Wednesday, March 12, 2008

Combating the Low Price Strategy

In an earlier post, I talked about the Low Price Strategy and the conditions under which it can be effective. To recap, the following conditions must hold true for a Low Price Strategy to be effective:
1. The economic structure of the market should be appropriate - typically a market with high fixed costs and low variable costs.
2. Driving additional volume should reduce marginal costs (not just average costs) - i.e. the additional amount of money required to produce/sell one more unit should decrease as the number of units produced/sold increases.
3. Price should be the key driver of value for your customers.
4. Finally, a long-term commitment to being the low-price player is necessary to sustain this strategy.

But what if you're in a market where there is a viable low price strategy, but a competitor has already capitalized on the advantages of volume?

Well, unless you have very deep pockets, taking them on head-on is unlikely to be beneficial. The best way to compete in a market that is already dominated by a low-price player is through segmentation and differentiation.

Almost every market has customer segments whose preferences differ. One way to win in a market is to identify a segment that isn't being served well by the low-price player and to go after them. This is the strategy followed by companies like Stella Artois (premium beer), Nordstrom (retail), etc.

Supposing the exhaustive list of attributes a product could offer are A, B and C, and there are four market segments. All customers value A equally and will not buy a product that does not offer A, and they all think A is worth $100.
Segment I values A at $100, B at $5, C at $10. This is the largest segment.
Segment II values A at $100, B at $20, and C at $10
Segment III values A at $100, B at $10 and C at $25.
Segment IV will not buy a product without A, B and C, and values this product at $150.

A costs $50 to produce, B costs $10 to produce and C costs $15 to produce. Because of complexity, a product that offers B and C costs an additional $5 to produce.

The Low Price player will likely go after Segment I, with a product that only has attribute A - but there's still room in the market for:
- A competitor who produces a product that offers A and C at $124 (Capture Segment III)
- A competitor who produces a product that offers A and B at $119 (Capture Segment II)
- A competitor who produces a product that offers A, B and C at $149 (Capture Segment IV)

So, the key to competing in a market which already has a dominant low-price player is to identify customer segments who are inadequately served by the low-price offering, identify the attributes that matter to them and how much they're willing to pay for those attributes, and craft an offering that serves them uniquely by offering them better value for their money. This is possible because different customers have their own ways of assign value to the different attributes a product may offer. This strategy is most effective when the attributes that your segment value make a low-price strategy impossible to execute - e.g. customers who value high-touch sales.

The "product attributes" I refer to above above need not necessarily be "features" - customer service, support, and even intangible attributes like aesthetics and experience are very valid ways to differentiate. Often, if you can't find a way to differentiate - you haven't yet tried hard enough.

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