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How a Price Simplifying Epiphany Turned IKEA Into a Billion-Dollar Business

How a Price Simplifying Epiphany Turned IKEA Into a Billion-Dollar Business
Image credit: PM Images

The following excerpt is from Richard Koch and Greg Lockwood’s book Simplify. Buy it now from Amazon | Barnes & Noble iTunes

Ingvar Kamprad has furnished more rooms than anyone else, living or dead. He built up a company from nothing to one worth more than $40 billion. And he’s done it all by simplifying.

Kamprad was only 17 when he founded IKEA as a mail-order company. Five years later, he started selling furniture. The story goes that one day he couldn’t fit a table into his car, and a friend suggested removing the legs. Kamprad immediately had the idea of flat-packed furniture. He realized that half the sale price of a table was in the cost of transporting it. So if he could persuade the customer to do the final assembly -- by engineering parts that fitted together easily and providing unambiguous instructions -- he could cut his costs in half. It was a true epiphany.

Related: 5 Ways to Increase Your Sales and Make Your Products Easier to Use

So how can IKEA be so much cheaper? Much of the answer lies in those transportation costs. Consider that a table or a bookcase sold through a shop has to be transported at least twice and often three times -- from the factory to a warehouse; from there to the store; then from the store to the customer’s home. IKEA eliminates most of this cost. Typically, its goods travel only once at IKEA’s expense -- from the manufacturer to the store. And because the goods are in flat packs, they’re much easier and cheaper to transport and store than pre-assembled furniture.

But if all there was to IKEA was flat-pack furniture, it would be easy to imitate. Indeed, many other stores now sell flat-pack furniture. But none has come close to emulating IKEA’s scale, success or rock-bottom prices. Why is that?

Part of the answer lies in the giant stores that IKEA has built on the edges of cities. These are far larger than its rivals’ equivalents in all of the countries where it operates. Another part of the answer is the way it organizes its stores. Right from the beginning, the stores were massive and featured a novel way of enticing customers past their wares -- what IKEA cheekily calls “the long natural way.” This involves a steady progression, as though in a theme park, anticlockwise through the store. There are a lot of product categories, but relatively few products within each category. Instead of asking a salesperson for advice, customers must choose for themselves, helped by clear instructions, placards and a very well-designed, mass-produced catalog. They then take their purchases on a cart or in a bag to the checkout, and from there they take them home.

Related: How Ford Created a Huge Market by Lowering its Prices

IKEA therefore obtains for itself and its customers five further cost benefits, over and above the transport cost savings:

  • One-stop shopping. IKEA covers just about every category of goods you need to furnish a home, from bedding and cushions to artworks. This is convenient for customers and also increases sales.
  • High sales per store, even relative to space, combined with lower premises costs as a result of being located outside the city center.
  • Low cost of sales staff as there are very few of them.
  • High sales per product stocked, by stocking a relatively limited range within each product category.
  • By testing new designs in a few stores first, IKEA works out which lines will work and which will not, so it doesn’t order large quantities of goods that won’t sell and will have to be discounted (a common bugbear in the furniture trade).

Yet that’s not all. At the heart of IKEA’s simple system is a different way of organizing its industry. IKEA is a retailer, but it also designs most of its furniture and selects its manufacturing partners carefully, giving them very large orders for only a few products. This lowers the furniture-makers’ costs dramatically; it also raises IKEA’s bargaining power. The manufacturers become part of the IKEA system. The all-encompassing IKEA system is a lot simpler and more efficient than the traditional way of producing and selling furniture, which comprises a patchwork of mainly small furniture-makers, selling to small chains of retailers, with the difficult job of moving products to retail outlets sometimes handled by the manufacturers’ own small transport systems, but mainly contracted out to third-party logistics firms that are not specialists in furniture. Before IKEA came along, the furniture industry was a mess -- highly complex and sub-scale in all three stages (production, retail and distribution), with poor coordination across these stages.

Kamprad gradually reconstructed the whole industry, developing a new business system that offered customers a much better deal -- much lower prices and better value for money -- by making his industries hugely more efficient.

Here are the IKEA elements that you can emulate if there’s a chance to reconstruct your own industry:

  • Simple product design to eliminate unnecessary costs
  • Limited product variety within each category, so more of each product line can be made and sold; as a result, stock-keeping costs are decimated.
  • Much greater scale
  • Great reduction in cost at every stage of production and distribution. Kamprad organized the functional equivalent of an assembly line within his stores, with the customer doing most of the “assembly,” both in the store and at home.
  • The creation of a proprietary system peculiar to the organization, excluding rivals. Once Kamprad had built his stores, nobody else could copy his system -- the market in each location and overall just wasn’t big enough. If he had moved too slowly, and an imitator had managed to out-IKEA IKEA by building a similar but larger system, Kamprad’s company would have foundered. But nobody did. The charm of his new business system was the way it all fitted together. Once rivals really understood how it worked, it was too late for them to imitate it.

How IKEA seduces its customers

IKEA wouldn’t make so much money without getting its customers to lend a hand. So how does it manage to convince those customers to do so much hard work? A very low price -- less than half the price under the traditional system -- is the obvious answer. But it’s not the whole answer.

If you look at the shoppers’ experience, you’ll soon realize that, although IKEA asks a lot of its customers, it gives back a lot too -- advantages you won’t find in a typical furniture store. IKEA increases the usefulness of its products and its shopping experience by offering a one-stop solution. A visit to the store can be a day out for the whole family -- there are play areas for children, and inexpensive restaurants. IKEA’s products are also well designed and stylish. And IKEA increases ease of use for its customers. The stores are easy to find -- with their colossal yellow-and-blue signs -- and have ample, free parking. There’s a more extensive range of stock sitting within the store. And the vast majority of items can be taken away immediately -- no waiting for delivery.

Related: Price Simplifying Vs. Proposition Simplifying: Understanding Your Options

For many customers, these advantages of shopping at IKEA -- quite apart from the low prices -- balance or even outweigh the disadvantages (mainly the time and effort that the IKEA system demands). But this is where Kamprad was particularly cunning. If you scrutinize the non-price advantages, you notice one thing in common: They are all either relatively cheap to provide or even generate extra profits for IKEA.

And IKEA has deliberately chosen not to provide certain typical -- high-cost -- industry services. For instance, if IKEA had lots of well-paid salespeople swanning around its stores, the cost would bite badly into profits. If the furniture wasn’t self-assembly, its cost would almost double.

Kamprad is the perfect example of a price-simplifier. A common tactic in price-simplifying is to cut back certain expensive services and to compensate for this by lavishly providing low-cost (or, ideally, profit-making) services. That is exactly what IKEA does.

The big test of any new system for a simplifying firm over the long term is whether it can be imitated or improved by a rival. If the new business system is bold enough, if it eliminates traditional benefits that the customer is willing to forgo in exchange for large price cuts, and if it provides other benefits that are both cheap and unique, then the risk of imitation or supersession falls dramatically. Market share provides the final bulwark against this risk. If, like IKEA, you can win more than half of the relevant market and be 10 times larger than any rival, you’re likely to be secure unless a rival spots a different way to discount prices again. In IKEA’s case, this seems highly unlikely.