Explaining Price Competition
A core strategy principle is that a market position which is both profitable and defendable (which is, by definition, the main goal of a business strategy), can only be achieved through differentiated products and services, lower costs or a combination both.
A low-costs approach to strategy should translate into lower prices (a low-price strategy) which, should lead to higher demand, higher margins or both.
But despite what many might think, competing on low prices doesn’t mean selling a crappy product but quite the opposite. An effective low-price strategy must always start with a good product.
While the success of low-price positioning hinges on rigorous cost discipline, low prices should not be the result of watering down good products, but from focusing on the most basic needs of price-sensitive buyers.
A low-price provider avoids extra features and frills that are only valuable to higher-end buyers, and instead delivers a basic solution that does a job that is just good enough.
Procter & Gamble’s Ivory soap bar, Ikea in furniture, and JetBlue in the airline industry are all examples of low-price players. Their success is not in making comprehensive products cheap but in carrying a basic, stripped-down offer, doubling down on the features that price-sensitive buyers need, and delivering that value proposition cheaper than anybody else.
A second misconception about cost-based competition is that low prices mean lower margins. That’s absolutely not true, and as we validated through our research, low-cost players like Walmart outperformed high-end players by making money through a different business model, in that
Successful low-price competitors target customers who are willing to pay less to get a more basic offer and operate super-efficient value chains that minimize all costs. Aldi, a supermarket chain with more than 10,000 stores around the world, runs a very efficient supply chain that allows it to achieve extraordinary cost advantages.
To start, it carries a very narrow product selection which helps it negotiate better prices with vendors and minimize logistic costs while increasing turnover on those items. It builds stores in inexpensive locations, products are displayed on pallets and customers have to bring their own bags.
Despite these seeming inconveniences and its low average markup of 13 percent (compared to 25-30 percent for other retailers), Aldi outperforms its rivals year after year on a return on investment basis. Its success is due in part to a low-cost operation that de-emphasizes factors that don’t add value for price-sensitive buyers, and focuses instead on improving factors that are important for those buyers, like having fast and efficient checkout.
When running a low-cost operation every penny counts, from the cost of manufacturing, packaging, distribution and advertising, to how employees are incentivized and how the company carefully invests in R&D and customer acquisition.
For low-price competitors, frugality becomes their way of living and something of a religion, and it must be well-rewarded by management. This penny-pinching mentality, which translates into highly efficient business models, permeates everything a company does and is the most valuable asset of low-price competitors.
Their success relies on continually challenging cost assumptions, sometimes defining their own metrics of quality and performance, just like JetBlue has done in the budget airline space.
In addition to cost efficiency, “speed to market” is the next most powerful tool of low-price competitors. To create new sources of growth, these low-price incumbents must continually bring their low-cost business model upmarket, integrating features and offers only available in higher-end solutions as a way to temporarily increase their margins.
For example, McDonald’s has added Angus beef burgers and grilled chicken sandwiches to its menu, Walmart and Costco began selling tires and offering car repair services, and Pepsi and Coke have added higher-margin drinks like Gatorade and Powerade to their portfolios.
These are all cases of low-price players bringing their low-cost business models to capture value from higher-end offers.
“Your margin is my opportunity”, is how Amazon’s Jeff Bezos best describes this strategy, as his company brings its low-cost business model upmarket in all directions to chase higher margin opportunities, sending waves of fear through every market it enters.
The speed at which low-price competitors embed higher-end solutions into their low-cost business models is what makes it so hard for high-end providers to compete with them.