When competitors pile high and sell cheap?

Sometimes consumers will put up with a lot to secure a good price. Just look at Ryanair, which is almost as famous for its tough no-frills approach to customer service as for its cheap airfares. As a business model it’s one that works: for much of 2009 and 2010 its market capitalization exceeded that of Lufthansa, despite the German airline’s revenues being more than seven times higher.

Other sectors have seen a similar rise in “good enough” businesses, from low-cost retailers such as Aldi and Lidl to “fashion” retailers like H&M and Zara. These companies do not offer a premium service – for example, Aldi offers shoppers little choice other than its own-brand products, while the fashions on sale at H&M are not generally made of high-end fabrics – but consumers do not mind. Who needs choice when the off-brand beans are cheap and tasty, and the checkout process fast? Who needs top-quality tailoring on a new shirt that will only be worn for one season?

Given the right market conditions, low-cost competitors can rise and challenge industry leaders very quickly. Vizio is a good example: in 2004 it was a small supplier of low-cost big-screen LCD televisions in the US, with sales in that year of $20 million. Over the next few years it exploited the emergence of new channels for its products at discount retailers such as Costco and Walmart; by 2007 it was the third-biggest manufacturer of large-screen LCD televisions in the US, and by 2009 it was the market leader, with a market share of almost 22 percent – just ahead of Samsung, but well ahead of Sony.

How, then, should premium companies facing competition from low-cost rivals react? The first step is to understand the three types of core value propositions (1) Price value. This is focused on providing “good enough” solutions and offering these standard products and services at an attractive price. This is the core value proposition of low-cost competitors such as Aldi, Ryanair and ING DIRECT Bank (2) Performance value. Companies that emphasize this offer their customers a combination of superior functionality, innovative features, an exceptional user experience, excellent quality and style, and fashion leadership. Examples include Apple and Bloomberg (3) Relational value. This tends to be particularly important to customers who have complex, diverse needs and see value in being able to buy an integrated solution from one supplier. Companies will try to provide customized offerings – if that is what the customer wants. Examples include GE Medical Systems, Cisco, and IBM Global Services.

The first option is to directly challenge low-cost competitors by moving into the lower tiers of the market and offering a “good enough” product or service that is competitive on price. Advantages to this approach including meeting a real market need, gaining additional economies of scale, creating sell-up opportunities, and helping to control low-end competition. However, while this approach seems quite simple in principle, it is difficult to implement successfully. Developing the core product or service is often the easy part – the real challenges are finding effective routes to market, pricing, manufacturing, and organizational structures. Other very real risks include the possibility that you will cannibalize your own higher margin business, damage your brand, and lose focus on your core business.
Another possibility is distancing your business from low-cost competitors by increasing performance value through superior quality, performance, and style. Companies as diverse as Intel, Research in Motion and Gillette have done this successfully for a period of time. However, in many cases it is increasingly difficult to get a good return on investment this from this strategy, particularly as the product category starts to mature. It can cost a lot to make what are, from the customer’s perspective, only marginal improvements, while useful improvements are often quickly matched by competitors. To increase performance value in ways that customers will be willing to pay for requires a deep understanding of their needs. The days when companies could simply try to “out-spec” a competitor and hope that the customer found something useful are long gone; R&D investments have to be much more focused if a company is to get a good return on these investments. In addition, more and more customers, particularly in B2B settings, are looking for proof that improved performance value will lead to improved financial results.

The third option, used by companies as diverse as P&G, Tesco, and Cisco, is to increase relational value. For example, Orica Mining Services – originally ICI Explosives – built more intimate relationships with many of its customers by moving from selling explosives to providing blasting services. It recognized that what mines and quarries wanted was rock on the ground that would meet the customer’s size specifications and facilitate further processing. To meet this need, Orica would take over the customer’s blasting activities and charge them for the rock on the quarry or mine floor that met the size specifications. As Orica developed more sophisticated models for blasting, it was able to deliver more and more of the rock in the specified size range, thus reducing waste and the need for additional processing of rocks that were too large. This created value for both the customer and Orica, and substantial barriers to entry for low cost competitors. But the journey to improved relational value is often long and difficult. Companies who take it have usually begun with a performance value proposition for their customers. In many cases, their emphasis has been on providing the best-performing, highest-quality, most reliable products. This is very different to focusing more on delivering truly integrated solutions, which requires deep and intimate relationships with customers.

Only the paranoid survive
In almost every market there is, or soon will be, customers looking for “good enough” solutions that are attractively priced. The low-cost competitors that emerge to meet this demand will eventually challenge the premium brands in the market. This threat may not be immediately apparent, but companies should not be arrogant enough to ignore it simply because initial losses are small. The sooner companies make the tough choices and start grappling with the implementation issues, the better their position will be in the long run.

Why Business Plans do not help start-ups?

It’s true that a good business plan can anchor an entrepreneurial venture. Once a company has been operational for some time, it has a well-defined value proposition, and it generates positive cash flow, a plan can help attract the necessary growth financing. The problem is that business plans are typically not helpful when ventures are in their early, formative stages. An anchor is designed to keep you in one place, which is precisely what an entrepreneur should not do. The usefulness of a business plan diminishes precipitously as an entrepreneur moves away from the original idea. In most cases, the plan is only valid when it is written.

Pierre Omydar, the founder of eBay, credits the fact he didn’t have a business plan for the success of the company. He said “eBay was open to organic growth – it could achieve a certain degree of self-organization. So I guess what I’m trying to tell you is: Whatever future you’re building … don’t try to program everything.”“Five-year plans never worked for the Soviet Union – in fact, if anything, central planning contributed to its fall. Chances are central planning won’t work any better for any of us.”

Surveys from the Inc. 500 suggest fewer than 25% of successful entrepreneurs create business plans at start-up. Those that do write them will generally stick to informal “back of the napkin” types of documents. Our own experience with high-tech founders over 15 years confirms this. But everyone from bankers and accountants to business professors and consultants say business plans are necessary. The fact is, you only need a business plan for one reason: to get financing. This brings up another important misconception. Financing is not typically a part of the early stage of a company’s creation. Banks fund assets, not ideas, and venture capitalists fund momentum and sales.

Unless you have a proven entrepreneurial track record, or you have created some kind of unique scientific breakthrough that has huge commercial potential, it will be difficult to secure financing outside a network of friends, family, and your own sweat equity.

There are numerous examples of ventures that start with minimal financing. Dell and Subway were both launched with less than $1,000. In fact, 98% of new ventures start with no venture capital or angel financing at all. Further, surveys from the Inc. 500 rank credit cards ahead of VC funding as a source of start-up capital.

All the millions that dot.com firms such as pets.com received in the early 2000s didn’t put them on the pathway to success. In fact, it probably hurt them. With money comes the temptation to spend it – on offices, people, advertising, and infrastructure – all of which takes an entrepreneur’s eyes off what is really important. Things like making sales, building networks, and improving product or services.

Business plans can be very useful in helping an entrepreneur think through the full implications of an idea. And they definitely come in handy when the time comes to pursue funding. But their negative potential as ‘anchors’ in a particular place and time mostly outstrips their benefit – particularly in the early stages.

Are great entrepreneurs born or built?

The process theoretically goes something like this: An entrepreneur has a brilliant idea, writes a business plan, gets start-up funding, puts together a team, creates a product or service, and sells out to a Fortune 500 firm. It sounds logical, but reality paints a different picture.

Let’s start with the brilliant idea. There are many stories floating around about entrepreneurs whose empires were sparked by blinding insights that occurred during some mundane activity, like waiting for a bus or taking a shower. We call this the myth of the epiphany, and the truth usually differs from the myth.

Most great ideas start out extremely rough and half-baked, and they are only chiselled into greatness over time. Howard Schultz’s flash of insight was to bring Italian coffee bistros to the United States, but in his original concept, customers stood or perched on stools (there were no chairs), listened to opera music, and were served by baristas wearing bow-ties – certainly not what a customer would expect to experience in today’s Starbucks.

Jeff Bezos had a good idea -- selling books online -- but his real insight was turning his store into a global marketplace for other people to sell their goods, even when they competed with Amazon.com’s products.

Ideas are important but they are not pivotal. We have conducted many brainstorming sessions in our classes, and the results have been intriguing. Teams of students and executives consistently come up with more than 100 start-up ideas in five or 10 minutes. Some of the ideas are absurd, but at least a dozen really good ones are generated each time we run the exercise. Ideas, as they say, are cheap.

Most great entrepreneurial ventures begin with a problem, which could be an unmet need, a bottleneck in a process, or an inconvenience. The idea is simply a solution for how to solve the problem. MIT Professor Eric von Hippel found that more new profitable lines of business came from customer complaints than from research and development departments.

A study by IMD Professor Stuart Read and colleagues suggested that it is more important to look at how successful entrepreneurs behave (what they do) than to look at their characteristics (who they are). According to this research, conducted at IMD, successful entrepreneurs consistently follow four basic principles:

1. They start with what they have: who they are, what they know, and who they know. They typically don’t worry about raising millions in seed capital or trying to figure out something new. They start close to home with something they already know and understand.
   
2. They set an affordable loss. This means that they are more concerned with how much they can afford to lose than they are with how much they can make. Most entrepreneurs only quit their day jobs after a venture has been in operation for longer than a year, sometimes much longer. In fact, surveys of the INC 500, the 500 fastest-growing private companies in the United States each year, suggest that 18 months is the typical length of time entrepreneurs take before they establish their first offices. We have personally seen this in our own interactions with hundreds of founding CEOs over the past 15 years.
   
3. They are great at taking advantage of unexpected situations. Most management textbooks regard surprises as anomalies that should be avoided or minimized. Successful entrepreneurs, by contrast, are able to adjust their strategies on the fly.
   
4. They are skilled at forming partnerships. Despite what you may think, successful entrepreneurs do not stay at home tinkering with their inventions all day long – they cannot generate sales this way. Instead, they spend a great deal of time developing and nurturing a steady stream of formal and informal partnerships.

The entrepreneurs in Professor Read’s study are  adaptive thinkers who are willing to adjust and modify their strategies based on constant feedback from a shifting set of partners. The entrepreneurs understand that failure is a part of building and developing ideas, and they are willing to switch gears when better opportunities arise.
This differs radically from the guidelines set out in most entrepreneurship textbooks. Good entrepreneurs are talented at recognizing problems, but their first ideas are usually not very good. Lucky for them, most are also tenacious – they don’t give up easily. Ideas get tested, prototyped, revised, stretched, shared, prototyped again, and then retested until they evolve into a workable form. This process is the central concept behind a new field of entrepreneurial research called effectuation, the core principles of which are about adapting your business model to opportunities as they evolve.