Are You Facing a Commodity Trap?
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What do high-end fashion companies, New York restaurants and Harley-Davidson have in common? All are, or have been, in a battle against commoditization. Whether caused by a new, low-cost competitor (such as fashion's Zara), new product innovation or the introduction of substitutes and imitations (such as motorcyle maker Big Dog), commodity competition is always costly and sometimes even deadly.
What I call the commodity trap has the potential to destroy entire markets, disrupt whole industries and drive previously successful firms out of business. A commodity trap happens when a company sees its competitive position being eroded so that it can no longer command a premium price in its market.
There are several factors that lead to the commodity trap, including managers failing to innovate, issuing bad products or denying trends already in motion. Usually, commoditization is the result of a failure to act early enough. Managers just don't see commoditization coming, and they fail to respond in a timely manner.
Once the situation is urgent, most managers will fight low-priced competition by discounting higher-value offerings. This has the unfortunate and unintended effect of increasing the depth and severity of the commodity trap. Already in a hole, executives often grab the nearest spade and keep on digging.
Identifying Your Commodity Trap
The conventional wisdom for fighting commoditization advises either cost and capacity reduction (without sacrificing margin) or increased differentiation (to maintain a higher end position). But there's little advice on how to identify the root cause of commoditization, so that the very source can be avoided, eliminated or, in some cases, even used to your advantage.
Over the last decade, I've developed a framework to help companies better understand the dynamics of price-product benefit positioning, and to sharpen their own strategies for handling rampant commoditization. The Three Commodity Traps Framework offers strategies that have been proven to work in companies often caught up in fearsome price and proliferation wars.
To succeed over time, firms must manage commoditization by influencing the momentum, threats and market power posed by rivals driving the process of commoditization. By improving their power over real prices, firms can actually beat their commodity trap rather than simply trying to outpace it.
Based on an in-depth study of more than 30 industries, I have identified the three most common patterns that create commodity traps:
- Deterioration: Competitive firms enter with low-cost or low-benefit offerings that attract the mass market--how Zara undercut high-end fashion companies.
- Proliferation: Companies develop new combinations of price paired with several unique benefits that attack part of an incumbents' market--as Japanese and American motorcycle makers did to Harley-Davidson.
- Escalation: New players offer more benefits for the same or lower price, squeezing everyone's margins--as the iPhone did to the mobile device market.
And then there's another complication: a recession creates a particularly pernicious kind of commodity trap--evaporation. Evaporation occurs when demand declines substantially.
Commoditization: What to Do?
But, things don't have to be this way. It's far better to act early--to identify and tackle the cause of the commoditization trap. My research shows there are lots of strategies companies can adopt to escape the clutches of commoditization.
In a battle with a dominant low-end discounter, sometimes avoidance is the best possible strategy. If appropriate, you can shift your position in the market to sidestep the power of the low-end discounter--a new market nullifies the competitor's pricing power over you.
When Asian companies began taking over the memory chip industry, Intel realized it could not compete in terms of price, so it shifted to making microprocessor chips for personal computers. When it faced newly competitive imitators in microprocessors, Intel moved to making chips for consumer electronics and other special applications.
Companies can also change channels, time and place. While coffee companies such as Folgers were fighting bitter price wars in the supermarkets over a completely commoditized product, Howard Schultz aggressively expanded a Seattle-based coffee chain called Starbucks--an entirely new channel for brewed coffees and beans--and broke free of commoditization.
You might also try to undermine the market power of the low-end discounter. This can be achieved by redefining the way customers see price.
Unless you are constantly aware of the perils of commodity traps, you're unlikely to develop avoidance or coping strategies in time. So keep a look out.
Richard D'Aveni is the author of Beating the Commodity Trap. He is professor of strategic management at the Tuck School of Business at Dartmouth College, and he was named by The London Times as one of the world's leading business thinkers.