Commoditization… A word that we often encounter these days… But how to escape this commoditization trap and while doing so trying to remain profitable. I had to tackle this question already myself when being product manager of mobile modem, in fierce competition with Chinese brands. I’ll not elaborate on that case, but take as example the “video disc” player market.
Before we dive into this example, let’s have some definitions:
- Price = the price the consumer will pay for his product
- Perceived Value = the price perception that the consumer has about the product. Many factors play here. Some factors that can pull up the perceived value are the more emotional values linked to Brand or perceived quality. But if you lack these, the perceived value will be between the average and bottom price of equivalent products. Perceived value is the price the consumer is willing to pay for your product.
- Value Gap = Price – Perceived Value
The ideal situation is of course when your price is equal to the perceived value. You always want to be on this diagonal line where they are about equal (orange line in the image below). So let’s apply this to our example:
DVD players are still selling in a price range of low €50 to low €100, but there are also already (lower-end) Blu-Ray players in the €60-€100 price range and Blu-Ray players can of course also play DVD discs. These two factors create that the perceived value of a DVD player is now more around €50. If you are selling DVD players at €80, you have an issue, as you have a Value Gap of €30, as shown in the example below.
Entering the commoditization trap means that you will lower your price towards the price the consumer wants to pay (the perceived value), otherwise you will lose sales to the competition.
Escaping the commoditization trap
One way of escaping the commoditization trap is to work on your Brand:
- Some companies do succeed in creating an emotional appeal to their Brand, by the attitude, coolness, freshness, etc the Brand stands for or by having unique designs of their products. Just think about Apple, Mini or Nespreso
- Other companies have built a strong reputation of quality or safety (e.g. Toyota and Volvo respectively for the car industry) and gain value increase out of this
- Still others put the customer in the center of all decisions, like at Zappos, who have 80%-90% NPS scores (http://youtu.be/py1iRsBcYMc)
More on this emotional brand building can a.o. be found at: http://www.lovemarks.com/
Another way to escape commoditization: smart partnering. The trick here is to bundle your product with one or more other products or services that have a logical fit with your product and a high perceived value (and low cost). You could categorize this under ‘Innovation’. In our example, that could be for instance a set of 5 DVD movies. With DVD movie retail prices around €10, the 5-DVD-set would have a perceived value of €40 to €50 (one may not like all movies, thus have a lesser value perception).
This creates a totally new picture, where you would now have a Value Premium compared to your price. This means that your product becomes very competitive for the price you ask. Even so competitive that you can think of increasing your price, to let’s say € 95. Remember, the ideal situation is near the line where Perceived Value equals price. If you and some competitors don’t respect this balance, the whole line will shift towards a new equilibrium:
So you better option is to increase the price towards the perceived value.
Let’s not talk only revenue, but margin…
Selling more is one thing, but an even more important goal is margin. Let’s assume you have a margin of about 30% compared to 70% total costs (components, manufacturing, shop & distribution commissions). That will give you a DVD player cost of about €60. For the DVD movies, if you choose the titles and your partner carefully, the cost of these can easily be only 50% or even lower. Thus, a 5-DVD-pack could cost you €25.
It becomes immediately even more obvious what your best choice is.
- Option 1: you keep your price as it is… Result: bye bye sales. No one will buy your overpriced product.
- Option 2 (left image): you lower your price to a user acceptable price of €50 to €60… Result: bye bye margin.
- Option 3 (right image): you look for Smart Partnership, in our example a 5-DVD-movie-pack. Result: Now you can do a price increase and get a marging of €10. That’s obviously still not 30% margin you want to achieve, but it generates margin.
This is only one example and one tactic. Some other examples are “a holiday with insurance included” or “gasoline for the first 6 months when purchasinh a car” or “music streaming service with a GMS subscription”. The essence is to increase the Perceived Value for the customer and get back into the “successful league” that is sitting around the equilibrium line of Perceived Value and Price. But be always remember that a partnership needs to be a win-win situation, you should not force your partner in a commoditization trap of its own.
I’m personally a strong believer that an important part of Value Creation and thus profit will be realized by smart partnerships between companies. It’s already present, but not yet all over the place, so now’s the time to look for strategic partners and secure your profit!