Co-Opetition - Adam M. Brandenburger [66]
The dungeon approach isn’t the cheapest, after all.
Private-enterprise prisons are a growing phenomenon. We suspect that there are many other public-sector activities that could deliver higher quality while at the same time saving costs. Any sector of the economy where market forces have historically been absent is a good place to look for trade-ons.
Engineering Added Value
TRADE-OFFS
1. Raise the amount customers are willing to pay by more than the incremental cost.
2. Reduce cost without reducing willingness to pay by as much.
TRADE-ONS
1. Lower costs in a way that helps you deliver a better product.
2. Deliver a better product in a way that helps you lower costs.
3. Added Value of a Relationship
You do your best at figuring out how to provide high quality at low cost. But so do your competitors. That’s the nature of competition. If there are many others who can do what you do, then you don’t have much added value.
When you don’t have much added value, you can’t sustain much of a premium over cost. You don’t make much money. It’s even worse if your business has low variable costs relative to fixed costs. Then you could well be unable to cover your fixed costs, in which case you end up losing money.
Examples of businesses with significant fixed costs come easily to mind: airlines, car rental agencies, health clubs, hotels, and restaurants. Many commodity businesses—aluminum, chemicals, oil refining, pulp and paper, and lots more—have similar economics. A common denominator is that all these businesses have to run their operations more or less independently of how many customers show up.
That by itself isn’t a problem. Some companies in these businesses do quite well. For example, the Four Seasons hotel on Nevis offers a unique Caribbean vacation; it has a high added value. But the downtown hotels—Hilton, Hyatt, Marriott, Sheraton—to be found in almost any city in the world have much less to distinguish themselves from one another. That puts all of them in a weaker position. Each has a large added value when the market is tight. But if the market gets overbuilt or demand slacks off, profits tumble.
As for airlines, they’re in a very vulnerable position. Sure, there are some routes on which one airline has a large added value. If you want to fly nonstop into Minneapolis, the odds are that you’re going to have to travel on Northwest Airlines. There are hardly any other options. But on most routes, there are several alternative carriers, and the flying experience on one isn’t that much different from that on another. Add to this the fact that there is significant excess capacity in the industry and that almost all costs are fixed, and you have a good explanation of why airlines face such a challenge making money.
Facing the biggest challenge, the airlines have been the most creative in coming up with solutions. They’ve long understood the power of engineering a relationship with customers as a way to engineer added value in a competitive market. That’s the point of frequent-flyer programs, as we’re about to see.
Creating Loyalty
The $64,000 question is how to develop a relationship. To some extent, relationships are automatic. After customers have bought from you once, next time they have a natural incentive to buy from you again, rather than from the competition. It’s simple inertia. Familiarity breeds content. That gives you some added value, but it may not be enough.
You can do more. You can actively promote strong relationships with your customers—and with your suppliers, too, of course. And even if it’s not love at first sight, you can help turn the first date with a customer or supplier into a lifelong romance.
Free Riders In 1981 the U.S. airline industry was experiencing turbulence. The market was still adjusting to deregulation. A wave of entrants—mainly no-frills carriers, such as People Express—was adding new capacity.