Winning with low prices is not merely a game of math in which you stay one notch below the competition; it is far more a game of culture and attitude. It takes a special kind of company, from the CEO on down, to make a low-price position sustainable and profitable. The skills and traits to pull that off — such as cost-consciousness, relentless efficiency, and customer-driven design — must be anchored in the company and its culture from the very beginning.
Before we continue, though, we will need to heed two caveats. First, we should not confuse a fundamentally low-price position with the decision to wage a price war. A healthy low-price position has a long-term orientation built on consistency and sustainability, not quick results. The groundbreaking price war in the U.S. airline industry the early 1990s highlights this distinction. As American, Delta, and United changed their fare structures and slashed prices month after month to undercut each other, Southwest took out advertisements saying, “We’d like to match their new fares…but we would have to raise ours.” Southwest was born with a sustainable low-price position the others could not reach, no matter how aggressive their price cuts became.
The allure of discounting and the adrenaline rush of a price war seem irresistible, but they are delusions that have nothing to do with a low-price position. The best cure I have found for these delusions is a cultural one. Don’t start price wars. Don’t fight them. Don’t engage in over-the-top discounting that trains customers, both in B2C and B2B markets, to buy cleverly on price and price alone.
The second caveat comes from the late Peter Drucker, my dear friend and mentor, who once told me that low prices and high profits rarely come together. That combination only occurs when a company has a clear, significant, and sustainable cost advantage over its competitors. The choice of the price position affects the overall business model, the product quality, branding, and how to innovate. It also determines which market segments the company will serve and what channels it will use to reach them.
When the combination of low prices and high profits does occur, it means companies have relied on seven decisive success factors:
- They have a low-price position from day one. All successful low-price companies have focused on low prices and high volumes from the very beginning. In many cases they created radically new business models. Successful transformation from a high-price or mid-price position to a low-price one are extremely rare, though I will provide one example below.
- They have a high-growth, high-revenue focus. This creates economies of scale that they exploit to the greatest extent possible.
- They are extremely efficient. They operate with extreme cost and process efficiency, which enables them to enjoy good margins and profits even while charging low prices. They are procurement champions, tough but fair on supplier prices and terms. The German-based retail chain Aldi and the Swedish furniture company IKEA are masters at this.
- They guarantee adequate and consistent quality. Low prices can never offset poor and inconsistent quality, at least not over a long period. Sustainable success requires only adequate quality, but you must deliver it consistently.
- They focus on core products. They do nothing that isn’t absolutely required by the customer, saving costs without jeopardizing value creation.
- Their ads focus on price. To the extent they advertise at all, they focus almost exclusively on price. Consider Aldi or its German competitor Lidl, the low-cost airline Ryanair, and Southwest’s “Transfarency” campaign.
- They never mix their messages. Almost all of the successful “low price, high profit” companies stick to an EDLP, or “every day low price,” strategy rather than one that relies on frequent temporary promotions.
Marketing is a formidable challenge for companies with a low-price or ultra-low-price position. Their hard work differs from the classic marketing efforts of premium and luxury goods companies, who combine attractive design, high performance, and high quality with elaborate packaging and aspirational advertisements. The art of marketing for low-price companies lies in understanding precisely what a customer needs and wants at what level of quality — and, perhaps more importantly, what the customer can do without.
The same seven success factors apply to an even greater degree when a company or one of its business units wants to go one step further and pursue an ultra-low-price position. In his book The Fortune at the Bottom of the Pyramid, the late C. K. Prahalad said that the ongoing growth in China, India, and other emerging economies means that every year millions of consumers acquire enough purchasing power to afford mass-produced products for the first time, albeit at ultra-low prices.
The Wave, a motorbike manufactured by Honda for the Vietnamese market, provides clear, affirmative proof that a huge, global manufacturing company can win in the ultra-low-price segment against local competitors. Honda once dominated the motorbike market in Vietnam, with a share of 90%. Its best-selling model, the Honda Dream, sold for the equivalent of around $2,100. Chinese competitors then entered the market with bikes selling for between $550 and $700 each. The Chinese manufacturers soon sold over 1 million bikes per year in Vietnam, while Honda’s volume dwindled from about 1 million to just 170,000.
Honda cut the price of the Dream from $2,100 to $1,300, a price it knew it could not sustain profitably. But this action did not signal a price war. Instead, it was the first step in a change in Honda’s price position. At the same time, Honda was developing a much simpler and extremely inexpensive model called the Wave. The new bike combined acceptable quality with the lowest possible manufacturing costs.
The Dream’s days may have been numbered, but Honda’s days weren’t. Honda launched the Wave at an ultra-low price of $732, which was 65% less than the former price of the Dream. Honda reconquered the Vietnamese motorcycle market so thoroughly that most of the Chinese manufacturers eventually withdrew.
Large manufacturers such as Honda can indeed compete against ultra-low-price suppliers in emerging markets, but not by cutting prices on their existing products. Success requires a radical reorientation and redesign, massive simplification, local production, and extreme cost consciousness.
Ultra-low-price products from emerging markets have already started to penetrate high-income countries. Renault’s Dacia Logan, originally meant for Eastern European markets, sells well in Western Europe. Siemens, Philips, and General Electric have developed radically simplified medical devices in Asia, conceived for those markets. Yet they are now selling those same ultra-low-price devices in the United States and Europe. These devices do not necessarily cannibalize the much more expensive devices used in hospitals or specialty practices. In some cases, the ultra-low-price products have opened up entirely new segments, such as general practitioners, who can now afford these kinds of devices and can make some basic, preliminary diagnoses themselves. (This is a strategy Tuck’s VG Govindarajan calls “reverse innovation.”)
The price positions available to companies cover a vast spectrum, from extreme luxury down to ultra low. No matter what strategic price position a CEO chooses, he or she must still fulfill two additional and essential roles: aligning each function of the company with that price position, and then defending it against threats from inside and outside the company. Only then can the company capitalize on the powerful link between price and profit and create long-term value for shareholders.
About the Author
Hermann Simon is the author of the newly published Confessions of the Pricing Man. He is the founder and chairman of the consulting firm Simon-Kucher & Partners
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