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The Gap Test: How to Determine If You Should Simplify Your Business Go for the gap -- and do the opposite from the market leader before anyone else does.

By Richard Koch

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

Business strategy -- especially when it involves case studies from business schools -- is always written with the benefit of hindsight and often with a very broad brush. It's like the plot of an old-fashioned thriller in which the good guys and the bad guys are sharply defined: the good guys always get stuck in terrible fixes, but they know what they're doing and somehow emerge victorious as the story races to its climax.

But business doesn't work like this. The good guys often don't have a clue what they're doing. They try one approach, find it doesn't work, then pivot to a different strategy, and another, and another, until they finally find one that works.

A superb illustration of this phenomenon is the struggle in the 1960s and 70s between the iconic motorcycle manufacturer Harley-Davidson and the Japanese upstart Honda. We know Honda eventually won the war because they price-simplified. They were able to introduce to the market bikes that were "inferior" to those of Harley-Davidson -- lower in power and much smaller -- but priced much more competitively.

Related: 25 Ways to Simplify Your Business

But Honda actually started with the wrong strategy and found the right one only by accident. Honda "knew" that its little 50cc delivery bike had no market in America, so it didn't try to sell it there. Unsurprisingly, the company's market research showed that Americans liked heavy, fast, powerful bikes and that price was relatively unimportant to them. So Honda decided to design and make a big, relatively expensive bike. Then they sent three employees to Los Angeles to start selling it.

The project was a fiasco. Most dealers refused even to stock the Honda bikes. But even worse was what happened after Honda managed to sell a few hundred of the bikes. Honda had no experience making bikes that were driven over long distances on freeways, and it soon turned out that its new product was no good for this -- the clutches wore out in no time and oil leaks splattered American roads. Honda conscientiously air-freighted replacement parts from Japan to the United States, but the expense of doing so nearly bankrupted the firm.

Kihachiro Kawashima had the unenviable task of leading Honda's three-man American sales and marketing team. One Saturday he sought relief from his work troubles by going dirt-biking in the hills around LA on the little "Supercub" 50cc bike he'd shipped over from Japan. The next week, he invited his colleagues to share this biking therapy. (They had had also brought over Supercubs to get around LA.) Long story short, these three bikes were noticed and admired by the other dirt-bikers, with many of them asking where they could buy one. The three Honda executives became convinced they could sell the Supercub for recreational purposes. The head office in Japan hated the idea, because they still believed the market research that stated that chunky Americans would never buy tiny Japanese bikes. But out of sheer desperation -- after the evident failure of the big-bike strategy -- they agreed to let Kawashima give it a go. The small-bike market took off, initially among off-road enthusiasts, but then with commuters and other road users, too. As the company sold more bikes, it was able to cut costs and retail price even further and the market exploded.

The moral of this story is that Honda initially chose the wrong strategy -- it targeted ground that was already well occupied by a competitor with better products. Instead, it should have aimed for a gap through price-simplifying, for which it already had the ideal product. Honda could have saved itself a great deal of money and frustration if it had asked a simple question from the outset: "Does a competent competitor already occupy the ground we plan to target?"

If the answer to that question is "Yes" -- as it would have been in this instance -- that's always a red flag. A necessary follow-up question is: "Can we simplify to provide a product that's better in terms of usefulness, ease of use and/or art?"

Unless the answer to that question is a clear "Yes," too, it's better to scrap the whole project.

Every firm should abide by two decision rules:

  • If the market leader is competing on features and performance, don't try to muscle your way into its market unless and until you have simplified to provide a much superior product that's a joy to use.
  • If there's a gap and no firm is occupying the price-simplifying ground, and you can think of a way to cut prices in half, go for it.

In 1931, Charles Guth bought the Pepsi-Cola Company. He was already a successful entrepreneur, but Pepsi was just a shell company, with a trademark and a formula, but no sales. Guth tried to breathe life into the brand by selling it through his confectionery shops. It didn't work. Meanwhile, Coca-Cola remained dominant in the cola market, increasing sales and profits even during the Great Depression.

Related: 5 Ways to Simplify Your Business Plan and Almost Anything Else

Guth realized he had to try a new tack, so he price-simplified. He halved the price of cola by selling a 12-ounce bottle of Pepsi for a nickel, the same price as a six-ounce bottle of Coke. The new strategy was clever because the vast majority of the cost of a bottle of cola lies in the bottling and distribution, not the ingredients, so the cost difference between a 12-ounce bottle and a six-ounce bottle was relatively small.

Guth's business system was pretty rudimentary, but it worked. In less than four years, he built five bottling plants and a network of 313 franchised bottlers, all churning out the new, bigger bottles. No other soft-drink producer moved quickly enough to copy Pepsi's strategy. Coca-Cola refused to contemplate competing on price and didn't retaliate, even though, with its much larger economies of scale and far lower costs, it could easily have bankrupted Pepsi if it had chosen to create a new "fighting brand" (not Coke) to imitate its rival's strategy and undercut the price. That was a fateful decision.

By 1940, Pepsi had a 10.8 percent share of the total U.S. soft drinks market. The following year, Pepsi declared a pre-tax profit of $14.9 million, which compared very respectably with Coca-Cola's $55.2 million. A one-horse race had become the two-horse race we've witnessed ever since -- and it started when Pepsi took the price-simplifying ground that Coca-Cola had ignored.

But what if there is already a mass market, yet no substantial premium market? If you can think of a new strategy and build a unique a new business system, occupy the vacant ground.

If no firm is the clear leader in proposition-simplifying and you can simplify to deliver a much better product or experience, go for it!

In 1921, Pierre du Pont, the boss of General Motors (GM), asked his vice president of operations, Alfred Sloan, to look at product policy and work out a new strategy to compete with Ford. The prospects seemed bleak: Ford was dominant, with 62 percent of the market; GM was only a quarter the size.

Presented with this uninviting task, Sloan didn't attempt to compete with Ford in what we would call the price-simplifying space. Instead, he pitched GM into the proposition-simplifying space. He defined new segments of the market and tailored products for them that would excite target customers. He started by giving each of the five GM car marques a distinctive position and price range, eliminating duplication and competition for the same customers between them. This not only improved margins for GM but simplified the product image and role for the buyer. Customers were encouraged to trade up to whichever GM marque was positioned immediately above the one they already owned.

Sloan also introduced annual model changes. "The changes in the new model," he wrote, "should be so novel and attractive as to create demand for the new value." Finally, he facilitated purchase by extending credit to both customers and dealers -- making GM the first carmaker to offer this. Local dealers immediately lined up to defect from the frugal Ford system to the more open-handed GM one, which resulted in a massive increase in the quality and quantity of the company's dealer network. This was especially important for GM's trade-in/trade-up policy, which Ford, still with just one basic model, couldn't emulate. Sloan courted the dealers assiduously, asking for feedback on GM's products and plans, and on customer attitudes.

Related: Key to a Successful Business? Simplify, Simplify AND Simplify.

By doing the opposite of Ford, GM not only occupied the product proposition space but gained overall market leadership in 1931, a position it then kept for the next seventy-seven years. It finally lost the top spot in 2007 to another proposition-simplifier, Toyota, which, just as GM had done decades earlier, offered a simpler range and a much higher-quality product. In 2008, GM sold nine different vehicles that were all priced at $25,500. Toyota offered just two.

So go for the gap -- and do the opposite from the market leader before anyone else does.

Richard Koch

British Author, Speaker, Investor, and former Management Consultant and entrepreneur.

Richard Koch is an entrepreneur who has made over $300 million from starting businesses and investing in early stage venture capital. His businesses have included Filofax, Plymouth Gin, Belgo Restaurants, Betfair, FanDuel, and Auto1. Formerly he was a consultant with the Boston Consulting Group and a partner of Bain & Company before cofounding LEK consulting. He is author of many books on business and ideas, including The 80/20 Principle, which has sold over a million copies and been translated into 35 languages, and his newest title Simplify: How the Best Businesses in the World Succeed. Richard wrote the foreword to the Entrepreneur Press bestseller, 80/20 Sales and Marketing by Perry Marshall.

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