Wednesday, November 23, 2011

Price Wars:The Sandwich Strategy

With the emergence of social media today, customers are more informed and demanding than ever before. Customers are spoilt for choice, with a variety of products and services available in the market. However with increased competition, products and services continue to become increasingly similar and less differentiated - making it more difficult to develop and extract value from a brand. Companies too often compete exclusively on price, and this could lead to a race to the bottom. Often when quality is difficult to judge, price may be interpreted as an indicator of quality. Furthemore with Mobile apps such as TheFind, consumers are able to compare prices of a product just by scanning the barcode using their smartphone. As a result, companies must find ways to launch new products or services that create meaningful differentiation in the minds of their consumers while capturing and sustaining the value they have created for their different target segments. This requires companies to employ new innovative models if they are to create the necessary conditions for their success. In my blog post titled, "Innovation at it's Best" I talked about how companies need to consistently innovate to turn consumers expectations upside down and take an industry into the next generation. Failure to innovate is a recipe for disaster.  

Traditionally companies responded to competitive pressures using the different elements of the marketing mix. Among the Four P's of marketing, product, price, place and promotion, price is the most important factor as price is the only element that captures value and brings resources back to the firm as compared to product, place and promotion. As a result, it is important for companies when launching new products and services to use price as a strategic weapon in order to capture the value it creates for its customers, while also enhancing the firm's profitability. 

If a new competitor enters the industry, and a company responds to the competition simply by dropping the price, two undesirable consequences can occur: you give legitimacy to your competition, signally that the two offerings are more or less identical, and you send an unpleasant message to your existing customers that you have been overcharging them for years. How should companies respond then? How do they compete for price without damaging their brand equity? Fear not, the "Sandwich Strategy" can help companies introduce a value-price offering as well as a premium one. Even though this a relatively new concept, employing this strategy can help a company reap the rewards. This method helps segment the market to draw new customers and squeeze competitors within the "sandwich". It is a 3 step process that involves 1) Redefining the current market, 2) Resegmenting the current market, and 3) Adopting a Sandwich Strategy for market resegmentation. Let's take a look at the case of FedEx vs USPS.

Though most people would consider Federal Express (now known as FedEx) a high quality leader in the premium overnight delivery service, this company launched overnight service to compete with United States Postal Service, USPS. To compete with FedEx's market dominance, USPS created a product called Express Mail priced at $8.95 as compared to FedEx's $12. Instead of reacting on price alone, FedEx reacted by redefining its market. 

FedEx used to call its product "Overnight Delivery", but "Overnight" does not specify what time the delivery will arrive. Hence FedEx introduced precision not only in terms of the delivery day, but also in terms of the delivery time. Using this new definition of their business offering, they resegmented the market. The resegmentation included two delivery methods, one in the morning and one in the afternoon. In branding terms, rather than calling the new product "morning" or "afternoon" delivery, they labeled the service as "Priority" and "Standard". This sent powerful messages to customers about how a client perceives the value of a business. Customers such as investment bankers Goldman Sachs and JP Morgan Chase, were happy to pay for this service distinction, seeing it as an additional tool to help them better manage relationships with their own clients by providing them with a more convenient timely service. 

Most importantly with regards to the Sandwich Strategy, FedEx increased the price of its Priority service to $13, slightly more than the amount they were charging previously for overnight delivery. At the same time, it kept the lower end Standard service at $9, which is almost identical to the price of the USPS Express Mail product, hence Sandwiching USPS in between its premium and value price offering. Under this method, customers might buy the brand leader's current offering at the new price, or switch to the new offering at a higher price. In short the company with the stronger brand will win. This approach not only helped FedEx gain market share, but also increased its profitability. Its current clients migrated upward from the company's existing offering to its new Priority offering, paying an additional premium. At the same time, FedEx also acquired an entirely new customer segment at the lower end of the market, a segment that would have otherwise belonged to USPS. One of the factors that also contributed to FedEx success was its technology investment. FedEx had invested in technology that featured parcel tracking, which was not available to USPS at that time. Tracking proved to be an additional benefit for customers. Some of the feedback gathered from clients of Goldman Sachs and JP Morgan Chase was that when they received the package, the first thing they do is to check if the package was sent by priority or standard. This information tells them whether the company treats them as an important client or an ordinary client.  This indication helped FedEx capture its value for the overnight delivery of the packages. 

3 important factors for the Sandwich Strategy to succeed are cost leadership, market expansion capabilities and speed of execution. 

Cost Leadership
In order for a company to create a successful low-priced alternative, it is essential that the firm enjoys a position of cost leadership. This translates into a company being able to maintain cost efficiencies before they strive for product or market leadership. FedEx knew that they could transform its business and offer greater value to customers without the company incurring extra costs in providing that value. Airlines like Delta and US Airways have tried to create a low-cost alternative such as Metro Jet and Shuttle by United respectively to compete with Southwest Airlines. However both of these new branches were unsuccessful as they had large cost structures. They would be better off resegmenting their current offerings under the existing structure by providing value added services.

Market Expansion
To successfully employ the Sandwich Strategy, a company must have developed and be able to leverage its market expansion capabilities that enable it to create innovations in its offerings. When a company offers variety, it is offering a customized product that closely fits a consumer's needs. Hence the ability to innovate helps a company achieve speed-to-market and customization. P&G in its Head and Shoulder shampoo line offers shampoos and conditioners for all types of hair. As a result, customers walking into a store can find a hair product that is close to their needs. This gives P&G the advantage to charge a greater average price compared to its competitors which have a less customize product.

Speed of Execution
A company must demonstrate superior speed-of-execution capabilities. Companies should have a portfolio of products that will allow them to launch products in small batches to gauge market reactions from competitors. With this they will be able to quickly react to developments by using other offerings waiting in line. Even though speed is essential, research shows that a company does not need to react immediately to its competitor.  When a new competitor attacks with a low-priced alternative, firms must ask themselves whether a market at the lower end exist. Toyota's entry into the luxury car market with its Lexus offerings was to compete with Mercedes-Benz and BMW where neither brands were players in the lower-end luxury car market as they did not know if such an offering exist. Lexus was doing a favor for its competitors by conducting  market research, however Mercedes Benz and BMW decided to wait for the results of that research before entering the new market. Presently Mercedes Benz and BMW are successfully in the lower-end luxury market, however it is still too early to say if they waited too long to enter this market. What's concrete is that the costs of entering the market later may have proven to be much higher for them than the cost of entering the market earlier.

The value capture strategy presented in this article, called the Sandwich Strategy, offers a powerful way to beat the competition while expanding the company's market share. However the approach demands that firms cultivate the necessary conditions for success, including deepening their understanding of customer's needs and adopting a more sophisticated perspective on market segmentation and positioning. I will leave you with one of my favorite advertisements by FedEx. Happy Thanksgiving everybody =)

Ideas from: 
1) Kellogg on Marketing by Alice Tybout & Bobby Calder


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