Tuesday, July 22, 2014

Strategic Planning Analogy #533: Planning the Periphery

Last week I got bumped off an airplane in exchange for a ticket voucher discount for a future trip. I thought that was a pretty good deal until I tried to redeem it.

The airlines said I had to redeem it on their online site. Unfortunately, there was a flaw in the website making it impossible for me to redeem the voucher online. As a result, I had to call the airline on the phone.

After a terrible phone experience, I finally got an email notification of my transaction. There were two parts of the email that irritated me. First, they still had not corrected the problem. Second, they charged me a $25 service fee for using the phone to do my booking.

So I had to call the airlines a second time. It struck me that this was a pretty good deal for the airlines. By creating incompetency on their website and on the phone, they were able to create numerous $25 services fees they would not otherwise receive.

They were getting rewarded for incompetence as my travel voucher was becoming less of a deal.

Airlines have an interesting pricing strategy. They sell the seat ticket at unsustainably low prices and then make up the difference by charging all sorts of associated fees, like the $25 I had to pay for calling them on a telephone. They have other extra fees for things like luggage, earlier pre-boarding, seats with slightly more legroom, pillows, blankets, meals and a host of other things.

How did it get to this point? Well, the core business of selling a seat to get you from one airport to another became commoditized. Let’s face it. There is very little difference between the standard seat experience in one airline over another. If you closed your eyes, you’d never be able to determine which airline you were flying.

I remember one time flying from London to Germany. I was about to go up the boarding steps to the airplane door when I noticed that the steps had the wrong airline logo on them. At first I thought that I might be boarding the wrong plane. But then an airline employee came along with a magnetic sign with the right airline logo. He put in on top of the other logo. Voila! Suddenly I was going up the proper airline set of stairs.

But that’s how it is. The standard airline service is so commoditized that you could slap any logo on it and it wouldn’t make a difference.

And we all know what happens when a core service becomes commoditized. The only way to create a preference is by lowing the price. So all the airlines lowered ticket prices to unsustainably low levels.

Since the airlines could no longer make a profit on the seats, they had to get the money somewhere else. That’s why I had to pay $25 to make a phone call to complain about a defective website.

And the point of this blog is that nearly every industry is moving in a direction towards this airline pricing model. Core businesses in numerous sectors are becoming commoditized. If you cannot come up with ways to make money on the periphery of your business (like charging for phone calls), you will have an unsustainable business model.

The principle here is that in industry after industry, the core business is becoming commoditized. The commoditization is causing core businesses to be priced as a “loss leader.” To remain viable, one has to get nearly all of the profit from non-core elements on the periphery. So, ironically, one’s strategy may need to be more focused on the periphery than the core if one wants to succeed.  So much for all that literature on “sticking to one’s core.”

Fast Food Example
This is not just an airline problem. Look at the fast food industry. The basic hamburger is commoditized. All the major fast food restaurants sell the core hamburger at a loss.

With the core product priced at a loss, the only way to make money is by focusing on the periphery. So McDonald’s adds fancy coffees and fruit smoothies. They all start putting a slice or two of bacon on everything so that they can charge a premium price. They push the higher margin fries and beverages. They try to get you to upsize to a larger combo meal and to add a dessert.

This is their version of what the airlines do. They come up with all sorts of peripheral things to charge you for, because the core item on the menu (the hamburger) can no longer make it on its own.

Or how about the cable TV industry?  Cable TV in the US is commoditized. They all give you essentially the same channels in the same way. When watching your favorite show on TV, the viewing experience is identical, regardless of the cable company piping it to your screen.

As a result, US cable TV companies can no longer price their core TV business at a profit. The only way to earn a profit is by focusing on the periphery—phone service and internet service. Cable TV service has become a loss leader in order to sell the periphery.

In a similar fashion, phone companies sell talking over the phone at a loss and have to make it up on peripheral services like data transfer.

In social media, it is quite common for companies to give away the core business for free and then try to recoup their losses in sales of peripheral features to peripheral customers (think of LinkedIn). It’s called the “Freemium” model. It is very common in gaming, where the core game is free and you pay for periphery features which help in the game experience.

It’s common for digital companies to use the word “monetization.” It is their way of saying that they have to give away the core for free in order to build out network to a critical mass. So, to make a profit, you have to create a secondary strategy for collecting cash—the “monetization.”

When you try to buy something at the store, they try to get you to pick up impulse items at the checkout, get the extended warranty, add on the optional extras, get a matching belt for the pants, and so on. Why? Because the core products are not profitable. The money is made on the peripheral goods. Even big ticket items like cars are sold this way.

I could go on and on, but you get the idea.

So what should a strategist do? Well, first one can try to fight the commoditization by creating uniqueness at the core. It can be difficult, but some can succeed. I’ve talked about this in a prior blog. The problem is that if everyone starts adding the same “uniqueness”, then that becomes a commodity as well.

Therefore, one should seriously consider the periphery while developing the core strategy. The periphery strategy may be even more important than the core strategy. After all, if the core truly is commoditized, all you need to do is copy industry best practices and build scale to get credibility at the core.

It is in the periphery where you not only get a chance to make extra margin. It is also the place where you have the best shot at creating differential advantages. The periphery is where you have a shot at creating a sustainable reason to be preferred over the competition.

For example, Comcast has a reputation for absolutely horrible customer service. A cable TV competitor can take the peripheral element of customer service and create a meaningful advantage over Comcast. Southwest Airlines has created an advantage by treating the peripheral business of baggage differently from its competitors.

Apple tries to get around commoditization in smartphones through the unique peripheral features in the closed system it attaches to its phones. All along, it has been the closed systems circling on the periphery (like iTunes) which have made all the Apple innovations truly successful.

So the periphery may not be at the core of the industry, but it is probably at the core of what helps you to win and make a profit. So treat it accordingly when doing your planning.

There is a tendency for the core business of all industries to become commoditized and/or become a loss leader in price. As a result, if your strategy only focuses on the core, you will most likely never achieve sufficient profitability to make your business a financial success. Real profit tends to come from the periphery, where there are more opportunities to enhance your margins. As an added bonus, the periphery also often is the best place to create meaningful differentiation. With all those potential benefits coming from the periphery, one should not leave the periphery to chance. It needs strategic planning emphasis as much as the core, if not more.

I know a lot of social media companies have a singular focus on building out the core. They say they will get around to figuring out how to monetize it later. That’s like saying I have a great strategy, except that it does not provide me with a differentiating position or a way to make a profit. You’d never settle for a strategy like that. Why would you settle for a business like that?

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