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Brands or Merchandise?

Published in LaZOOZ - Strategy, Marketing and Innovation Newsletter, Issue 57, By Ari Manor, CEO, ZOOZ

You may have already noticed that the microwave oven, the PC, and the DVD have undergone a process of commoditization. They have become significantly cheaper, the differentiation between the various brand names has blurred, and almost all these products are currently undifferentiated merchandise. How did it happen that you can now buy them at rock bottom prices at supermarkets? What caused IBM to sell the production rights of its laptops to the Chinese company Lenovo? Why is it now cheaper to buy a new DVD than to fix the old one?
 

Did lowered production costs cause this? Apparently not. The microwave, the PC and the DVD have become mass consumer goods in recent years, and while this development unfolded, their production costs have decreased to a tenth of what they used to be, perhaps even less. However, even though the production costs have gone done tremendously, the market prices of these appliances have not decreased to the same degree. In some cases, their prices have even gone up. As long as the customers believed that the leading brands have significant technological advantages, they continued to pay prices for the brand names that were much higher than their production costs.


What caused commoditization, to the demise of the demand for brand names in these domains and settling for generic and undifferentiated brands, and to the eventual disappearance of the brand names? According to the book The Innovator’s Solution, which was reviewed in a previous edition of this newsletter, the main reason for this is not production costs, but the improvement in the quality of the appliances. As long as computers, microwaves and DVDs were not good enough and did not satisfy customer expectations, the demand for the brand names continued. Meaning, as long as the quality of the appliances (including the brand names) was low, customers were prepared to pay more for the leading brands in order to get better products (yet still far from satisfactory). They continued to pay more for a faster computer, for a more powerful microwave, for a DVD with a better picture. However, when these appliances became good enough (faster, stronger, and precise to a satisfactory degree), and when the customers also internalized this – the majority turned their backs on the current brand names, and settled for cheaper generic appliances.
 

These types of processes, where brand names are usurped by cheaper generic products, have important strategic implications that should be considered and utilized: 

  • Value migration: When brand names are merchandized, the added value in the market, as perceived by the customers, migrates to new places. For example – the added value for computers migrated from the actual PC to the operating system and processor, and later migrated to other programs and accessories (mouse, printer, webcam). The brand name manufacturers that adopt an added value strategy need to realize this and migrate at exactly the right time, together with the entire industry, in the direction in which the added value has moved.
  • Preparing for rapid change: Commoditization generally occurs very rapidly (customers can be convinced within a few months that the cheaper products are already good enough, and to stop buying brand names). Therefore, the brand name manufacturers must identify new areas of value ahead of time, and invest in them when the time comes, long before the industry undergoes commoditization and the added value quickly migrates to new places. Brand name manufacturers that missed the boat may go bankrupt in the blink of an eye because they were not prepared for a price war.
  • Longitudinal sprawl: Subcontractors that manufacture various parts for the brand name manufacturers in a specific industry, at competitive prices, need to exploit commoditization processes to dominate the industry, and expropriate them from the brand name manufacturers. They therefore need to manufacture complete solutions at precisely the right time (such as entire appliances and not just parts of them), and to acquire distribution rights from the brand name manufacturers (like Lenovo acquired its rights from IBM).
  • Branding merchandise: In conservative, non-branded markets, the opposite opportunity exists. It is possible and profitable to brand merchandise in an industry where there was no differentiation between the various products for a long period of time. For example – it is possible to brand oranges (Jaffa), flour, or concrete.


In summary: In any given industry, when the quality of the existing solutions improves and becomes satisfactory, brand names may quickly lose their advantage and be usurped by much cheaper generic products. Instead of ignoring such changes, which constitute a strategic threat, you can prepare yourself wisely and use them to grow.