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Playing it cool with a hot commodity

Successful businesses often attract rivals that can undercut their prices. Rather than get caught in a cycle of hypercompetition, they can survive with smarter and subtler responses, an author says.

January 18, 2010|By Stefan Stern

Unusually for a business book these days, this one has a restrained, unsensational title. But "Beating the Commodity Trap" describes a process that is (or should be) terrifying for its readers: commoditization.

You may think your business offers rare and valuable goods and services. But the chances are that, somewhere, a recent entrant or potential competitor is preparing to do something similar, for a lower price. As the author says, "Everything becomes a commodity eventually."

Richard D'Aveni is professor of strategic management at the Tuck School of Business at Dartmouth College, in Hanover, N.H. This book is a successor to his 1994 work "Hypercompetition," in which he described how technology and globalization were destroying long-established competitive advantages.

Now, he says, businesses face the commodity trap -- "a particularly virulent form of hypercompetition."

His tone is sober and urgent. D'Aveni is writing for the time-poor executive, who is aware of encircling threats but uncertain what to do about them.

When facing low-cost competition, companies traditionally try to cut costs or innovate. But this can trap them in "never-ending cycles of hypercompetition," D'Aveni says. Survival requires smarter and subtler responses.

The author describes three types of commodity traps. First, there is deterioration, in which low-end businesses enter with "lower cost, lower benefit" options that attract the mass market, much in the way Zara, the Spanish fashion chain, has done. In the deterioration trap, prices go down, and the benefits for customers go down too.

The second type is proliferation. Here, either cheaper or more expensive alternatives with "unique benefits" attack different parts of an incumbent's market -- as Japanese and U.S. motorcycle makers did to Harley-Davidson. Prices and benefits for customers may go up or down.

Third, and perhaps most dramatically, there is escalation. Here, players offer more benefits for the same or lower price, squeezing everyone's margins, as Apple has done with iPods. Prices go down and benefits for customers go up.

In this world of commodity traps, D'Aveni says, managers will understand what the Red Queen in "Through the Looking-Glass" meant when she said: "Here you must run faster and faster to get nowhere at all!"

To move on, companies must be resourceful, and "change the industry's structure," "redefine price" or "define new segments."

How do you avoid deterioration? Diesel, the fashion business, has done this by establishing expertise in denim products, the author says. Other high-end fashion companies have begun selling "baby cashmere" clothes, made from the first combing of a young goat. You need 20 goats to make one jumper. "This is a place where low-end players cannot follow," D'Aveni writes.

Another alternative is the side-step strategy: "Move away from the pull of the market power of low-end rivals." Armani and Dolce & Gabbana preview part of their collections in private showings to avoid early copying. "Some 60% to 70% of Armani revenues are attributable to such 'pre-collection' sales," D'Aveni said.

Proliferation is daunting, but you "cannot fight everyone, everywhere, all the time," D'Aveni says. You have to try to manage these threats. As A.G. Lafley, former chief executive at Procter & Gamble, used to say: "Where are you going to play, and where are you going to win?"

The hotel sector has suffered from proliferation. Andrew Cosslett, InterContinental Hotels CEO, tells D'Aveni: "Hotels in the past have been segmented by price and not much else. . . . Brands in the future will have to stand for something."

Executives may question how useful it is to follow advice from D'Aveni, who is also a consultant. But every business needs to think about how to defeat these threats. As he says: "Commoditization doesn't just happen to commodities."

Stefan Stern is columnist for the Financial Times of London, in which this review first appeared.

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