristics of more than 200 industries facing some type of hostility. Through our client work, we have examined over 40 of these industries in great detail. We have studied the strategic policies of companies in these industries over a several-year period corresponding roughly to the mid-1980s, using analyses of internal data and extensive interviews with customers, current and retired industry executives, suppliers, industry analysts, and trade association officials.
Specifically, we compared and contrasted the policies of matched pairs of competitors. The first member of each pair held the first or second unit market share position in its industry, had grown faster that its industry, and had returns on investment above average for its industry. These companies we called Gold competitors. The second member of each pair held a unit market share position of third or below. It, too, had to have gained share and out-earned its industry average during hostility. These companies we called Silver competitors.
1980's INDUSTRIES AND COMPETITORS
|Air Express||Federal Express||Airborne Express|
|Plain Paper Copier||Canon||Pitney Bowes|
|Polyvinyl chloride (PVC)||Oxychem||Shintech|
|Residential Roofing||Owens/Corning Fiberglas||Tamko|
It is not the companies themselves that are important, but their policies. Companies may change policies – even successful policies – in search of faster gains in revenues or greater margins. Then their performance is likely to change.
One caveat on our research and observations: we reached our conclusions inductively. We followed a successful firm once it had succeeded. As consultants, we were concerned primarily with what policy worked rather than with why a policy might work. We examined in detail the policies followed for several years by companies that succeeded and then attempted to explain and interpret these policies. At the same time, we tried to learn how the less successful firms' policies varied from those of the winning firms. Further research by the academic community might reach alternative, or more detailed, explanations for success in tough markets.
(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.