No-frills product

The most obvious and straightforward way to keep costs down is to invoke the well-known KISS (Keep It Simple, Stupid!) principle. When you cut out all the extras and eliminate the options, you can put your product together on the cheap. A no-frills product can enjoy success if you can market it to customers who don’t see any benefit in (or are even annoyed by) the “bells and whistles” in your competitors’ products that drive up costs and prices — the upscale fashion house with personal shoppers at the customer’s beck and call and, of course, a glass of chilled champagne and canapes readily available.

In addition to removing all the extras, you can take advantage of a simple product redesign to gain an even greater cost advantage. Home-builder firms replaced plywood with pressed board, for example, to lower the costs of construction. Camera makers replaced metal components with plastic. And of course, you can follow the example of those hip West Coast techie firms with their cool open-space offices — which coincidentally cut down on the amount of floor space per employee and reduces the rent.

As the old saying goes, “You get what you pay for.” And companies that choose to compete on the basis of price typically sell products that don’t sport the highest quality, the most features, or the best service in the marketplace. Is the target segment you’re after large enough to support this strategy? Will the cost-cutting tarnish your reputation for other products and services you offer? You must decide whether the strategic trade-off is worth it.

Stripped-down products and services eventually appear in almost every industry. Some obvious examples today include the following:

• No-frills airlines, such as Spirit Airlines in the United States, or Ryan Air in Europe and AirAsia in — well, you guess.
• Warehouse stores, such as Costco and Sam’s Club, which offer a wide selection, low prices, and hardly any customer service.
• Online educational providers like University of Phoenix and American Public University System, which offer college degree programs to students via digital technology — without the cost of expensive classrooms, dormitories, or rah-rah sports teams with their “fight on for old whomever” songs.

Experience curve

Companies often attain (or fall short of) cost leadership based on the power of the experience curve, which traces the declining unit costs of putting together and selling a product over time (see Figure 14-2). This is one of those concepts that apply mostly to production sector goods rather than intangibles like legal services or educational training programs. The curve measures the real cost per unit of various general business expenses: plant construction, machinery, labor, office space, administration, advertising, distribution, sales — everything but the raw materials that make up the product in the first place. The combined total of these costs tends to go down over time when they’re averaged out over all the products that you make. (You can refresh your knowledge of “economies of scale” in Chapter 5.)

There is, however, an implicit experience curve effect for intangible goods firms, such as online retailers or online securities firms selling stocks and bonds. Astute programmers in these lines of business learned long ago that building in the ability to scale a software product (that is, reproduce it exponentially at essentially zero additional cost) was often required before investors would plunk down the necessary start-up dollars. The difference was that the benefit of lower cost didn’t derive from the firm’s learning as it brought in more and more customers; rather, it was assumed that growth would occur so an ability to handle expansion was hard-wired into the original bits-and-bytes design.

The underlying causes of the experience curve include the following:

• Scale: Scale refers to your fixed business costs, which are fixed in the sense that the amount of your product that you make and sell doesn’t affect the costs. (Fixed costs usually include such things as your rent, the equipment you buy, and some of your utility bills.) The more products you produce, however, the more immediate scale advantage you gain, because the fixed costs associated with each unit go down automatically.

  Think about widgets for a moment. Suppose you rent a building at $1,000 a month to house widget production. You add that rental expense into the cost of the widgets that you make so you don’t lose money. Perhaps you turn out only ten widgets in the first month. No matter what they cost, you have to add $100 rent ($1,000 divided by 10 units) to the price of each widget if you want to break even. But if you can boost production to 100 units the next month, you add only $10 in rent ($1,000 divided by 100 units) to the price of each widget, reducing your rental costs per unit by a whopping 90 percent. Scale is good for business and your bottom line.

• Scope: Scope works a little like the scale effect, although it refers to the underlying cost benefit that you get by serving larger markets or by offering multiple products that share overhead expenses associated with business areas such as advertising, product service, and distribution. (Chapter 15 provides more information on your product portfolio.) These expenses aren’t exactly fixed, but you do gain an automatic scope advantage if the ad you run reaches a larger market or if your delivery trucks deliver two or three different products to each of your sales outlets at the same time.

  We might add that economies of scope are an opportunity for service providers (as opposed to strictly tangible product manufacturers) to benefit from scale. A general hospital that offers patient services in obstetrics and pediatrics as well as general surgery and ophthalmology can use a centralized IT system, food or laundry service, and front door admission personnel to serve all the patients in the facility regardless of their specific ailment. However, a specialty health provider like a surgery center, which does no more than surgical procedures, must maintain all these services for only the limited number of patients it cares for.

• Learning: As you learn, the overall cost of doing business goes down. Remember the first time you tried to tie your shoelaces? Big job. A lot of work. Now you can do it in your sleep. What happened? The more you tied your shoes, the better you got at it. The same is true whether you work on a factory floor, at a computer workstation, or in a conference room. You (and your employees) get better at something the more you do it. And there’s another benefit here as well: Doing the same thing repetitively calls attention to the task and triggers innovation. Tying shoelaces — who does that anymore? Now just press the Velcro together to secure the fit. Moms and dads everywhere were relieved.

A general rule suggests that all these underlying causes result in what’s known as an 80 percent experience curve. Every time you double the total number of products you produce, unit costs go down by about 20 percent — or 80 percent of what they were before. This isn’t voodoo; it comes from the accumulated cost reduction from all of the above. Lots of empirical studies support this finding.

The cost benefit you get out of your company’s experience varies and depends partly on your industry. Some industries don’t benefit from experience effects at all. In industries where the basic costs of raw materials are high, for example, you don’t have much room to gain a big advantage through experience. If only a few suppliers control a critical input to your operations, they might not give you a volume discount since they know you don’t have any other place to turn. And as noted earlier, many service industries may not get much of an advantage from experience, either. It doesn’t matter how good hairstylists become at what they do; it still takes them about an hour to wash and style each customer’s hair, so company costs don’t change. (In fact, service providers might get a bit more bored or sloppy in their work after doing the same thing hour after hour. Do you really want to be the last patient the surgeon operates on that day?)

Low-cost culture

You can sustain low-cost leadership only if every part of your company commits to keeping costs under control by reducing or eliminating expenses and unnecessary spending. This kind of commitment doesn’t occur without the owners’ leadership.

Perhaps more than any other strategy and business plan that you can pursue, the push to be the low-cost leader in your industry succeeds or fails based on how well you carry it out. Knowing where and when to bring in cost-saving technology may be one important aspect of your drive, for example. But at the heart of your plan, you absolutely need to figure out how to structure the company, reward your employees, and create the spirit of a “lean, mean fighting machine.”

Low-cost leadership means exactly what it says. First, second, or third runner-up equals failure; you don’t want to be first among equals. If you can’t assume the low-cost leadership position, you run the risk of playing a part in your worst nightmare: a high-stakes, cutthroat industry in which price wars threaten to destroy all the players. After all, if you don’t have a clear leader, everyone’s a challenger, and when low-cost challengers decide to battle for market-share advantage, they use price as their favorite weapon. If you happen to find yourself in such a Wild West industry, take action. Look for new and different ways to compete — alternative strategies that you can count on to reward you in the end.

But be careful; sometimes the intensity of competition tempts incumbents to cross the line and seek underhanded means to avoid mutual destruction.

Product features

You often can find the source of a successful differentiation strategy in what your product can or can’t do for customers. Some smarties out there have likened products to candidates in a hiring hall: The boss wants to hire the worker for a specific job. So what is your product being “hired” to do? A product’s features are frequently among the first factors that a potential buyer considers. How do your products compare? Are you particularly strong in product design and development? Or is the customer selection criteria based on the need for accurate order fulfillment and delivery speed? If so, you should consider how to leverage your strength in developing new features to make your company’s products stand out. (Chapters 9 and 10 help you answer these questions.)

Unfortunately, major product features represent big targets for your competitors to aim at, so differentiating your company based on major product attributes alone is sometimes hard to sustain over the long haul. Technology-driven companies — such as Apple, Google, and pharmaceutical firms — stay one step ahead of the competition by investing tremendous resources in research and development (R&D) and always offering the latest and greatest products.

Different companies create successful differentiation strategies for distinct dimensions. The auto industry is a prime example of product differentiation. The purpose of a car is to get you from point A to B. When you think of Porsche, for example, you think of performance; Volvo signifies safety; and Toyota and Honda are energy-efficient, reliable choices. Tesla indicates environmental concern. These differences allow competitors to prosper in the same industry, each in its own way, even though their products all do essentially the same thing.

Competition is a bit different in service industries. For one thing, you have to face the importance of customers’ impressions when you deal with services. By definition, a service is something you can’t physically hold; you can’t touch it, feel it, or kick its tires. So customers face a bit of a quandary when it comes to making well-informed decisions. Figuring out what is and isn’t a quality service is harder. How do you know whether your doctor is a genius or a quack, for example? Is the pilot of your flight an ace or just so-so?

Based on this lack of insider information, customer perception dominates the service industry. When customers don’t have all the data, they go with what they can see. No matter what other dimensions are important, the tangibles — equipment, facilities, and personnel — play a significant part in a customer’s perception of service quality. They look for any clues to either confirm or deny a priori beliefs and attitudes. This is especially important if your market offering is a one-time experience, like a college education, a coronary bypass operation, or a bucket-list vacation. Perception is everything.

This is one reason why online product/service customer evaluations by prior users have become so popular with shoppers. They want guidance. Lo the firm that generates a gaggle of negative reviews and does nothing in response.

Product packaging

Customers often look beyond the basics to make the final decision on what to buy. In fact, your packaging may influence customers as much as the standard set of features that your product or service offers. You can’t judge a book by its cover, as the saying goes — but many people buy books simply because of that cover. Remember those universities noted earlier in this chapter? Today college administrators are adding expansive food courts in the dorms and upgrading the sports stadium to professional level standards. It’s like dressing up the diploma.

You can develop an effective differentiation strategy based on product or service packaging — how and where you advertise, what warranties or maintenance agreements you provide, and where you decide to sell your product or service.

With creative advertising, attentive service, and sophisticated distribution, you can make almost any product or service unique in one way or another.

Niche markets

If you’ve traveled to nations that are struggling to move up the economic ladder, you may have noticed that many products and services you find there are basic commodities, without much variety or choice. This is not because people living in those lands don’t want a broader selection. It’s due to the fact that low income levels and a lack of communications and distribution infrastructure makes it difficult for sellers of upscale goods to survive. In many product and service categories, it’s a one-size-fits-all market.

Countries with large populations in which household incomes are spread over many levels create opportunities for the diligent business planner to find niches. These nations typically enjoy modern communications technologies, such as TV and the Internet in addition to radio stations. This allows for relatively easy access to large numbers of people, so that the planner can slice and dice markets into countless shapes and sizes and target a relatively small group. For example, KingSize is an online seller of men’s apparel — but targeted to those who are greater than 6'2″ in height and 225 pounds in weight, a group of 13 million that is less than 4 percent of the U.S. population. And then there’s so-called one-to-one marketing, in which sellers are able to pinpoint just a tiny fraction of potential customers and give them precisely what they’re looking for.

Limited territory

A focus strategy works especially well for the new kids on the block who want to establish a foothold in an industry in which the big guys have already staked out their claims. Instead of going after those fat, juicy markets (and getting beat up right away), you can avoid head-on competition if you focus on smaller markets, which may be less attractive to existing players. After you establish yourself in a niche market, you may want to challenge the market leaders on their own turf. Motel 6, for example, started out as a small regional chain that offered clean beds and private baths at bargain-basement prices. Now the company is a major player in the motel industry — and, of course, attracted others who saw success and said “I can do that, too.” While we’re not yet aware of any Motel 1s, this is what competition is all about. (Actually, we are aware of Motel 1s; ever been around a college campus?)

For small, established companies in a market, a focus strategy may be the only ticket to survival when the big guys decide to come to town. If your company has few assets and limited options, concentrating on a specific customer segment gives you a fighting chance to leverage the capabilities and resources that you have.

Unfortunately, a focus strategy is one of the most difficult generic strategies to maintain over time. Dangers lurk both inside and outside the company. Those dedicated employees you hire can see what you’re doing, and get the entrepreneurial urge to go out on their own. If your market suddenly gets bigger because you’re so good at what you do, you can count on intense competition down the road from much bigger players with much deeper pockets.

Your best bet is to stay focused. Small companies have the best chance of sticking around over the long haul if they rally around a strategy and business plan that concentrate their resources and capabilities. Focus your energy on serving a specific market segment better than the competition. The history of business is filled with tales of smallish companies that took on more than they could handle — and those stories didn’t end well.