Your product strategy. Should you be the cheapest or the best?

In most pitch decks there is a slide called ‘why us’. This is the slide that lays out a company’s ‘strategic advantage’ — the secret sauce that will ensure they succeed where others have and will fail.

In my experience this slide is often the most challenging one to write for many start-ups. Many founders are so concerned with getting their products out of the door and getting initial traction that they have spent little time considering what will enable them to win long term.

Even if a market is not already crowded, it’s a sure bet that if a company is successful it’s only a matter of time before there will be other entrants. So the sooner we can start to think about strategic positioning the better.

In his influential book Competitive Advantage Michael Porter famously describes 3 fundamental strategies a business can have:

1) Cost Leadership — being the cheapest in the market for an equivalent product or service

2) Differentiation — adding a particular kind of value for the consumer which entices him or her to pay more than the cheapest product

3) Focus — serving a particular subset of the market better and more effectively that competitors

In this post I want to look at the first two of these and discuss whether leading on price is a sensible decision for new products.

Cost Leadership

There is a truth held to be self-evident in business theory which says that competition on price only works if you can be the best at it. Or rather, to compete on price successfully you need to be the cheapest.

There is no point in being the second cheapest with an undifferentiated product.

Price differentiation can be very effective, but it takes commitment from the entire business. To sustain a competitive advantage on price, a company needs to value engineer each cog in its business process, shaving off cost at each stage of the process. It will need to centralise its systems and processes and most likely invest in automation and cutting edge technology to see efficiency gains.

To do this effectively takes commitment from the entire business, not just management. Companies that go after price, such as Walmart or Ryanair, commit one hundred percent to the strategy.

For example, Ryanair has consistently looked for ways to shave valuable time off turnarounds and keep their aircraft in the air and earning money longer. As part of this they decided to remove the magazine pockets in their airline seats. They lost ad revenue from the inflight magazine in doing so, but it meant that they saved valuable seconds on each turnaround as cleaners no longer needed to check inside them.

Cost leadership for start-ups works well in uncompetitive markets where a few incumbents have kept prices artificially high. Dollar Shave Club and Warby Parker were able to steal a march on their competition by selling direct to the consumer and severely undercutting them. Even once the incumbents started to take the disruption seriously, they were unable to respond by matching prices as their business systems had not been set up to deliver cost efficiencies in the same way.

A word to the wise however. While it might be easy to maintain a cost leadership strategy in the face of bloated and entrenched incumbent competition, it might not be so easy to maintain this as new, leaner and fitter entrants enter the marketplace. When start up Casper launched in 2014 they were able to undercut existing players by an average of 50%. By 2017 however, the ‘mattress wars’ were in full swing with over 100 hungry new entrants.

Not only was such competition creating intense downward pressure on prices, but the increased marketing costs required to break through the noise were driving many entrants out of business completely.

While a start-up should attempt to deliver a product or service that is ‘orders of magnitude’ ahead of what’s already in the market place, it rarely makes sense to rely solely on a cost leadership strategy as this will be almost impossible to maintain in the long term.

Differentiation

The Apple iPhone is one of the most expensive products in the market and has a gross margin of around 50%, yet people continue to buy it in droves. Why? Because they ascribe a value to the product that justifies its inflated price tag.

Differentiation means providing something to your customers that they value over and above simply getting the cheapest product. This is a strategy that often makes sense for start-ups as they look to ‘disrupt’ an existing experience.

It’s true that some start-ups have delivered a product which is cheaper and better than incumbents. Uber, certainly in the UK, is a good example of this. However, many of the most successful start-ups in recent years have focussed on differentiation rather than cost leadership.

Is Airbnb cheaper than staying in a hotel? Maybe sometimes. But for many the experience is simply more convenient.

Then of course, the question becomes how to differentiate and that’s the million dollar question and something we will look at in another post.

About me

I’m a product strategist based in London. I help companies make compelling and engaging digital products, and optimise for growth. www.timbichara.com