REVIEW: BEATING THE COMMODITY TRAP: Richard D’Aveni (Harvard Business Press)

In his latest book, Professor Richard A. D’Aveni focusses on a topic that most businesses should be acutely concerned with: the problem of commoditization. In interviews he has accurately described commoditization as “the black plague on modern corporations” and “a deadly disease that’s spreading like crazy”.

Certainly, if one had to pick the ultimate nightmares to keep CEOs awake at night, commoditization would definitely be among the top of the list. Specifically, given the economic uncertainties around the world in the last couple of years, business leaders who are not concerned about their products or services being turned into commodities are either supremely equipped to maintain their differentiation, or immensely deluded as to their capabilities to fight market forces. Prof. D’Aveni suggests that maintaining differentiation alone is not enough to sustain business.

A product or service becomes a commodity when it is not distinguishable from competing offerings and therefore not valued above the competition. Prof. D’Aveni views commoditization along two key attributes: the benefits or features that are being offered and the price (margin) that is available to the business. Based on his model, he has identified three types of competitive stress that a business could face:

• Deterioration: In a deteriorating market, competitors present low-cost and low-benefit offerings that appeal to the mass market. This is possibly commoditization in its “purest” sense, where the customer ends up valuing the lowest price over and above any other benefit or feature. In this scenario a business can either get stuck in the commodity trap, fighting an ever downward spiral of price and cost minimisation, or could marginalize itself to a niche where it can protect its margins.
• Proliferation:  According to Professor D’Aveni, a proliferating market constantly sees the emergence of new combinations of benefits and price that serve specific segments. This is not about the business offering turning into a true commodity, but extreme differentiation and proliferation of choice do make it difficult for businesses to create a clear value statement that can be priced above competition. Professor D’Aveni describes this as “being squeezed in the middle of a pack of piranhas” which are snapping away pieces of the market.
• Escalation: This form of commoditization is possibly the most prevalent in industries that are prone to disruptive changes (such as technology, consumer electronics and communications). Simply put, extreme competition here results in more for less, as each competitor goes one-up in terms of offering more benefits for the same price, the same benefits for a lower price, or at its most extreme, higher benefits for a lower price. Prof. D’Aveni suggests that companies try and control this downward momentum.

The book suggests competitive strategies that a business could take to avoid getting caught in the commodity trap.  These strategies can be boiled down to the biological choice: fight or flight (escape). Professor D’Aveni echoes the basic warfare strategy laid out by many military and business strategists through the ages. He suggests that businesses need to gauge the opponents, choose their battles, and pick opponents against whom they can win. He also calls for pre-emptive action: where companies can, they should either change the business environment to avoid commodity battles entirely, or initiate the battle of commoditization and control its direction and momentum.

In fact, anticipation and pre-emption is the key to avoiding the commodity trap. To help with this, Prof. D’Aveni offers a relatively simple framework to analyse a current market situation in terms of a price-benefit matrix, and to identify the advance corrective actions to be taken.

The book is short and straight-forward enough to pick through a domestic flight, or to read in the back-seat during a long commute between office and home. The easy to understand framework gets the messages across quickly. In analysing the variations of commoditization, both in consumer and business oriented industries, the Professor also offers up something for everyone.

However, the book’s strengths also turn out to be among its biggest weaknesses. The book would have benefited from more depth to each of the concepts. Skipping quickly from one area to the other, in some places the book risks losing coherence of thought.

Some short books are like downhill hairpin bends on a mountain road; Prof. D’Aveni’s book is one of those. Much as you might be tempted to go fast, it’s advisable to go slow. If you speed through it, you might miss a nugget that actually makes sense to your business.

One of the other grouses I had was with the examples quoted. The predominantly US market examples reduce the book’s relevance for a global audience – the Professor presumes the reader will know the company and its context well enough to understand the lessons being discussed. In some cases the examples are incomplete and possibly even incorrect: one such is the example of Zara. The broad-brush attributes Zara’s business success to turning fashion into commodity, and ignores the fact that fashionability and desirability are a cornerstone of Zara’s offer, not the cheapest price. Others would possibly be far more accurate examples of commoditization in the context of price.

However, if you are sufficiently concerned about the possibility of being commoditized out of profitability, or being marginalised out of market share, I would suggest that you could easily overlook these flaws. The fundamental premise of the book is far too important to ignore. [Beating the Commodity Trap on Amazon]

(This review was written for Businessworld.)

An article in the San Francisco Chronicle sparked off a debate on whether ecologically friendly can be mainstream, whether customers will switch from traditional to eco-friendly fashions and if so, when. There is the view that eco-friendly products are necessarily niche and cannot match up in fashionability and affordability to ‘mainstream’ products.

I don’t think it is an either/or choice between styling and eco-friendly. To sell, eco-friendly merchandise absolutely MUST be comparable to or better than eco-unfriendly merchandise, both in style and quality.

Pricing is another story. The article also quotes Joslin Van Arsdale (founder of Eco Citizen, a San Francisco boutique devoted to Earth-friendly clothing) as saying, “When it comes to buying green or price, the general public will more likely choose the cheaper item on anything, whether it’s fashion or tomatoes.”

While most consumers will not willingly pay higher prices for eco-friendly merchandise, that may change as the cost of being eco-unfriendly goes up through awareness and legislation. There was a time when safety belts in cars were optional at an extra cost. No one would argue against paying the extra price for safety today.

Perhaps many of us would rather trash the planet cheaply because we may not feel the heat within our lifetimes. That is no reason that others, who feel more responsible, will allow that to happen indefinitely.

One way or the other, eco-friendly merchandise will compare in price, too.

Some of the parity will come from reducing the cost of eco-friendly stuff, but the bulk will probably happen because the cost of being eco-unfriendly will go up.

The original article is here – “Green fashion has new cachet“.

If we were to look at phrases that have cropped up during the recent recessionary times in the consumer goods sector, “private label” has to be among those at the top of the list.

From clothing to cereals, toothpaste to televisions, there is hardly a category that has not seen retailers trying their hand at creating own labelled products.

The first motivation for most retailers to move into private label is margin. On first analysis, it appears that the branded suppliers are making tons of extra money by being out there in front of the consumer with a specific named product. The retailer finds that creating an alternative product under its own label allows it to capture extra gross margin. Typically the product category picked at the earliest stage of private label development would be one for which several generic or commodity suppliers are available.

At this early stage, the retailer is aiming for a relatively predictable, stable-demand and easily available product whose sales would be driven by the footfall that is already attracted into the store. A powerful bait to attract the customer is the visible reduction in price, as compared to a similar branded product. If the product can be compared like-for-like, customers would certainly convert to private label over time.

However, maintaining prices lower than brands can also be counter-productive. In many products, while customers might not be able to discern any qualitative difference, they may suspect that they are not getting a product comparable to one from a national or international brand. And while private label can drive off-take, the price differential can also erode gross margin which was the reason that the retailer may have got into private label in the first place. Over time, such a strategy can prove difficult to sustain, as costs of developing, sourcing and managing private label products move up.

The other strong reason a retailer chooses to have private label is to create a product offering that is differentiated from competitors who also offer brands that are similar or identical to the ones offered by the retailer. Department stores, supermarkets and hypermarkets around the world have all tried this approach – some have been more successful than others. The idea is to provide a customer strong reasons to visit their particular store, rather than any of the comparable competitors.

Of course, when differentiation is the operating factor, the products need more insight and development, and closer handling by the retailer at all stages. A price-driven private label line may be sourced from generic suppliers, but that approach isn’t good enough for a line driven by a differentiation strategy. In this case, costs of product development and management increase for the retailer. However, to compensate, the discount from a comparable national brand is not as high as generic nascent private label. In fact, some retailers have taken their private label to compete head on with national brands – they treat their private labels as respectfully as a national branded supplier would treat its brand.

So what does it take to go from a “copycat” to being a real brand?

Third Eyesight has evolved a Private Label Maturity Model (see the accompanying graphic) that can help retailers think through their approach to private label, whether their product offering is dominated by private label, or whether they have only just begun considering the possibility of including private label in their product range. The model sketches out a maturity path on five parameters that are affected by or influence the strength of a retailer’s private label offering:

• consumer knowledge and insight
• product design and quality
• pricing
• promotion
• supply chain & sourcing

(Click here for a larger image)

In some cases, retailers may have multiple labels, some of which may be quite nascent while others might be highly evolved, clear and comparable to a national brand. This could be by default, because the labels have been launched at different times and have had more or less time to evolve. However, this can also be used as a conscious strategy to target various segments and competitive brands differently, depending on the strength of the competition and their relationship with the consumer.

The interesting thing is that size and scale do not offer any specific advantage to becoming a more sophisticated private label player. Some extremely large retailers continue to follow a discounted-price “me-too” private label strategy where even the packaging and colours of the product are copied from national brands, while much smaller players demonstrate capabilities to understand their specific consumers’ needs to design, source and promote proprietary products that compare with the best brands in the market.

For a moment, let’s also look at private labels from the suppliers’ point of view. As far as we can see, private label seems to be here to stay and grow. Suppliers can treat private labels as a threat, and figure out how to ensure that they retain a certain visibility and relationship with the consumer. On the other hand, interestingly, some suppliers are also looking at private label as an opportunity. They see the growth of private label as inevitable, and would much rather collaborate in the retailer’s private label development efforts. This way they can maintain some kind of influence on the product development, possibly avoid direct head-on conflict with their own star branded products and, if everything else fails, at least grab a share of the market that would have otherwise gone over to generic suppliers.

If you are retailer, I would suggest using the Private Label Maturity Model to clarify where you want to position yourself, and continue to use it as a guide as you develop and deliver your private label offering.

If you are a supplier concerned about private label, my suggestion would be to gauge how developed your customer is and is likely to become, and ensure that you are at least in step, if not a step ahead.

Of course, if you need support, we’ll only be too happy to help! (Contact Third Eyesight to discuss your private label needs.)

Prompted by an article in the New York Times, Bernice Hurst, Contributing Editor of RetailWire, brought up an interesting subject to discuss – the tradition of small, independent retailers on Manhattan’s Lower east side, their survival despite the recession, and their determination to thrive. 

One of the retailers interviewed for the article said that the business was “so much fun”. In referring to the kind of products she was developing said, “there are no boundaries to these things”.

Imagination may have no boundaries, but markets always do. When you’re small fry the pond seems limitless. And if all is in harmony (no tuna to gobble you, all fry remaining small, enough algae to feed off, forever), then the market is a good and boundless place. If only.

Personally, I hope there will always be some ponds with room in them to let such small fry bubble up their innovations: they keep the fashion business alive.

They also serve to remind us that there are reasons for running business that are not based on the race-to-scale.

The New York Times article is here – Yes, We’re Open – and the Retailwire discussion is here – Manhattan Still Home to Independent Retailers.

There’s been a lively debate on Retailwire.com initiated by Tom Ryan (Managing Editor), and prompted by an article in the Washington Post about how consumers are literally taking matters in their own hands and testing toys and domestic items for the presence of toxic substances.

Some of the commentators feel that this is going too far and could create waves of unnecessary panic, that consumers and consumer advocacy groups do not have the necessary expertise nor a balanced judgement, that it is a job for the government agencies. Others support the move and say that such moves are absolutely in order.

In my opinion, despite good intentions on the retailer’s part and the humongous bureaucracy in the supply chain, if product safety compliance is incomplete and if consumers feel insecure, then they will provide the wake-up call any which way they can.

We may decry the paranoia, but let’s also consider the increase and concentration of risk in recent years due to factors such as:

1. Vague responsibility for unsafe products due to the nature of the current supply chain
2. Extreme focus on factory costs leading to corners being cut in the supply base
3. Long lead-times between the buying decision and actual delivery, with multiple hand-offs (and sometimes, meanwhile, people changing jobs and responsibility)
4. Significantly larger consumption and disposal volumes than earlier generations
5. “Strategic sourcing relationships” leading to concentration of sourcing volumes–if one product line has been produced with unsafe toxins by a vendor, the likelihood of others being handled the same way are higher as well. While we all hope that more business gets concentrated to a vendor with better practices, such is not always the case.

However the industry may feel about it, I think consumer advocates have the steering wheel on this one. Unless government outlaws ‘unapproved’ testing…but I wonder how palatable that would be, politically speaking.

Here’s the original article from the Washington Post.

And the discussion on Retailwire.com is here (needs a free sign-up).