How to turn a commodity into a specialty product?

Commoditization is a major concern for my clients.  The process that brings decision-makers to that point is a familiar one.  As soon as a new product is introduced, competitors typically reverse engineer the product.  Reputable companies will tweak the product so that they do not trigger intellectual property disputes but manufacturers in China do not even bother.  Depending on the product, if it is successful, so many suppliers will introduce it that price alone becomes the main factor in purchasing.

You would be surprised that not all companies give up so easily.  In the building product industry where a homeowner would not the difference between two types of siding or roofing, windows companies have done a remarkable job of turning their products into branded products.  Think Andersen Windows, for example.

Like most products that go into a typical home, they are nearly identical and home-builders use them interchangeably based on price.  The same is true for windows.  However, companies like Andersen engaged in a comprehensive and sophisticated branding effort to make homeowners aware that not all windows are same.  In addition, they offered customization of windows.  By doing so, they were able to reduce the share of off-the-shelf windows to just about 20%.  When nearly 80% of the windows are custom built for a homeowner, it enables manufacturers to realize higher prices and reinforce the brand.

So how can you turn a commoditized product into a branded product?

The figure below presents a simplified version of the process that we at Xinvest use with our clients.

Ecolab has business lessons for all types of companies

While advising clients on a range of business issues, it is almost universally helpful to study other companies.  Most of the time I will highlight one or more companies during the presentation itself to build a case for a certain strategy, highlight challenges that another company faced in a similar situation, or warn about following a certain strategy because it did not work out so well.

Obviously, the closer the example is to client's business, the better it is to make the argument.  It also addresses the doubts of those in the conference room who do not fail to point out the industry of the example is so different than theirs.  I, on the other hand, believe that there is no reason to get too hung up on the industry, market, product, or technology, because there are so many similarities in business.  And because I have experience across multiple sectors, it is useful to borrow from other industries.

One company that I have repeatedly used as an excellent is Ecolab, Inc.  There really is nothing bad to say about this company and there is something that every business decision-maker can learn from them.  This is the slide deck I often use with my clients.

Analytical process to identify a growth opportunity for an existing product

We at xInvest Consultants spend bulk of our time analyzing new growth opportunities.  A very typical scenario is a manufacturer that may sell a chemical to automotive, aerospace, consumer electronics, and medical device market.  After research and development, they have now been able to develop a formulation that maybe sold to semiconductor manufacturers.  They believe that their product can replace existing chemicals, lower the cost for their customers, and speed up the process.  However, in order to find out how big the target market is, how is it segmented, what are the trends, what does the competitive landscape looks like, how will competitors react to a new product, and what can be done to successfully penetrate this market, they must do a comprehensive market analysis.

When they come to us with a situation like this, below is the process that we typically use.  

Process used by consultants and market researchers to analyze a new market segment

What I want to emphasize is that clients must do as much research as they can on their own (if possible) but hire an outside consultant (either because they do not have the resources in-house or because an unbiased opinion is a must) at some point.  It is a fact that when you talk to a potential customer, you will not get the answer that we will get.  Since consultants like me work across industries and technologies, we can bring unique perspectives and insights.  In addition, we are trained to look at every observation, conclusion, and comment with a critical eye.  The best approach is the one that combines the internal findings of a firm with that of an independent consultant.

The Price Paid for Serving the Millennials

I have argued previously that companies must be able to make product portfolio changes in order to serve specific market segments.  The company that I have been tracking is the homebuilder D.R. Horton, Inc. (NYSE:DHI).  I will not dwell in detail in this post about the transformation of the US economy since the 2008 housing and financial crises, but it is a fact that since the recovery started in 2012, incomes have been flat, most of the job creation has been in low-wage service sector, Millennials are struggling with student debt, and most Millennials are choosing to rent than buy.

When selling lower priced products is an imperative

When I help companies develop corporate strategies, I generally discourage them from pursuing low-margin businesses.  These opportunities can be very competitive, it is hard to realize value for innovation, and you join a race that you will lose over time.  However, what should a company do if we are undergoing a structural change in the economy?  That is exactly what is happening in the American economy.  We aren't in a short-term slump; we are gradually transitioning to a new form of economy in which incomes of Americans will be a lot lower than they have been in the past.

Smart companies are responding to this by making changes to their product portfolios (e.g. lower priced stores by Whole Foods Market) and new companies are emerging that either capitalize on this trend (e.g. Uber is using mostly college educated folks to drive cabs) or are there to serve them (Forever 21 and H&M).  That is why the introduction of Express Homes by D.R. Horton was worth analyzing because the company saw the need to serve the first-time home-buyers by building lower priced homes during a time of rising property values.  Now that we have some more data, let us review the impact on their financials:

Lessons from the D R Horton Strategy

  1. When you are selling a lower priced product with lower margins, while it is possible to improve the top line, it is nearly impossible to maintain the bottom-line.
  2. Responding to changing market structure is smart.  Imagine what would have happened if D R Horton would have stayed away from pursuing the Millennial first time home buyers.
  3. It is important to be disciplined about the pricing of lower-priced products because customers tend to be very price-sensitive.  It is encouraging to see that number of Express Homes has continued to grow even as the average selling price has been rising, but there is a limit.