Dealing with Powerful Customers

Often, when the topic of specialty and commodity behavior is discussed, people feel that it doesn’t apply to their industry. This feeling comes from a perception that customers in some industries demand benefits that are typical of a specialty product - high value added, strong customer support, high levels of service and quality, added features, etc. - while also demanding the lowest price. Is this a specialty customer or a commodity customer? How can this situation arise - and how can you manage it?

First, let’s step back and look at some definitions. A specialty customer is one who prefers products in which he perceives premium value at a premium price. A commodity customer chooses products with price as the most important factor in his decision. It is important to note that, in both cases, we are talking about customers, and not products or vendors. This is because the specialty/commodity concept refers to customer behavior. Much confusion arises because many products are designed to appeal to specialty or commodity customers, leading people to think of them as “specialty products” or “commodity products”. The product - let’s say a tire - may be very nice, and originally designed for specialty customers, but if a given customer (call him “Bill”) prefers a lower price product, it tells us very little about the tire. We can say that Bill is exhibiting commodity behavior with respect to tires, and it is this behavior that we must build our strategy around.

“A specialty customer is one who prefers products in which he perceives premium value at a premium price. A commodity customer chooses products with price as the most important factor in his decision.”

Now, an individual consumer customer like Bill is unlikely to bring on a dilemma of demanding specialty product (with outstanding features and service) at a commodity price (always the lowest price). This is because vendor behavior also shapes the marketplace. The price/volume relationship can generally be described by a normal distribution curve, that is, fat in the middle, at the average price, and tapering off at both ends. (Figure 4) At the high end, fewer and fewer customers are willing to pay a high price for a product, and at the low end, fewer and fewer suppliers are willing to sell the product for a low price. A single customer like Bill may be able to find a vendor who is willing to sell him a tire that costs $50.00 at a price of $40.00, but he won’t find many, and they probably won’t be offering tires at that price for long. This is because most vendors would simply walk away from a customer like Bill.Because of this, Bill - if he really wants a tire - probably has to adjust his behavior, and seek vendors who charge somewhere around $50.00 for the tire, because he is more likely to find sellers in that price range.

Graph 1 This situation tends to be very fluid in consumer markets where there is great freedom of choice given to the consumers (i.e. Where a large number of consumers can pick between a large number of brands). Fluidity is evident when consumers will easily switch between products if they perceive differences in value and price - a large number of consumers can be said to “flow” from a low-value product offering to a higher-value offering in much the same way as water flows downhill. Anything that restricts this flow can - at least temporarily - hold customers to lower-value offerings in much the same way that a dam can stop water from flowing downhill.

In many consumer markets, this fluidity is less because market channels can restrict the choice of brands available. For example, if Bill lives in a town with only one store (we’ll call it “Monster Tire World”), and that store only sells one brand of tire, Bill may have to settle for a tire that costs $75.00 if he doesn’t want to drive to the next town for a tire. This situation also affects the vendor - if you want to sell Bill that tire, you had best sell exactly the tire Monster Tire World wants to buy at exactly the price they are willing to pay. The buyer at Monster Tire World is able to set all aspects of the transaction - features, price, service, etc. - as the price of entry into the tire market in Bill’s town. Many people think that this is exactly where the specialty-commodity model breaks down, since Bill’s commodity preference has no effect on the market and the buyer at Monster Tire World can demand specialty product at commodity prices.

Let’s take a closer look at this situation, to see how this buyer can get specialty features at commodity prices. The Monster Tire World buyer is a gatekeeper, controlling access to an entire market. If we want to sell tires into Bill’s town, we must satisfy this buyer. If there is no competition - that is, no other vendors are seeking to sell tires to this buyer - then Monster Tire World must buy the tire we are selling, regardless of what the market wants. If there is one other competitor, the store has more power. This power can be used in a number of ways. Ideally, it can be used to purchase exactly the tire the market wants at a price the market finds attractive. If there are enough competitors, the power of the Monster Tire World buyer can be used to demand even more of the vendor, and naturally, a smart buyer will seek to improve the store’s margins by getting a better price, better service, and a better product. The buyer’s ability to command this kind of ideal treatment hinges on three things:

the buyer’s control over the market - the closer the buyer is to controlling 100% of purchases in this market, the greater his power,
the desirability of the market - the harder it is for us to ignore Bill’s town, the greater the power of Monster Tire World, and,
the number of suppliers who consider the controlled market vital - if 80 tire suppliers think Bill’s town is the key to their future, competition to sell to Monster Tire World will be fierce.

In this situation, we can call Monster Tire World a true commodity player, since they can get the best product possible and still select on price. It doesn’t matter that the product and service are superb here, what matters is that the Monster Tire World buyer can use price as the primary decision criteria and still end up with exactly what he wants.

Graph 2 In describing specialty and commodity strategies, we like to think of a saddle shaped curve that indicates higher levels of profit as a company gets closer to a “pure” specialty or “pure” commodity strategy. (see graph) In the powerful customer example we have just examined, this curve can show exactly what is happening - the customer is using his power in the marketplace to force tire suppliers into the middle of the curve, where profit is lowest. Naturally, as a tire supplier, we’d like to have a strategy that puts us at one end or the other, either a clear commodity strategy or a clear specialty strategy. How can we do this? There are eight possible ways to succeed in a market with a powerful customer like Monster Tire World.

First, ask yourself if you really want the market that the customer controls. Walking away from a controlled market is the easiest way to avoid having the customer set your strategy for you. While this may ultimately make your company a smaller company, it will likely make yours a more profitable company in the long run. This is often the essence of a successful contract strategy, and is sometimes referred to as “cherry picking”.

Second, do what you can to encourage those who would compete with your powerful customer. Obviously, the powerful customer will not be happy with this, but any competition for access to the controlled market gives you a choice and reduces the power of the customer.

Third, try to create additional choices for the end customer. If Bill can choose between two different models of your tires, the powerful customer will be more inclined to purchase on the basis of optimizing value to their end customer. Also, you may be able to build more margin into the less popular models, since most buyers will focus more attention on the higher volume part of the line.

Fourth, try to be the reason why your customer dominates the market. Remember, if Monster Tire World is the only game in town, there is a reason for it, and you will fit the Monster Tire World strategy better if you are part of that reason. For example, if having the tires in stock 100% of the time is critical to dominance in this market, you should make it easy and cheap for Monster Tire World to keep your tires in stock.

Fifth, try to control the decision criteria to match your strengths - or , even more ideally, your strategic competencies. If the Monster Tire World buyer has a checklist that says “1. Round, 2. Rubber, 3. Cheap” you may not have much to work with. But let’s say our company has a competency in rapid delivery, giving us a solid 1 week lead time where our competitors can only deliver in 1 month. Anything we can do to get the buyer’s checklist to read “1. Round, 2. Rubber, 3. 1 Week Delivery, 4. Cheap” will give us more power, because it makes us the preferred supplier.

Eight Ways to Deal with Powerful Customers

Consider exiting the market
Encourage competition
Appeal to the end customer
Be the reason your customer wins
Control decision criteria
Advertise to create brand preference
Acquire or eliminate competition
Offer the best product, service and price

Sixth, in some markets, you may be able to - often at great expense - create a brand preference that a powerful customer cannot ignore. This is certainly what Intel has attempted to do with their “Intel Inside” advertising campaign.

Seventh, some of us may be able to eliminate competition. The difficult - and profit-damaging - way to do this is to drive them out of business, the easier and capital-intensive way to do this is to purchase competitors outright. Both have disadvantages, both are relatively difficult, but they do have the effect of putting your company closer to even with a powerful customer.

Finally, it may actually be possible to really be better - to offer a superior product, service and price, while still making a profit. If you have a trick up your sleeve, a technological edge, or truly superior management, you can win the game by playing it exactly the way your powerful customer wants you to. If you set out to do this, do be sure that you can ultimately win. If you don’t win, you will simply end up trading away profits for volume.

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