Strategic Planning Analogy #533: Planning the Periphery

THE STORY
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.

THE ANALOGY
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
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.

Others

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.

Implications

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.

SUMMARY
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.

FINAL THOUGHTS
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?

Analogy #187: A Cup's Worth of Value

THE STORY
In Lemonland, most of the children tried to make a little money by running lemonade stands. All the children got their lemons for the same Lemonland lemon groves. They also all used the same official Lemonland Lemonade Recipe. As a result, the lemonade at all the lemonade stands tasted pretty much the same.

With all of these children on every street corner trying to sell the same product, it was hard for any one child to get an advantage. There were just too many lemonade stands relative to demand and all the lemonade tasted the same.

As a result, some of the children started cutting the price of the lemonade. At first, this created an advantage, but eventually all the other children dropped their prices to match, eliminating the advantage. So then, some of the children started dropping the price even more.

These cycles of price dropping and price matching went on for quite awhile, until there was little revenue left for making a profit. As a result, the children started doing whatever they could to cut their costs. Again, as soon as one child got a cost advantage, the others would copy it, eliminating the advantage.

There was one child, however, who refused to follow this trend. She charged more than any other child. Yet, at the same time, she sold more lemonade than anyone else.

I went to see her to find out what her secret was. When I asked her how she could sell more of the same identical lemonade than anyone else, even though she charged more than anyone else, she responded, “I’m the only one left who still offers the lemonade in a cup.”

THE ANALOGY
Sure, everyone was selling the same identical lemonade. However, lemonade without a cup is not very valuable. It’s not like you can pour some in your pocket to drink later. And if you pour it into the palm of your hands, it will just run through your fingers and make your hands all sticky. Without a container to put your lemonade in, there is little desire to purchase it.

So even though the lemonade was a commodity, the user experience could vary considerably, based on something as simple as a little paper cup.

In the business world, a large number of items appear to be commodities, just like that lemonade. And like those children, there is a temptation to cut prices and cut costs in order to get a temporary advantage in the market.

However, as the story illustrates, if you focus just on the commodity, you can miss out on the bigger picture—the entire experience. People don’t just buy an item (like 8 liquid ounces of lemonade). Instead, they buy a “purchase experience”, which includes convenience, service and maybe a little paper cup to hold the purchase. The item may be a commodity, but the purchase experience doesn’t have to be.

THE PRICIPLE
The principle here is that the way one develops their strategy depends a lot on how one defines their business. For example, if you take a narrow product-centric approach to define your business (like “I sell lemonade”), you may take one approach (like cutting prices and costs to the point where you no longer offer a cup).

However, if you define yourself more broadly, as playing a roll in the entire consumption experience, you could develop a much different strategy. In the case of the lemonade stand, a broader definition could be something like this: “I provide convenient, on the spot, liquid refreshment to hot, thirsty customers.” With this type of definition, you would never consider a strategy which eliminates the cup. You might even add ice to the lemonade to make it more refreshing.

Just because you sell the same identical product as someone else does not mean that you have to provide the same identical experience. When you define yourself as an “experience provider” rather than a seller of a particular product, it can open your thinking to more strategic alternatives.

I was recently reading a story about a company called Granite Rock (courtesy of theWiseMarketer.com). Granite Rock sells granite, which is a commodity product. If Granite Rock had defined themselves narrowly as just a seller of commodity granite, they probably would have created a strategy of minimal investment and lowest prices, just like most of the other companies in the field.

Instead, however, they looked at the entire value chain and defined themselves as a company which improves the value process for purchasers of granite. With that type of definition, the strategic focus turned from “pushing granite” to “helping customers”. What they discovered was that for granite purchasers, time is money. Granite Rock determined that each wasted minute for its customer’s truckers cost them $1.20.

As a result, Granite Rock invested considerable sums of money to make their transaction process faster. They developed a system called “Granite Express” that automatically loads trucks like an ATM machine. The driver swipes a card, pulls in his truck, and lets the machine do the loading. This process cut the loading time from 24 minutes to 7 minutes, saving the purchaser over $20. Better yet, because the machine was automatic, it is open and available 24 hours a day. Just think of how much money could be saved by not having to wait all night for the granite loader to open up for business.

Thanks to these kiHow to Brand Sandnds of added services, Granite Rock is doing well, in spite of charging about 6% more than its competitors.

Back in 1998, the Booz Allen Hamilton consultants (now called Booz & Co.) wrote an article called “How to Brand Sand.” The point of the article was that nothing—not even sand—is a true commodity, if you look at the bigger picture. This article resonated with me because in college I worked for a company which sold sand. Unfortunately, the sand company I worked for thought narrowly about their business, so they cut out virtually all the costs and sold primarily based on price (and eventually had to shut down the business).

In the Booz article, they listed the variety of strategic options which open up if you define yourself more broadly within “commodity” industries. They defined the strategic process to find these options as follows:

1) First, carve up the market from every angle—profits, needs, behaviors—to identify those customers who are responsive to differentiation.

2) Second, differentiate your offering in one or more of the six "generic" dimensions of differentiation.
a) Quality Control
b) Supply Reliability
c) Product Customization
d) Applications Knowledge
e) Convenient Packaging
f) Services which make Process More Convenient for the Customer

3) Third, bundle several differentiations into a brand, and then communicate that brand consistently and strongly.

4) Finally, align your business capabilities to reinforce and defend the brand and the underlying sources of differentiation.

If you follow a process similar to this, you can have a far richer strategy development process—both richer in terms of strategic variety and richer in terms of profitability.

SUMMARY
Before starting the process of choosing one’s strategy, first take some time to make sure you have properly defined the business you are creating that strategy for. If you define yourself too narrowly (product-centric), you may end up feeling trapped in a commodity free-fall, where your only strategic option is to keep cutting costs and prices to get an edge.

However, if you define yourself more broadly as a provider of consumption experience solutions, you may find many, more desirable strategic options. This does not just apply to fast moving consumer products. It can also be applied to seemingly mundane industrial products like granite and sand.

FINAL THOUGHTS
When I was a child, a buddy and I opened up a lemonade stand. Business was awful. Adults didn’t take the time to stop. They just drove buy. The only people to hang around the stand were other children.

We soon discovered that the other kids were more interested in toys than in lemonade. As a result, we went and got some of our old toys we no longer wanted and started selling them to the other children. Suddenly, we were making money.

If we had stuck to a narrow, product oriented business definition (selling lemonade), we would have been a dismal failure. However, by taking a broader business definition (making people who hang around on the sidewalk happy), we were able to modify the strategy to create a success.