6 Tips to De-Commoditization

These Companies Did It and So Can You
by Per Sjofors, Atenga, Inc.

A commodity is a product whose buyers make purchase decisions on price and availability. Commodity marketplaces return substandard profits to most of their vendors, as the lion’s share of the business goes to the lowest-cost supplier. In most business-to-business markets, buyers pressure vendors to offer higher discounts, lower prices, and extra services. One tactic is to threaten taking the order to a competitor, who will often offer a lower price. The drum beat of downward pricing pressure convinces salespeople, sales managers and even some chief executives that low price is the major, or even the only, decision driver of their buyers. They gradually come to perceive their marketplace as ‘commoditized.’

But most marketplaces are not commoditized. Very few markets are dominated by the low-cost supplier. In fact, it is often noted (with surprise!) that the dominant player in a given market is able to maintain its dominance even with higher prices.

The classic example is Starbucks, who decommoditized the coffee marketplace. Starbucks replaced the fifty-cent cup of Joe with a $2.00 “low end” product, and successful offerings as high as $4.95. But Starbucks is a consumer product, and examples abound in the business-to-business world as well. Intel is routinely underpriced by AMD in the business of microprocessors, but the company had 80.2% of the microprocessor market in the last quarter of 2010. VMWare confronts both Citrix and Microsoft in the virtualization software market, and commands more than 80% of the market. Microsoft’ Hyper-V and Citrix’s Xenserver are both offered for  free. Microsoft, AMD and Citrix are credible companies with histories of quality, reliability and world-class support. Nonetheless, like Starbucks, Intel and VMWare are able to hold commanding market shares along with higher prices.

Are you a commodity? This would mean that your management team has failed to establish differentiators meaningful in your marketplace.  You are a commodity when your market views you as nothing special, and decides to buy from you primarily on your price. Feeling this pressure, you probably feel forced to cut prices and to add more and more value to what you offer. You feel pressure to win your customers by providing even “more for less”.

But there is another way. Starbucks does it, Apple does it, Intel does it, VMWare does it, John Deere does it.  Zantac came into the market deliberately with prices 10% higher than the established leader. The list goes on and on. In nearly every industry, there are companies who have found ways to differentiate themselves from their cheaper competitors, to compete on bases other than price. They have escaped the commodity trap, and you can, too. These are some of the methods they have used:

  1. Decide. The most important leap you need to take if you want to decommoditize your  business is a willingness to say no to a portion of your marketplace. You can’t sell to everybody, and you can’t sell to the portion of the marketplace that views price as its most important decision driver. If the guiding principle of the company is “we will never lose on price” the company is admitting that it has failed to establish differentiators that its customers will pay for, and in which it has confidence.

    When netbooks emerged, they appeared to be an exciting new segment of the PC industry—a category defined by its low price point and low-powered processors. Industry analysts pressed Steve Jobs, CEO of Apple to bring out a netbook. Jobs’s answer was “I don’t know how we could bring out a quality product for $300.00”. In that one sentence, he reaffirmed Apple’s very strong willingness to lose on price. Apple said ‘no’ to the very large number of customers looking for cheap computers. If customers wanted a $300.00 computer, they would have to go elsewhere. In that statement, he also defined his marketplace: customers looking for quality and other differentiators. And Jobs had confidence in his differentiators’ value to his segment of the marketplace, and their willingness to pay for them. 

  2. Segment. The Decide step is a matter of attitude. It’s a matter of will. It’s a matter of confidence. The Segment step is a matter of research and analytics. Its importance cannot be overstated. A study by McKinsey and Company of the 100 largest corporations in American found that the decision of where to compete accounted for a full 80% of their differences in growth. If these companies competed in segments that were growing, they would grow. The segment step is the very difficult, soul-wrenching process of deciding which segments you can serve most profitably, what segments you should say no to, and dedicating product development, partnering strategies, marketing resources, go-to-market strategies and sales resources to serving those segments better than anyone else. 
  3. Price. Choose a pricing strategy and stick with it. Your pricing strategy is largely a function of the maturity of your marketplace. A revolutionary product with an entirely new value proposition should command a premium price. This is in part simple recognition that most prospects won’t buy it; they need to be educated. The ones who will buy it are typically willing to pay premium prices, and the high price is itself a statement of the value being offered.  An evolutionary product which only modestly improves on what is on the market should command a neutral price – one that reflects the value perceptions of the buyers, adjusted for the brand value of your company vis-à-vis those of your competitors.  If the marketplace is declining, and the technology has been superseded, you can, at some point, resume pricing at a premium.

    This somewhat counter-intuitive finding arises from the fact that there will be instances where there are complex systems relying on older technology, and rather than replacing the system, it becomes cheaper and simpler to continue to rely on that older technology. These customers will typically be willing to pay premium prices for it. We see this at play today in the markets for vacuum tubes and for vintage data storage systems for mainframe computers. 

  4. Drive Customer Value.  This direction has been a staple of management seminars for nearly 50 years, but it rarely achieves the prominence in day-to-day management that it should. Monitor customers’ circumstances as they change constantly. This means you need to be constantly monitoring your value creation landscape, continually finding new ways to improve customer value. Drive Customer Value dovetails with Segment, as different market segments will benefit from very different parts of your offerings and when changes apply to your target segment, this can create singular opportunities for you to improve your perception of value.

  5. Bundle. Bundles are versions of your products – often several products grouped together – that solve a specific customer problem or give you access to a desired customer segment. When you identify a customer problem and present a commitment to solve it, this improves your perception of value in the eyes of the customer, enables you to close sales more readily and often earn higher prices as well. Bundles typically do not need new product development; design them based on how your customers use your products. These use cases can be turned into usage notes, case studies, pre-installed configuration options and combinations with other products –yours as well as complementary products from other vendors.

  6. Unbundle. Unbundles are offerings with specific attributes removed in order to offer a lower-price alternative. Well-designed unbundles can serve a segment unwilling to pay your standard prices, enabling you to earn profits from customers who would otherwise buy from competitors. They also give your sales channel (salesperson, menu, website) a way to respond to customers’ demands for lower prices, forcing them to recognize the value of the attributes and decide whether or not to pay for them.

Summary. Commoditization is more often the perception than the reality. It is the natural result of customers constantly pressuring companies to lower their prices. When companies lack the structures and the sales skills to resist that pressure, they give in to the pressure, compete mostly on price, and end up…commoditized.

Per Sjofors is the founder and CEO of Atenga, Inc., a leading pricing strategy authority providing services to commercial and industrial firms worldwide. Visit http://www.atenga.com for more information.

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