Loyalty Programs: A Defense Against New Competitors

Loyalty Programs: A Defense Against New Competitors 
by Michael Hurwich, President SPMG

Loyalty Programs generally help boost customer retention,

The following case study is a composite made up of the actual experiences of several companies that have adopted loyalty based pricing programs. It has been written to provide an example of a successful program while maintaining the confidentiality of the companies involved.

BACKGROUND

COMPANY (A), a dominant force in the high technology industry, was facing the entrance of a new competitor (Company D). At the time, there were two other significant players in the industry, and while (A) enjoyed a 75%+ market share, some customers were showing signs of dissatisfaction. Complaints that (A)’s dominant position in the market had led to arrogance and an inflexible attitude were becoming more frequent. Indeed, many buyers made no attempt to hide their enthusiasm for the impending entry of a new competitor for Company A. Against this backdrop; (A) began to search for a pricing strategy to defend itself from possible market share erosion while maintaining profitability.

THE DECISION TO LAUNCH A LOYALTY PROGRAM

            

In the search for a defensive pricing strategy, Company A explored the feasibility of implementing a loyalty program. While management was wary of the amount of time and resources that would go into implementing a loyalty program, they also recognized that a loyalty program might be their best defense against the new competitor, for several reasons.

For starters, a loyalty program would send a strong signal to customers that (A) was prepared to recognize and reward their loyalty in the face of new competition. This was an especially important message to communicate, given (A)‘s reputation for arrogance and inflexibility.

            

Management also realized that a loyalty program could be a tactic where pricing details would not be readily transparent to competitors. A loyalty program would thus be unlikely to incite immediate price retaliation from the new entrant. In addition, if successfully executed, the program would provide a long-term competitive advantage to (A) by discouraging customers from diverting business to the new entrant. Finally, management concluded that if they did not implement a loyalty program, the new entrant might.

            

The advantages of being first in an industry to implement a loyalty program are usually enormous. Once a customer has made a commitment to a particular program, it is often difficult to dislodge the customer‘s loyalty. (Consider how often members of a particular frequent flyer program go out of their way to fly with ”their” airline.)

DESIGNING THE LOYALTY PROGRAM

One of the first steps taken by Company (A) in designing the loyalty program was to hold a brainstorming session with the sales force to determine what products or services offered by (A) were highly valued by its customers and, at the same time, not replicable by any of its competitors. During the brainstorming session, the group identified (A)‘s breadth of product offerings as key to implementing a successful loyalty program. In essence, (A) was the only significant supplier of a full systems solution, encompassing both hardware and software. By leveraging off this dominant position, (A) management felt it could also promote customer loyalty.

PARAMETERS OF THE RPOGRAM

The program provided customer discounts based on three major criteria:

·         Percentage of (A)’s product bought relative to purchases from the competition

·         Volume purchased of a single product

·         Number of different products purchased.

THE RESULTS

This loyalty program was a tremendous success for Company (A). Not only was the potential erosion of both margin and sales halted, but many current customers actually increased their purchases. Moreover, although other competitors – including the new entrant – attempted to introduce their own loyalty programs, (A) had achieved the dual advantage of being first in the industry to implement a program, and designing a program based on features that were very difficult for competitors to copy.

 

Buffett Says Pricing Power More Important Than Good Management. By Andrew Frye and Dakin Campbell - Feb 18, 2011 12:00 AM ET www.bloomberg.com

Buffett Says Pricing Power More Important Than Good Management

ARTICLE FOUND ON WWW.BLOOMBERG.COM - Feb 18 2011

Warren Buffett, the billionaire chief executive officer ofBerkshire Hathaway Inc., said he rates businesses on their ability to raise prices and sometimes doesn’t even consider the people in charge.

“The single most important decision in evaluating a business is pricing power,” Buffett told the Financial Crisis Inquiry Commission in an interview released by the panel last week. “If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”

Buffett, 80, accumulated the world’s third-largest personal fortune through a career of stock picks and takeovers. He has bought companies such as railroads and electricity producers, whose pricing power stems from a dearth of competitive options available to clients. Buffett has also built stakes in firms like Coca-Cola Co. and Kraft Foods Inc., which rely on the appeal of their brands to attract and keep customers.

“The extraordinary business does not require good management,” Buffett said in the interview, which was conducted on May 26 in Omaha, Nebraska.

The FCIC investigators focused on Buffett’s investment in Moody’s Corp., the bond-ratings firm blamed by lawmakers for handing out inflated credit grades during the housing boom. Buffett said he held stock in Moody’s because the company’s leading market share, along with that of rival Standard & Poor’s, a subsidiary of McGraw-Hill Cos., gave the two firms flexibility in setting prices.

Pricing Power

“I knew nothing about the management of Moody’s,” said Buffett. “If you own the only newspaper in town, up until the last five years or so, you had pricing power and you didn’t have to go to the office.”

A dominant position can’t prevent a bad manager from destroying a company over time, said Benjamin E. Hermalin, a professor of economics at the University of California, Berkeley’s Haas School of Business.

“If you have a really dominant position you can survive for quite a long time with bad management but eventually it will catch up to you,” said Hermalin. “In the short run I would agree with Buffett but in the longer-run perspective there is something to be said for having a good manager.”

Burlington Northern Santa Fe, the railroad Buffett bought last year for $26.5 billion, owns more than 30,000 miles of track across the U.S. West connecting producers and distributors of coal, grain and consumer goods. Omaha-based Berkshire’s power company, MidAmerican Energy Holdings Co., sells electricity to homes in the Great Plains and transports natural gas fromWyoming to California.

Praise From Buffett

Buffett routinely singles out and praises managers from Berkshire’s more than 70 operating companies. MidAmerican Chairman David Sokol and Gregory Abel, the unit’s CEO, are “two terrific managers,” Buffett said last year in his letter to shareholders. The acquisition of Burlington Northern had the “additional virtue” of bringing the railroad’s CEO, Matthew Rose, to Berkshire, Buffett said.

Buffett criticized Kraft Chief Executive Officer Irene Rosenfeld last year for her takeover of Cadbury Plc and the sale of the foodmaker’s pizza brands. “Both deals were dumb,” Buffett told Berkshire investors in May. Berkshire is the biggest shareholder of Kraft with a stake valued at $3.3 billion at the end of December.

“In the short run, good management can make a stock pop but I follow what Warren’s saying, especially because his point of view looks at the fundamentals,” said Terry Connelly, dean of the Ageno School of Business at Golden Gate University in San Francisco, and a former managing director at Salomon Brothers. “Good management can’t do anything with a bad case.”

Pricing Czars vs. Institutionalized Pricing Strategy

Pricing Czar vs. Institutionalized Pricing Strategy 
by Michael Hurwich, President of SPMG

PRICING Czars. They sit in their offices, colossus' spanning the universe. Salespeople telephone them begging their indulgence as they present their deals – deals which could make or break performance bonuses and incentives. Discounts are requested, competitive information reviewed, special requests are considered and then, with pontifical certitude, a decision is rendered.

Anointed by the CEO, a price czar is the absolute final arbiter on any deal done on a day-to-day basis. Ideally, the czar is a competent and benevolent despot who will advance the cause of the organization.

Often they emerge within an organization over a number of years and are generally acquire considerable experience, a track record of selling success, and an intimate knowledge of customers. Eventually, by virtue of history, the organization turns to him or her, time and again, whenever a tough decision has to be made on a specific deal. This pattern can become so widespread and routine that the individual, de facto, becomes a pricing czar.

Sometimes the position is institutionalized by the CEO and the power to finalize deals is formally granted. This requires the absolute trust of the Chief Executive because any overturned decision has the potential to undermine the authority of the czar, perhaps irreparably. A successful pricing czar requires the absolute respect of the sales force; otherwise this individual can significantly demoralize their efforts in the field.

Advantage:

There are a number of factors to weigh when an organization is considering institutionalizing a pricing czar. The big attraction is that it provides a simple, quick fix to an often-chaotic pricing situation. The pricing environment is generally characterized by a lot more deal making, special off invoice discounts, and special service requests. If these special arrangements are not managed properly, pricing can quickly spiral out of control and result in an overall collapse of profitability. Rather than investing in the monumental task of installing sophisticated internal and external-tracking mechanisms supported by adequate controls, it is tempting to turn to “good old Charlie” who has been with the company since the dawn of civilization and make him a pricing czar. 

Drawbacks:

There are drawbacks to this position. 

1. Evaluation

One of the immediate ones is evaluating the performance of a pricing czar. No company has ever structured a test whereby half the deals are turned over to a czar and the other half are managed through a more sophisticated systems/management structure. So a lot of faith is required in the setup to sustain it over time.

2. Disconnect

A further difficulty comes when the organization wants to take a new direction with its overall marketing strategy. Often it will become apparent that brand managers, who develop the price positioning strategies and have ultimate profit responsibility, are not in control of, or possibly even aware of, the actual prices being paid in the marketplace. They quickly come to learn the limitations of developing marketing strategies with only three of the “4 Ps” at their disposal.

3. Continuation

With all of the knowledge and decision-making resting with one person, another problem is inevitable: what to do upon the czar‘s departure. Many organizations have gone through wrenching transitions after losing their czar, because new systems and controls require significant time and effort to design and implement. As an additional hurdle, the overall approach to pricing may have become so individualized to the czar, it cannot be replicated. The alternative to a pricing czar is to institutionalize pricing strategy.

Institutionalizing a pricing strategy 

Institutionalizing a pricing strategy provides the context and guidelines for day-to-day decisions. This requires comprehensive customer research and tracking, detailed financial analysis, competitive positioning, and a careful tie-in to business objectives. In addition, if the strategy is communicated effectively it will, in and of itself, improve organizational pricing performance.

To ensure the strategy becomes ingrained and that positive results are maximized, it should include a policy outlining the steps to be taken in determining and negotiating prices, the assignment of responsibilities, and a definition of the organization‘s pricing objectives. Measurement mechanisms must then be installed to monitor performance and keep the organization on track.

With these elements in place, an institutionalized pricing strategy can have dramatic impact on the bottom line, much more than the reliance on a pricing czar. The czar may be a good stopgap when an organization is scrambling, but a firm should invest the resources for the long term to build and execute a sound pricing strategy.

Price leader or price follower? Each has its merits.

Price leader or price follower? Each has its merits.

by Michael Hurwich President of SPMG

If the terms ‘cut-throat’, ‘bitter rivalry’, and ‘open warfare’ describe the state of price competition in your industry it is more than likely that several competitors are challenging each other for the role of industry price leader.

The problem, of course, is that in most industries market share competition is a negative-sum game. There can be only one leader, and until that leader is firmly established, price instability and continual downward pressure on industry margins will persist.

For organizations that optimize their role as leaders or followers, profitability can be dramatically improved by understanding the differences between the two stances.

As the name implies, price leadership involves establishing price discipline in the marketplace while followship means optimizing position behind the price leaders.

While the leadership role may sound like a highly desirable position for any firm to occupy, the fact is that attaining price leadership is expensive, and will only be successful if the leader has a perceived superiority for its products or services in the minds of industry buyers.

Perceived superiority can come from many sources, such as a unique brand image, technological advantage, or high levels of customer service.

Regardless of how it is achieved, perceived superiority creates brand loyalty and lowers the price sensitivity of buyers and this is a foundation of price leadership.

In most but not all industries, the price leader is also the market share leader. For example, Procter & Gamble holds both these leadership positions in many of the markets and categories in which it competes.

Note, however, that market share leadership is not necessarily a prerequisite for price leadership. In fact, in some industries, perceived superiority may require a perception of exclusivity, which is incompatible with a high market share.

Leadership strategies

Successful price leaders employ three key devices to protect their leadership status. Firstly, leaders can exercise their clout over industry buyers to raise the industry price ceiling. In raising the ceiling, the price leader can rely on brand loyalty to minimize customer fall-off. Nevertheless, the leader must be prepared to “bite the bullet” and refuse to budge in the wake of protests from buyers, even at the risk of losing a sale.

The second lever at the price leader’s disposal is the ability to demonstrate discipline to competitors who attempt to undercut them in the marketplace. The key here is to ensure that the demonstration is sufficient to convince the errant firm that challenging the leader does not pay.

Not surprisingly, in order to be effective, the demonstration of leadership can also be expensive. The cost to the price leader of temporarily reducing the price of a leading brand over the disciplinary period can exceed fifty percent of the contribution margin.

The final tool available to the price leader is the communication to the industry at large of the commitment to remain in the role of price leader.

Typically, successful price leaders clearly communicate their intention to retaliate vigorously against any competitor who refuses to follow their lead. One of the most effective methods of communicating this commitment is to establish a pattern of consistent behavior, since past behavior is normally used by competitors as an indicator of future actions.

While price leadership may not entirely define the battleground upon which the competition will be fought, it does identify one weapon that is off limits – price.

Price leadership also implies that the price leader will not use price in response to non-price threats to the leader‘s market share. For example, a price leader will not use price to respond to a competitive line extension or to a successful advertising campaign.

A “tit-for-tat” approach is usually established whereby competitive initiatives are met by appropriately related responses.

An alternative approach

Price leadership, if executed properly, can improve long-term profitability, but as stated before, leadership is expensive to achieve and maintain. Clearly, the strengths required to be the price leader are not always available to every company.

For some, a much more profitable alternative is to pursue a price followship strategy.

Where price leadership entails establishing price discipline, price followship involves a willingness to operate within the established boundaries.

The term “followship” may be repellent to those companies with an intensely competitive spirit and a sales-driven culture. Be assured, however, that price followship is not a “roll over and play dead” strategy. Rather, effective price followship involves an intelligent, disciplined commitment to maximize profitability.

·        The successful price follower is guided by these principles:

·        Match but do not undercut the pricing set by the price leader.

·        Refrain from using tactics that encourage the leader to respond with price.

·        Follow and openly support the leader‘s price increases.

·        Ensure that your pricing strategy is clearly understood by the leader and other competitors.

It is interesting to note that although price leadership and price followship are two very different strategies, the most effective action in executing both strategies is to establish a pattern of consistent behavior.

In the case of the price follower, consistent behavior would involve establishing a track record of such moves as matching but never undercutting the leader‘s prices, and never pursuing one of the leader‘s key customers through price.

It would be naïve to think that a company wishing to make the transition from a would-be price leader to a price follower would be able to do so overnight. It is likely that in the short-term other competitors, especially the price leader, will not trust the firm to behave like a follower, particularly if there is a history of bitter competition in the industry.

Moreover, from an organizational culture perspective, the shift to price followship can be a difficult strategy change, particularly in organizations that are traditionally sales-driven.

The payoff, however, of becoming a successful price follower can be enormous. After all, there can only be one price leader in any industry–and only a handful of companies have the resources and the abilities to be the leader.

For other firms, focusing on increased profitability by being a successful price follower surely makes more sense than continually provoking the price leader with vain attempts to overtake it.