Tuesday, May 4, 2010

Strategic Planning Analogy #323: Your Competition is Too Small

When I was a child, my parents gave me money so that I could have milk with my lunch at school. My parents thought that this money was giving me two options—either regular milk or chocolate milk.

I, however, found a third option…ice cream. Many was the time I skipped milk and used the money to buy some ice cream in the school cafeteria.

I never told my parents about using the milk money for ice cream. I figured ice cream was a dairy product, like milk, so I was still getting dairy nutrition (and that’s what my parents really wanted…right?).

My parents thought I had only two options with my milk money—regular or chocolate milk. Since they saw the only options as being milk, they referred to the money as “milk money.” I, however, saw the money as “food money” and substituted ice cream for milk. This third option did not occur to my parents.

Businesses can fall into the same trap as my parents. They can conceive of only a small set of options for their customer—smaller than the set of options seen by the customer. As a result, they may mistakenly predict the wrong behavior (choosing milk), because the right behavior (choosing ice cream) was not on their radar.

By defining the money as “milk money” my parents were blinded to any use other than milk. This could be like a business person in the tourism industry who sizes up her potential based on the “vacation money” people have and then become surprised when people skip a vacation one year and use that money to buy a new car.

As strategists, we must be careful not to make our industry definitions too narrow. If we do, we will fail to see the options the way the customer does. And those bad assumptions will lead to the wrong strategic conclusions.

The principle here has to do with choice and substitution. Just as I substituted ice cream for milk, your customers may make all kinds of substitutions when choosing how to spend their money. If you ignore the breadth of these substitutions (and only look at your direct competition), you will improperly define both the marketplace and your competitors.

This principle was made very clearly in an article last week in the New York Times. The article was discussing the high prices that designers were charging for their version of basic khaki pants. Georgio Armani’s khaki’s were $595. Michael Bastian had them for $480. Mary-Kate and Ashley Olsen’s The Row brand was selling a version for $495. Bottega Veneta had a version with elasticized cuffs for $780.

The article then compared these prices to two benchmarks. Traditional retailers, like the Gap and Abercrombie&Finch have basic khakis for $70 and $45, respectively—about one tenth the price.

Then the article compared the designer khakis to electronics, saying that these pants are getting into the price range of the iPad.

The fashion designers in the article were trying to justify their price by discussing the quality of the construction of their pants. But in many ways, that misses the point.

A lot of people are not buying designer khakis because they want khakis. After all, they can get a much better pant value by getting the Gap version. Instead, what these customers are looking for is status and prestige. They want the bragging rights in their peer group of being the coolest of the cool people. Designer khakis can do that.

Unfortunately for these designers, so can the iPad. In fact, the iPad may do a much better job of enhancing the status and coolness of its owner than designer pants. If the price of the iPad and the designer khakis are essentially the same, and the customer is attempting to purchase status and coolness, which will they purchase? My guess is that many will choose the iPad.

You can get immediate bragging rights with the iPad because its distinctive design stands out. People will notice it immediately. By contrast, people may look at your khakis and not know if they are $70 or $700 pants unless you tell them. Also, you can carry around that iPad for bragging rights every day, but you cannot wear those khakis every day.

As a result, many may substitute iPads for khaki pants. It’s a superior status option at that price. Even the fashion writers for the New York Times could see the connection between iPads and Khakis.

Hence, the competition in designer khakis is not just other designer khakis (not just other kinds of “milk”). Instead, the competition includes other status substitutions like the iPad (the “ice cream”). Therefore, when deciding the price to charge for designer khakis, you may need to consider the status value relative to the price of an iPad.

The whole apparel industry in the US has been essentially a low growth business for a long time—even before the recession. I think that part of the reason is because clothing used to be a key visual cue of one’s social standing, but now one’s electronic gear is taking on that role. A cool mobile smartphone provides more status than a cool outfit.

I was at a high school musical performance this past week. There were a large number of high school students in the audience. I never heard any of them commenting about each other’s clothes. I did, however, see them commenting about each other’s mobile phones. The ones with the coolest phones were having others ask if they could borrow them (a sign of status).

I believe that part of the rapid rise in sales at consumer electronic retailer Best Buy is coming from money which used to be spent at the clothing stores in the mall. In essence, Best Buy is providing a better status value than the clothing stores. Until the clothing stores figure this out, they will not break out of their slump. They have defined the competition too small (other apparel), so that they are no longer winning the battle for “cool,” which has shifted to a non-apparel substitute.

Starbucks gets it. They realize that they are not just competing with other coffee restaurants. They are also competing with at-home and at-work consumption. As a result, Starbucks invented Via instant coffee. This gives them a way to compete in the broader coffee world for those who substitute other points of consumption. With Via, Starbucks is now in the supermarket, where many coffee decisions are made.

So what does this mean for strategy?

1) Don’t Define your Market Too Small
People do not substitute products; they substitute solutions. If you define your market as just those selling similar products, you will define yourself too small. Instead, you need to look at anything offering to solve the same solution (like status), regardless of what the product is. Am I in the business of making movies (product) or selling entertainment (solution)? Am I in the business of selling diet pills (product) or selling weight loss (solution)?

People will flock to the best perceived entertainment option and the best weight loss option. And don’t be surprised if they choose a video game over a movie or liposuction over diet pills.

The customer’s definition of substitution options is much more important than your definition. And most often, their definition will be a broader definition based on solutions.

2) Build your Strategy Around Solution Superiority
Once you get that broader solution-based definition properly sized, build a strategy to win within that broad marketplace. Find a strategy which makes your offering so compelling that a significant sector of the population will not only see your product as the best among similar products, but also the best among a broad range of substitutes. Don’t strive to make the best movie…strive to be the best entertainment option, so that you can tap into money that might otherwise go to other entertainment substitutes.

If you are in the business of selling cool, keep migrating to where cool is moving. Add attributes which are cooler than what substitutes can offer. Price to be a better value than other cool substitutes. Computers used to be cool devices, and Apple had the coolest computer. Now computers are mostly just a tool and the coolness has moved on to other devices…and so has Apple. The apps are becoming cooler than the products, so Apple tries to be the king of apps. Apple’s strategy tries to win the solution (cool) rather than win a particular product.

One of Porter’s Five Forces impacting your strategy is the threat of substitution products. Build strategies which protect your business from substitutions within your solution. You may also want to consider reinventing the marketplace by offering a new option which is a superior substitute for the entire status quo (a sort of Blue Ocean approach).

Narrow, product-based definitions of markets miss out on all the various substitutions available to a consumer. If you want to win, your strategy must provide superiority versus all relevant substitutes.

Be careful of the words you use. Just as saying “milk money” can make a parent forget about the other ways a child might spend that money, using product-based jargon all the time can cause a company to forget about relevant substitutes.

1 comment:

  1. Gerald, you insist on bringing memory back in my head. This marvelous post revoked a study I carried out years ago in a developing country. The problem I was tackling why a strawberry-flavored soft drink sold in winter, but hardly any during the hot summer. My study revealed that women aged between 16-26 mostly bought the strawberry drink and hardly any male customers. The 5-why-based survey revealed that 1) - Secondary schools were open during winter and not summer. 2) Girls bought the strawberry drink to use it as a substitute for the unaffordable make-up cosmetics. As the universities and high schools were closed in summer the females found no reason to buy it. Male teenagers refrained from buying the strawberry drink for fear they would be “labeled” as girls. The recommendation was to double the strawberry concentration and double the soft drink price. Profits soared.
    This is in support of what you stated in your post “The principle here has to do with choice and substitution”