The commodity trap is a significant threat for manufacturers in premium market segments. It describes the tendency of competing products to become more and more similar, thus nullifying any competitive advantage that the high-end product might have had. The result is that products can only be sold on price, which can be disastrous for a market leader.
There are various standard reactions to this threat, none of which is sustainable. In this article we present an advanced innovation strategy which provides robust protection from low-price competitors.
A market leader has a product which offers a high performance at a premium price (the blue circle in the diagram.) A competitor enters the market with product at a lower-price, lower-performance point (the red circle).
The market characteristic is described by the dark grey line. The line is steep, which is a disadvantage for our company: Compared to the cheaper alternative, customers must pay a lot more to obtain only a moderate improvement in performance. When selling to customers whose requirements are not at the top of the spectrum, the company will be forced to make painful price reductions to prevent them defecting to the competitor.
The market leader is faced with both long-term and short-term threats to sales and to market share. In the short term, low-end customers will defect to the competition. In the long term, the competition will use their profits to develop better products and move up-market, where bigger profits can be made. Given that the low-cost competitor will usually have lower fixed costs, they stand to eventually drive the market leader out of business.
The Standard Responses
The market leader has two standard responses to this threat:
- Abandon the cheaper market segment to Red. This is tempting, because it is simple to implement and it can be argued internally as concentration on more lucrative market segments. However, in the long term, this may eventually lead to the market shrinking until practically nothing is left.
- Introduce a product that competes directly with Red. The disavantage of this approach is that the company’s expensive cost structure will probably not allow this new product to be profitable.
Neither of these responses is therefore sustainable.
The Innovation Defence
The new innovation strategy is more complicated than the standard approaches, but it avoids their disadvantages while protecting profits and market share. The strategy consists of two innovation steps supported by appropriate marketing activities.
First, the company introduces a new product shown as dark green in the diagram.This product performs a little better and is a little more expensive than the competitor’s red offer. The product might be a pruned-down version of the blue product, if this is technically and economically feasible, or it could be a white-label product from a cheaper manufacturer.
The function of the dark-green product is to prevent the competitor from using their profits earned from Red to move up market, increasing their profitability and capturing more and more market share. Most low-end customers should prefer Dark Green over Red, because it benefits from the company’s image as market leader. The competitor is therefore walled in at the bottom the the market. Note that the company may not actually need to sell many dark-green items – it is sufficient that they be available alternatives for the customer.
At the same time, the company invests in high-end innovation and uses their superior resources to create an improved product (shown in light green). This has a substantially superior performance compared to Blue at a similar or – better still – reduced price point.
The first function of the light-green offer is to maintain the company’s image as market leader and to generate profits accordingly. The second function is to reduce the slope of the (light grey) connecting line that characterizes the market. This means that customers can now purchase significantly more performance for a smaller increase in price, which is advantageous to the premium product.
Several conditions must be fulfilled in order for this innovation strategy to succeed:
- It must be possible to develop the cheaper (dark-green) product with the correct price/performance combination and to offer it cost-neutrally.
- The positive market-leader brand must be transferable to the dark-green product.
- The innovation capability must be sufficient to develop the light green product with the right price/performance combination.
- The new light-green product must enhance the market leader’s brand.
If executed successfully, the strategy has three benefits for the market leader:
- They retain their market position and brand.
- The competition remains locked in at the low-margin end of the market.
- Their profitable main product becomes more attractive relative to the cheaper alternative.
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Graham Horton is a professor of Computer Science at Magdeburg University in Germany and founder and co-owner of Zephram GbR, an innovation consulting company. As a professor, he is interested in IT support for innovation, and teaches classes in ideation and startup management. Zephram is specialized in the front end of innovation: planning and facilitating ideation and innovation workshops for clients and provide training in innovation management and creativity techniques for business applications.