The Fine Line Between When Low Prices Work and When They Don’t
There are still only two ways to compete.
Companies find it challenging and yet strangely reassuring to take on opponents whose strategies, strengths, and weaknesses resemble their own. Their obsession with familiar rivals has blinded them to threats from disruptive, low-cost competitors. Ignoring cut-price rivals is a mistake because they eventually force companies to vacate entire market segments.
Most companies behave as though low-cost competitors are no different from traditional competitors. When market leaders do respond, they often set off price wars, hurting themselves more than the challengers. Aldi, the German retailer that owns Trader Joe’s in the U.S., thrived in the brutally competitive German market.
In 2006, Germans voted Aldi the country’s third most-trusted brand, behind only Siemens and BMW. Aldi sells products far cheaper than rivals do. Low-cost companies stay ahead of market leaders because consumer behaviour works in their favour. Only new entrants with even lower cost structures can compete with price warriors.
Low-cost business models are designed to make money at low prices. In a race to the bottom, the challengers always come out ahead of the incumbents. Internet bookings are more attractive to leisure travellers than business travellers. Traditional airlines’ systems must provide for multiple cabin classes, several levels of refunds and reserve seats.
When businesses realize they can’t win a price war with low-cost players, they try to differentiate their products in a last-ditch attempt at coexistence. Companies, we’re told, should adopt the following approaches: design cool products, as, say, Apple and Bang & Olufsen do.
British Airways ignored low-cost rivals such as easyJet and Ryanair. BA now concentrates on long-haul flights, for which there are no low-cost carriers. In the financial services industry, HSBC, ING, Merrill Lynch, and Royal Bank of Scotland have set up low-Cost operations.
Conventional wisdom suggests that because low-cost operation’s sources of competitive advantage aren’t the same as those of the parent, the subsidiary should be housed separately. But as the case of the U.S. airlines shows, independent units are necessary but not sufficient for the success of a dual strategy. A distinct brand helps communicate that fewer services go along with lower prices.
By offering products and services as an integrated package, companies can expand the segment of the market that is willing to pay more for additional benefits.
In 1991, Michael O’Leary was tapped to turn around Ryanair, an unprofitable, high-cost, traditional airline. He replaced the entire fleet, comprised 14 types of planes, with a fleet of Boeing 737s. Ryanair flew 35 million passengers, up 26% over the previous year.
