Staving off Commoditization: Practical Ideas to Create Value

By Ernie A. Cevallos

Perfect competition is at one end of the competition spectrum, and one of the basis of the concept is that since firms produce undifferentiated products that any business in such an environment is a “price taker” or a firm that cannot affect the price of a good or service. Looked at another way, such commoditized products or services have many perfect substitutes. In theory, the better the substitutes for a product or service, the more elastic the demand for the product. So, how do your products and services stack up and what can you do to win in a commoditizing environment?


Let's look at things a little closer, perfect competition arises in industries if the minimum efficient scale of a producer or company is insignificant relative to the demand for the good or service. This extreme form of competition leads to commoditization of products and services. As sure as the sun rises in the East everyday, commoditization is a given when four factors of perfect competition exist in an industry:

1. Many firms sell similar products to the market.
   
2. Barriers of entry are low in the industry.
   
3. Competitors have little advantage over each other.
   
4. Sellers and buyers are well informed about prices.

In reality, industries have varying degrees of competition, but it is very easy for commoditization to creep in if a group of competitors have similar products and services, and customers find a way to dissect pricing and judge value to be homogenous. Furthermore, strong global competition, information availability (Internet), outsourcing, and offshoring are business aspects that drive competition and increase customer price sensitivity. The product life-cycle suggests that as product classes mature they become more vulnerable to the forces of commoditization. The distinction nowadays is that the speed from launch to maturity is quicker than ever before.

Should you use commoditization as a reason for not attaining sales or profit goals? No! No! The truth is that even when a product has no value added and quality standards are set by law or the industry, there is still ample opportunity to be able to raise the bar and differentiate around delivery, service, marketing, business process, availability, cost of ownership, relationships, payment terms, web enabled tools, and other imaginative value creation ideas. As the saying goes: "There are no mature products, only mature managers."

But how do you survive if you find yourself in a commoditizing industry characterized by me-too products, overcapacity, and frequent price cuts? How can you make money? You can do a number of things to fight the forces of commoditization:

1. Innovate: A new product that better meets consumer needs; even an upgrade of an existing process, can one-up competitors and force them to invest in matching or exceeding the new specifications.
   
2. Bundle: Increasing the sale by bundling products and services, and offering integrated solutions where your unique capability can appeal to buyers willing to pay a premium for the expertise.
   
3. Segment: Mature markets are large markets that can be divided profitably into multiple segments. Marketers can focus on providing applications expertise for less price-sensitive customer segments for whom the product is still important.
   
4. Price: Complicate your pricing structures so customers can't easily make side-by-side comparisons.
   
5. Quality: Keep on raising the bar of quality on all fronts, and perception of the value provided for your offerings. Continual improvement needs to be at the forefront always.
   
6. Sales force: Compensate your sales force on profit margin, not sales revenues. Volume without profit does not get the job done. You can pay on volume early in the product life cycle but not in maturity.
   
7. Customers: Decide which customers are not profitable and try renegotiating prices with them. If that fails a friendly termination may be a good course of action. You will lose some customers but improve profitability.
   
8. Marketing. A creative marketing campaign aimed at owning the customer’s mind is a sure way to attract value conscious customers.

The bottom line is that even salt the most basic of commodities can be differentiated. However commoditization is approached, it is important to innovate and create uniqueness and a strong value proposition. Peter Drucker said: "In a commodity market, you can only be as good as your dumbest competitor."