One of my fondest memories of the 90's was my weekly trek to the local independent book store to sip espresso while previewing the latest business books (I had no life back then either). With the emergence of Internet booksellers, independent book stores are on the verge of extinction.
The book business is braced for another watershed moment. Last week, Wal-Mart announced their intention to be the low cost leader for books online, and sent the first salvo with the announcement of a cut on the top 10 hardcover titles to the bare bones price of $ 10. Not to be outdone, Amazon matched the price within hours. Later that day, Wal-Mart cut the price again to $ 9, only to be matched by Amazon, as an entire industry gasped, "holy commoditization"!
Wal-Mart is not only sending a shot over the bow for the book business, but for the future of Internet retailing. Amazon, already positioning the Kindle as the next killer app, will need to redefine how books are sold and downloaded to maintain competitive advantage.
Welcome to the slippery slope of competitiveness on price. Wal-Mart is the "category killer" on everything from baby formula to tires. Wal-Mart and Amazon are built from the ground up to support the business discipline of low cost leadership. One salesman tells of a time he called on a Vice President of Purchasing at Wal-Mart who had lawn chairs set up as his office furniture. A scarcity mindset is part of Wal-Mart's DNA and its daily decision making.
Wal-Mart can afford to cut prices, every time a competitor enters the fray. The annoying Wal-Mart smiley face has become a caricature of low pricing and a message that Wal-Mart will not be undersold. The problem with being a low cost leader is that there is a low cost of entry as upstarts attempt to buy business with lower margins. Lower margin businesses also have more risk, as one or two bad quarters can put the low cost operator out of business.
The only way that low cost leadership can be sustained is through scale, or technological advantage (often a function of scale). When scale can be achieved, the bottom end can make money on purchasing power and operating efficiencies. Only a few companies in any space can create enough volume to remain competitive. The complex combination of attributes that combine into a unique selling proposition must continue to be shaped and prodded to create more value.
Globalization has opened the market to big box retailers and up starts that can create a virtual offer overnight. Discounting is rampant in almost every industry, and the sluggish economy has reinvigorated the trend towards consumer thrift and a "treasuring hunting" mentality.
Consumers are trading down on some goods so that they can trade up on the luxury goods that they desire. Go into any suburban Wal-Mart, and you will see a representation of Mercedes Benz in the parking lot. Upon boarding a Southwest Airlines flight, the business man in the next seat is an apt to be sporting a Rolex watch. The consumer (as well as the professional buyer) will vary their purchase triggers (quality, service and price), based on the use of the product they are acquiring. Customers find middle pricing offers confusing because they are not sure if the product or service stands for quality and service (which they perceive as higher priced) or for value.
Now that the bar has been lowered on many goods and services, it will be hard to raise it again. Consider the layout of US restaurant chains. Earlier this year, Bennigan's and Steak and Ale skipped Chapter 7 and went straight to liquidation, (because their business was so bad). At around that time, operating margins by segment were as follows:
White Table Cloth (Ruth Chris 6%, Morton's 4%)
Casual Specialty (Cheesecake Factory 6%, Olive Garden / Red Lobster 9%)
Casual (Bennigans, Steak and Ale-Chapter 7, Ruby Tuesday's 5%)
Fast Casual (Panera 9%, Corner Bakery / Chili's 6%)
Fast (McDonald's 27%, KFC / Taco Bell / Pizza Hut 12%)
White table cloth restaurants, operating on high margins were able to introduce an occasional special and remain solvent during the downturn. Themed restaurants such as Olive Garden and Cheesecake Factory eked out a small profit. McDonald's with its massive scale and zeal for consistency was able to capitalize on its dollar menu and build market share (McDonald's and Wal-Mart were the only Dow components to increase in value in 2008). The companies in the middle such as TGIF, and Ruby Tuesday struggle because they lack any differentiation and only create marginal economies of scale.
If restaurants are not proof positive that the middle had eroded, consider the department store industry. While Nordstrom's and Wal-Mart continue to thrive, Montgomery Ward's and Mervyn's shuttered their stores. The merger of Sears and Kmart was like two guys who did not know how to swim, grabbing for each other in the deep end. Only differentiated Target is able to price in the middle (Target is priced 5-10% higher than Wal-Mart).
Clearly, the highly differentiated brand that commands higher price points supports higher margins and less risk. Many are asking, how can a company preserve premium pricing in this economy? Any company can discount, but to cut prices on more lucrative goods only commoditizes a brand.
One approach is to create a separate offering. Ultra luxury brand Coach has developed the "Poppy" line of handbags sold at a lower price point. By marketing a secondary line, Coach can maintain its leadership as a premium brand, while providing the consumer a lower price alternative. Others are creating Internet offers which different products, case packs and terms (cash).
Marketers must make short term profit decisions within the context of long term brand positioning. Customers equate higher prices to higher quality and lower prices to … well, lower quality. A strategic view of pricing dictates that the value of the brand be preserved so that companies can take advantage of the real profit, to be made during the upturn. While one may feel compeled to cut prices to fend off competition, consider the attributes of the customer you are acquiring ….. a price buyer who does not value brands or quality. If you are unable to play on any field but price, it is an indication that more investment is required in creating a differentiated offer and unique bundle of services.