Beware the low-cost horde

For professor Adrian Ryans of the Swiss business school IMD, competition from low-cost companies is due to harden. His book analyzes the threat and provides guidance on how companies can fight it… or join it.

	Title:	Beating Low-Cost Competition
	Author:	Adrian Ryans
	Pages:	272pages
	Publisher:	Wiley
	Price:	$34.95

Just how dangerous is low-cost competition? What is it that keeps managers's brows furrowed all the livelong day? According to a study by management consultants McKinsey & Co, the threat from low-cost competition is either the topmost one, or close to it. Retailing, manufacturing and IT/Telecoms are the main targets.

Pick your value proposition
Before plunging into the meat of the low-cost matter, professor Ryans sets forth a classical value proposition framework, which explains why customers purchase a product or service (see box). It reminds us that the customer will select the best value offered on the market. Yet the offering's value is often subjective – after all, is Detergent X really better than Detergent Y? That is why it is posited that there are three different value propositions which a company can offer. One of these value propositions is price value. This is where the low-cost operators line up. A second value proposition is performance value. And the third value proposition is relational value. More on these three value propositions later.

Bean counter’s paradise
Deciding to be low-cost is not enough to guarantee success. Achieving low-cost success lies in thinking persistently about how costs can be trimmed every day in every way. Here Ryanair, with its obsession about shaving costs, is a case in point. What makes Ryanair fly profitably is questioning every aspect of the traditional business model. Cost innovation, thereby created, is the value that lures customers.

For ING Direct, a leader in e-banking, this includes shedding customers who are too demanding. That may seem cruel to the minority affected but, for that, it is kind to the majority who attain low-cost value.

Another feature of low-cost operators is that they are willing to make drastic price drops, the kind that may seem suicidal to traditional players.

Are you really at threat?
Before deciding on a low-cost strategy, professor Ryans recommends that one weigh the potential low-cost threat from competition against the potential of gain via low-costing.

Not all companies are equally at low-cost risk. Companies in the early stages of the product life cycle, or with strong brands, or with intellectual property, or with established relationships with distributors, are less vulnerable to the low-cost challenge.

Assessing the potential
Going hand-in-hand with the assessment of threat is market analysis of the low-cost potential. Just think, if in the early 1980s the traditional airlines had properly estimated that low-cost would grow the passenger market so significantly, they would have developed their own low-cost divisions in a jiffy. By the same token, low-cost retailing has captured over 40% of the food sales market in Germany.

To estimate the size of the low-cost market, professor Ryans recommends five paths:
•    Within your company, play “beat my business” scenarios
•    Identify and understand actual and potential low-cost competitors
•    Put yourself in the shoes of a low-cost competitor to assess what the potential is
•    Assess the untapped market: niches, peripheral users, low-end segments, segments with costs that are too high
•    Anticipate moves from unorthodox players

Playing a different game
When confronted with low-cost competitors, Ryans outlines three alternatives that provide aid. The first option is to enhance one’s performance value. By this, he means making sure that one’s products merit their higher price by offering sufficient added value. To illustrate, Ryans uses the Swedish white goods manufacturer Electrolux. He shows how, through a series of acquisitions, the company managed to first broaden and then consolidate its product range, while in the process creating manufacturing and marketing scale advantages.

The second option is to maintain performance leadership. For companies that use this lever, innovation is of the essence – one must always seem to be leading the competition. Open-source innovation has proven effective for IBM and other IT players in this regard. Other companies harvest ideas from customers and sales networks with the same goal of innovating continuously.

The third option is to build relational value, whereby the company develops such special links with customers that it becomes difficult for these to jump ship. This option is most easily found among B2B companies. Here Ryans provides insight into Orica, an Australian explosives manufacturer that fought off the threat of commodity pricing by developing customized solutions for clients such as mining companies. After several years of development, Orica was even able to innovate by billing for actual results, not just kilos of TNT.

Independent or integrated?
Once a company has decided to enter the low-cost segment in addition to its regular activities, the question then follows of how to do it. Ryans advocates the independent structure for many reasons. The advantages usually outweigh the inconveniences. An outstanding advantage is that it allows the low-cost company to operate without having to shoulder a share of the mother company’s high costs. Another is that only independence will impart to the offspring the motivation that setting and attaining own targets brings.

Some companies do go for the integrated solution. It prevents excessive intramural competition. It enables the company to leverage an existing, common brand. It allows upselling low-cost customers to more sophisticated products; and it can prevent what may be called re-inventing the wheel.

Change management required
In one of the later chapters of his book, Ryans covers some of the difficulties leaders encounter in going low-cost. It is not easy to change the basic strategy of a company. Citing the example of Tetra Pak, the giant packaging manufacturer, Ryans shows that it takes time for both employees and management to accept the need for change and then to implement it
- all in the face of the discouraging fact that the expenditure of time is often equated with that of money.

But Tetra Pak's problem with low-costing cannot be cited as typical. The problem with low-costing is that it contains a whole nest of problems. Thus, leadership requirements differ markedly, ranging from managing the creation of a new low-cost value to fending off competition by reinforcing relational value.

Consider this: the creation of a new low-cost division or company may involve engineering and sales-marketing functions. Talent available at the avatar may not be needed at its spawn. On engineering and design, local engineers can better comprehend local market exigencies. Similarly, local marketers have a closer feel for local pricing and packaging needs.  But what is really entailed is managing a complete cultural shift, to remove the gaze from pricey achievement and to re-focus it on low-cost imperatives. The book’s examination of how Ryanair and Aldi do this provides a glimpse into the mentality that goes with low-cost success.

For companies that choose to reinforce their relational value, Ryans proposes a peek at how Tetra Pak boosted its customer links, namely via a 50-million Euro equipment retrofit that decreased machine downtime. Ryans’ recommendations to CEOs in this area are to design their organizations for better customer awareness, to build relational value by a better understanding of customer needs, and to inculcate a customer focus inside the company.

Published September 2009