One of my all-time favorite Far Side cartoons showed a deer with a target on its chest. The caption has another deer commenting, "Bummer of a birthmark, Hal." In our work with firms serving business markets, we've come across many organizations that feel they are the ones sitting squarely in the bulls-eye, with supply chain managers and competitors alike taking aim on an ongoing basis.
The challenge faced by such firms involves the threat that they will have to succumb to the vicious cycle of price-based competition, resulting in the erosion of their profit margins and the denigration of their products to commodity status. Neither is a pleasant prospect.
There are three instances in which it's almost always correct for a firm to assume that it's sitting on the bulls-eye:
- If your firm is among the largest suppliers to a customer, assume you're on the bulls-eye. Your competitors are thinking "Wouldn't it be great to supplant them?" and the purchasing managers in the customer organization are thinking, "We'd be heroes if we can get a couple of percentage points off that bill."
- If your firm's ingredients or services are among the largest elements of the cost structure of some customer's product, assume you're on the bulls-eye. Competitors think, "This is where we want to be, because that's where the money is," and purchasing managers see that "a dollar saved here drops right to the bottom line, and there are a lot of dollars that can be saved on that ingredient."
- If your firm's products are among the highest-priced products bought by a customer, assume you're on the bulls-eye. Competitors say, "Let's take that high-ticket business," and purchasing managers say, "It takes as much work to get concessions on a $1,000 product as it does on a $1 product, so let's go for the elephants and let the ants alone."
Over the years, on some occasions, I've heard executives say, "Maybe that's true in general, but not in this instance." In almost every case, within a year or so, I've gotten a call lamenting the fact that their company was now sitting on the bulls-eye. It's smart to recognize the inevitability of that outcome and take actions in advance so your firm doesn't get pulled into a vicious cycle of price-based competition. There are three actions that can be taken to improve your outlook.
The first strategy recognizes that there are many instances in which price is notthe most significant factor in a customer's purchase decision. The saddest situation involves a supplier who elects to respond to a lower price competitor by cutting price, even though the customer's purchase decisions were based upon other factors, like product technology or services. For such suppliers, their next step is usually degrading their product and service to avoid cutting into their profit margin. This is an instance of using both edges of a double-edged sword to cut your own throat.
One firm in the tool market had been responding with price reductions to ever-tougher challenges from low-price imported tools. When it studied its market carefully, it learned that there was in fact one segment of tool buyers that made their purchase decisions on the basis of price. But there were other segments where product features and services were far more important.
The responses this firm was making to the challenge in the price-focused segment were exactly the opposite of what was required for success in the other market segment. When the firm redirected its strategy to product enhancements and collaborated with its dealers on service improvements, it was able to gain market share at premium prices, despite the ongoing presence of the low-priced tools.
The second approach to preempting the problems associated with sitting on the bulls-eye focuses on anticipating challenges and taking proactive steps to thwart them. A simple version of this strategy says that it's always smart to anticipate future price competition, and always smart to have a plan already implemented to avoid problems when it happens.
One firm with which we've worked puts into place a value engineering study on the day each significant contract is won. The purpose of this is to identify how this firm can get to a lower price point over the life of the contract -- with quite significant reduction targets given to the team assigned the project. As options are identified, this firm does two things: it implements them, and it goes to its customers with "good news" about the price path that can be achieved through ongoing collaboration.
Rarely has this firm ever had to respond after the fact to a competitor's price pitch or to supply chain managers upset about how "the old prices are out of line with market." And in many instances, this firm has translated value engineering successes into higher margins at the same time that they've brought lower prices to their customers.
There are four factors that determine how severe pricing pressures will be:
First is the capacity balance of both the supplier industry and the customer industry. When there is excess supply capacity in either industry, pricing pressures is likely.
Second is the various forms of "protection" that might exist for the product line in question. Protection can range from legal factors (e.g. patents) to structural factors (e.g. high levels of investment required to enter the industry). The more protection that exists, the less likely is price pressure.
Third is industry conditions. The faster the growth, the more important security of supply becomes, and the less likely is pricing pressure.
Finally, the quality of the relationship between the supplier and the customer is important. While a relationship can never overcome deficient products or pricing far off-market, strong relationships are as important to customers as they are to suppliers. The stronger and longer-standing the relationship, the less likely that pricing pressures will translate into a lost customer relationship. For firms sitting on the bulls-eye, knowing how severe the threat is allows a response to be calibrated to the situation.
Focusing On the Customer
The third strategy for managing life on the bulls-eye is the most important of all. It involves a focus on the customer, thinking about what creates a "win" for the customer. There is no better way to blunt a competitive threat or to disarm a supply chain challenge than to have advocates from within the customer organization say, "This supplier is critical to us and is doing a great job." Understanding what constitutes a great job and what creates a win for the customer is the route to creating champions in the customer organization who will make such a statement.
We worked with one company that made a control system that was used by its customers in their own equipment. When we studied the economics of these relationships, we found some situations where the total cost of the control system was as much as 20 percent of the cost of what they produced, with more than half of the total cost associated with integration and manufacturing. At the other end of the spectrum, we saw other customers where the total cost associated with the control system was less than 3 percent of the cost of the equipment produced. This control system supplier saw a great opportunity to create a win for the customers where these total costs were high -- in the 20 percent range -- by re-engineering their product to facilitate integration and manufacturing. When they did so, they created champions in these customer organizations and a huge barrier to competitive challenges.
You can sometimes transform a bulls-eye into a favorable spotlight designed to focus applause from within the customer organization when you provide your customers with an important and visible "win." You can do so by helping them take costs out and improve their bottom lines, by helping them to gain new sales and improve market share, and/or by helping them get to a more profitable price point through options and trade-ups. When you can create value in one of these ways, you have the opportunity to capture it for your own shareholders.
At the beginning of this article, I cited the Far Side cartoon's caption "Bummer of a birthmark, Hal". Like a birthmark, for many firms, sitting on the bulls-eye is something that can't be avoided. It's just a fact of life. But accepting the inevitability of the vicious cycle of pricing is wrong. It is not a fact of life. Those firms that learn and implement these lessons can join those that can just enjoy the humor associated with the Far Side cartoon rather than having to bemoan the analogy to their own sad situation.
George F. Brown, Jr. is the CEO and cofounder of Blue Canyon Partners, Inc., a consulting firm working with leading business suppliers on growth strategy. Along with Atlee Valentine Pope, he is the author of CoDestiny: Overcome Your Growth Challenges by Helping Your Customers Overcome Theirs, published by Greenleaf Book Group Press of Austin, TX. See www.CoDestinyBook.com for more details.