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Responding to Low-Cost and Disruptive Business Models: When and How

by | May 16, 2017 | Blog, Strategic Thinking

The internet has helped reduce traditional barriers to entry, enabling new entrants to burst onto the scene, forge a bridgehead into the incumbent’s customer-base, target business model weakness and erode product margins. Undeniably, this is true in many instances but not every. Sometimes the incumbent doesn’t need to respond or should respond in a counter-intuitive way to win the day.

Seasoned Business Leaders of incumbents have observed how new market entrants purposefully target their over-served customers with a lower-quality or “just good enough” offering, whilst they continue to predominantly focus on those customers that afford the best combination of volume and margin to maximise returns. The outcome? Incumbents are often slow to react and choose to respond with a price war that weakens their position and strengthens that of the new entrant. Business Leaders need to think through their options carefully before committing the company. A “no-regret” approach is needed.

A Low Cost or Disruptive Business Model

In simple terms, when a new entrant’s offering is more affordable or more convenient to a specific target audience, it can be described as a low-cost or disruptive business model. The management team deliberately chosing a different combination of the key competitive variables: price, product quality, customer focus, customer service and image to achieve a new differentiated positioning in the incumbent’s market. Commonly, but not exclusively, the new entrant focuses on customers who are paying for value they don’t need from the incumbent supplier and/or overlooked benefits. Some common characteristics are shown below:

  • Greater convenience
  • More affordable
  • Reduced quality/ performance
  • Less risky
  • Fewer features and benefits
  • Less complex
  • Simpler design
  • Less sustainable
  • Better or easier access

The customer’s perception? “I’m now paying less and enjoying the same benefits because I’m not paying for things I don’t need/ use: the same for less.”

A Framework to Help Formulate the Most Appropriate Response

  • The Business Leader should determine whether the new entrant will take away any existing or future customers? If the answer is no, then the Business Leader should take no immediate action but watch the company closely to decipher where and how the company plans to grow market share.
  • If there is a real danger the new entrant will take away existing and future customers, then the Business Leader should ask: Are sufficient numbers of existing and future customers willing and able to purchase a more differentiated product from ourselves i.e. if we enhance customer value in some way are customers prepared to pay for this? If the answer is yes, then intensifying differentiation by offering more benefits makes sense. The Business Leader should also seek to reduce the cost of providing these benefits over time.
  • If the Business Leader is confronted with a situation where customers will defect to the new entrant and are unlikely to pay for enhanced differentiation (e.g. improved product quality) then the Business Leader needs to ask: will there be material synergies from creating a new low-cost offering myself (i.e. the company competes with two separate offers: the existing and a new low-cost offer)? If there are synergies available and the Business Leader is convinced the company can ‘ring fence’ the low-cost operation, then this should be explored further as a viable response to the competitive attack.
  • If no synergies are available then the Business Leader needs to consider transforming the company by focusing on selling solutions (an end-to-end service) or becoming a low-cost company itself.

Some Key Learnings for Dual Offerings

  • Incumbents choosing to compete simultaneously with a low-cost and higher cost offering should manage the operations separately – from brand identity to working processes and systems to resources and decision making.
  • Incumbents have an advantage in having existing relationships with their ‘over-served’ customers who will be the target audience for the company’s new low-cost offer.
  • There should be a clear distinction between the two customer offerings that is underlined with a clear price differential
  • The low-cost offering is most successful when the company chooses to be offensive: having a clearly defined target customer profile and selling to everyone that meets the profile – not just existing customers ‘trading down’
  • The low-cost operation should be supported by a low cost-to-acquire and cost-to-serve-model. Management should avoid trying to replicate the existing ways of doing business because this leads to cannibalisation of sales and margin. It’s common to find profit levels in the low-cost operation are similar or higher than the existing levels, if the operation is established as a stand-alone low-cost operation.
  • Over time, existing customers that ‘trade-down’ to the low-cost operation ‘trade-up’ as their organisations grow or change. This starves the new market entrant of the oxygen it needs: revenue