As Michael Porter of the Harvard Business School concluded, when you boil it all down, there really are only two business strategies: Differentiation and Low Cost. For a lot of companies, taking the low cost approach is very appealing. Managers understand that profit is the difference between price and cost, and therefore they may decide to compete based on low cost with the idea that it will assure a healthy profit. Of course the key assumption is that a low cost product will sell.
The problem is that products and services that have minimal costs to produce are typically products with few differentiating features (other than price). Customers who perceive this usually opt for the product or service with the lowest price. Because there can only be one company with the lowest cost, that company tends to be the winner of any price competition. So if a company is the low cost leader, competing based on low cost is a great idea.
However, if a company does not have the lowest costs and adopts a low cost strategy, it should expect low profits and low customer satisfaction. This situation is what former IBM head Lou Gerstner called “commodity hell.” When a company’s products look very similar to everybody else’s they seem like commodities. When products are not differentiated a company must have a low price in order to sell items. If a company is selling a commodity and cannot match the low price of the competition, then the company is in a weak position.
Fortunately, companies don’t have to compete with commodity products and services; instead, they can differentiate. By differentiate I mean companies can use just noticeable differences (JNDs) to give customers reasons to purchase other than simply a low price. Ideally, these JNDs satisfy a specific target market’s needs. Crafting innovative solutions for a market niche means more customer satisfaction and less price competition. In fact, if any customer group finds that there is only one product that truly solves a particular problem, then the company producing it has a virtual monopoly within that specific target market.
Companies that want to avoid price competition and that want to reduce the negative effects of price competition need to learn how to meet the customer needs better than the competitors through better offerings. This is why most companies need to innovate. Companies with innovation processes and employees with innovation skills are more able to offer products and services that command a reasonable price and ensure long-term profits.
About the Author:
Calvin Bacon is the Director of Creative Services at Wisepreneur.com. His areas of interest include idea generation and innovation management.