One of my all-time favorite Far Side
™ cartoons shows a deer with a target on its chest. In the caption, another deer comments, “Bummer of a birthmark, Hal”. In our work with firms serving business markets, we’ve come across many organizations where people feel they are the ones sitting squarely in the bull's-eye, with supply chain managers and competitors alike taking aim on an ongoing basis.
These firms face the threat of having to succumb to the vicious cycle of price-based competition, which could result in the erosion of their profit margins and the denigration of their products to commodity status. Neither is a pleasant prospect.
Is your firm sitting on the bulls-eye? Here are three sure-fire signs:
1. Your firm is among the largest suppliers to a customer. Your competitors are thinking, “Wouldn’t it be great to supplant them?” and the customer’s purchasing managers are thinking, “We’d be heroes if we can knock a couple of percentage points off that bill.”
2. Your firm’s products or services are among the largest elements of the cost structure of a customer’s product. Competitors think, “This is where we want to be, because that’s where the money is” and purchasing managers conclude, “A dollar saved here drops right to the bottom line, and there are a lot of dollars that can be saved on that ingredient.”
3. Your firm’s products are among the highest-priced products bought by a customer. Competitors say, “Let’s take that high-ticket business” and purchasing managers say, “It takes as much work to get concessions on a $1000 product as it does on a $1 product, so let’s go for the elephants instead of the ants.”
Over the years, when facing a situation outlined above, executives have told me, “Maybe that’s true in general, but not in this instance.” However, in almost every case, within a year or so, I’ve gotten a call lamenting the fact that their company was now indeed sitting on the bull's-eye.
There are four factors that determine the severity of pricing pressures:
—The capacity balance of both the supplier industry and the customer industry. When there is excess supply capacity in either industry, pricing pressures are likely.
—The various forms of “protection” that might exist for the product line in question. Protection can range from legal factors (e.g., patents) to structural factors (e.g., high levels of investment required to enter the industry). The more protection that exists, the less likely is price pressure.
—Industry conditions. The faster the growth, the more important security of supply becomes, and so pricing pressure becomes less likely.
—The quality of the relationship between the supplier and the customer. While relationship can never overcome deficient products or pricing far off market, strong relationships are as important to customers as they are to suppliers. The stronger and longer-standing the relationship, the less likely that pricing pressures will translate into a lost customer relationship.
For firms sitting on the bull's-eye, knowing how severe the threat is allows them to respond in a way calibrated to the situation.
So, what can you do to avoid being pulled into a vicious cycle of price-based competition? There are three actions that can be taken to improve your outlook.
1. Recognize that price is not necessarily the most significant factor.
There are many instances in which price is not the most significant factor in a customer’s purchase decision. It’s a sad situation when a supplier elects to respond to a lower-priced competitor by cutting price, even though the customer’s purchase decisions were based upon other factors like product technology or services. For such suppliers, their next step is usually to degrade their product and service to avoid cutting into their profit margin.
Here’s an example. One firm in the tool market had been responding with price reductions to ever-tougher challenges from low-price imported tools. When it studied its market carefully, it learned that there was in fact one segment of tool buyers that made their purchase decisions on the basis of price. But there were other segments where product features and services were far more important. The responses this firm was making to the challenge in the price-focused segment were exactly the opposite of what was required for success in the other market segment. When the firm redirected its strategy to product enhancements and collaborated with its dealers on service improvements, it was able to gain market share at premium prices, despite the ongoing presence of the low-priced tools.
2. Be proactive
Anticipate challenges and take proactive steps to thwart them. It’s always smart to anticipate future price competition and to have a plan already in place so you can avoid problems once they arise.
One firm we’ve worked with immediately implements a value engineering study whenever they win a significant contract. The purpose is to identify how the firm can get to a lower-price point over the life of the contract, with significant reduction targets given to the team assigned the project. As options are identified, this firm does two things: it implements them, and it gives its customers “good news” about the price path that can be achieved through ongoing collaboration. Rarely has this firm ever had to respond after the fact to a competitor’s price pitch or to supply chain managers who are upset about how “the old prices are out of line with market.” In many instances, the firm has translated value engineering successes into higher margins while simultaneously bringing lower prices to their customers.
3. Focus on the customer
This strategy is the most important of all. It involves thinking about what creates a “win” for the customer. There is no better way to blunt a competitive threat or to disarm a supply chain challenge than to have advocates from within the customer organization say “This supplier is critical to us and is doing a great job.” Understanding what constitutes a great job and what creates a win for the customer is the route to creating champions in the customer organization.
We worked with a packaging supplier that saw an opportunity to bring a new packaging innovation to one of its largest customers. This innovation, in fact, cost almost 50% more than the previous generation of packaging. But it was a market place success, first validated by market research and subsequently by sales. The new packaging “jumped off the shelves” as customers saw something different and interesting. The customer attributes a substantial gain in market share to the shelf appeal of the packaging, and claims that the product has had a life cycle that has already surpassed the industry average by a wide margin. The supplier created strong champions in this customer organization as a result of its contribution to the firm’s success.
Transforming the bulls-eye into a spotlight
You can sometimes transform a bull's-eye into a favorable spotlight designed to focus applause from within the customer organization when you provide your customers with an important and visible “win.” You can do so by helping them take costs out and improve their bottom lines, by helping them to gain new sales and improve market share, and/or by helping them get to a more profitable price point through options and trade-ups. When you can create value in one of these ways, you have the opportunity to capture it for your own shareholders.
A firm sitting on the bull's-eye can take definitive actions to improve their situation: focus on the real factors that drive purchase decisions, rather than assuming it is always about price; make proactive efforts to get ahead of price challenges; and learn what creates a “win” for customers. Transform the bull's-eye into a spotlight deserving of applause. Those firms that implement these strategies will be able to enjoy the humor associated with the Far Side™ cartoon rather than bemoaning the analogy to their own sad situation.