![]()
CHAPTER 1
The growing challenge from low cost competitors
Every year at the International Motor Show in Geneva, automotive companies like BMW, Audi, Lamborghini, General Motors, Toyota and many others present their new cars. In 2007, executives from these companies saw a potential new competitor presenting its cars at the show for the first time. The new competitor was a Chinese company called Brilliance. Its initial sales goals for Europe were modest - 150 000 cars over five years but it also planned to enter the US market in a few years. Few Europeans or North Americans had heard of the company or the brand. The companyâs pricing in Europe looked quite attractive - the price for one of its models being almost 40% less than that of a 5-series BMW with similar specifications.
Many automotive executives might have been tempted to dismiss this threat. Brilliance had just opened its first significant production facility in 2002 with an annual capacity of about 100 000 units; clearly, it lacked the decades of experience of its major Western and Japanese competitors. Complacency might also have been encouraged by a lukewarm review in a UK automotive magazine when the first Brilliance car was launched in Europe. This low cost competitor, however, probably represented a much bigger threat than these indicators would suggest. Brilliance was BMWâs joint venture partner in China producing 3- and 5-series cars, initially from knockdown kits; they later utilized more and more locally produced parts. This experience undoubtedly helped Brilliance learn about high-quality manufacturing and quality control. It had also entered into a technology transfer agreement with Toyota. For the cars it manufactured and sold under its own brand, the company used the design services of Italian designers such as Giugiaro, who has designed cars for Ferrari.1 One of its engines was manufactured by a joint venture with Mitsubishi, a Japanese company with decades of experience in the automotive industry. Johnson Controls - a world-class player in car interiors - manufactured the car seats. And, the carsâ air bags and safety systems were developed in cooperation with TRW, a North American-based company with extensive automotive experience. With this kind of support and a very low cost structure, given its base in China, Brilliance could become a world-class manufacturer and a formidable low cost rival for European, North American, Japanese and Korean manufacturers.
However, there were some initial setbacks. Brillianceâs largest sedan, the BS6, disastrously failed a crash test in Germany in June 2007. Brilliance, with the help of a leading European engineering company, rapidly redesigned the car body and it performed acceptably on a second European crash test in late 2007. Perhaps more worryingly, the Brilliance BS6 was targeted at a market segment that was declining in sales in Europe. In addition, the car lacked a diesel engine option and a station wagon model, both of which were important selling points in this segment.2
Even if Brilliance does not achieve its initial objectives, the executives at the European, American, Japanese and Korean automotive companies can be sure that more than one of the dozens of low cost players that are developing automobiles in China and India will be a serious challenge to the industry titans. Perhaps one of these companies will be Tata, an Indian company with formidable engineering skills. Tata launched its 100 000 rupee (US $ 2500) Tata Nano in India in January 2008, with plans to start selling variants of it in other countries in the future. Perhaps another will be Chery, a Chinese manufacturer that had some early successes in peripheral markets, such as Russia and Eastern Europe.
Similar developments are occurring in industry after industry in many parts of the world. And these low cost or value competitors that offer âgood enoughâ products and services at low prices represent a large and growing challenge for executives and managers in a variety of traditional companies - those companies that tend to compete more on the basis of the performance, quality, fashion or style leadership, or on the basis of the close and intimate relationships they have built with their customers. The emergence and growth of these low cost competitors suggest that there is a tremendous appetite for low cost products and services that are good enough - something traditional companies in many industries have often been slow to recognize and to capitalize on.
In this chapter, we will begin by looking at some examples of low cost competitors in a variety of industries. While many low cost competitors are based in developed countries, an increasing number can be found in developing countries like China, India and Brazil. We will argue that it is these competitors in developing nations that represent a particular threat to Western, Japanese and Korean companies in many industries. Yet, companies that compete in the very high end of their markets sometimes feel insulated from the threat this type of competitor poses. We will discuss how low cost competitors can threaten the profitability - and even the survival - of traditional companies while at the same time actually creating new opportunities for the high-end players by opening up markets. Some executives believe the myth that the products and services provided by low cost competitors are inferior and will therefore never appeal to their customers. As we will see, this complacent and even arrogant attitude often does not coincide with the perception of many customers who see the low cost offerings as meeting their needs, although perhaps only in certain applications or for certain uses.
The threat from low cost competitors is real, and it creates a very depressing picture for some executives about the future of their companies. In many industries, however, the traditional companies are fighting back, quite successfully in some cases. Some have found effective ways to stay ahead of their low cost competitors - at least for now. The final section of this chapter features a flowchart to help the reader think through the challenge that low cost competition presents, as well as deciding how to respond to that challenge. This flowchart provides a useful introduction to the organization of the rest of the book.
THE CHALLENGE IS REAL AND IT IS HERE TO STAY
When McKinsey surveyed almost 3500 executives around the world in 2006, 85% of the respondents described the business environment in which their companies operated as âmuch more competitiveâ (40%) or âmore competitiveâ (45%) than it was five years previously. âMore low cost competitorsâ was singled out as being the most important factor contributing to this increased competitiveness by 23% of the respondents. In several industries, such as consumer products, heavy industry and telecommunications, it was identified as the single most important factor (see Figure 1.1).3
FIGURE 1.1 McKinsey survey of business executives indicated that low cost competition was increasing competitive intensity in many industries
Source: McKinsey Quarterly Global Survey of Business Execitives, March 2006.
Retailing
Wal-Mart, the second largest company in the world in terms of revenue, is a low cost retailer that dominates many retail product categories in the US, Canada and Mexico, with a smaller presence in a number of other countries. However, for almost a decade, Wal-Mart struggled to establish a strong position in Germany and finally withdrew in 2006. One of the reasons for its failure in Germany was the entrenched position of the so-called German âhard discountersâ. The major players Aldi (actually two separate companies Aldi Sud and Aldi Nord) and Lidl, and some minor players, had captured over 40% of the retail grocery market in Germany. These hard discounters, and other similar low cost competitors, had significant and growing shares of the retail grocery market in almost every European country. Across the whole of Western Europe, their market share in 2004 was 18% and they were growing much faster than the more traditional retail formats in many markets, including those outside of Europe.4 Hard discounters are not only a threat to other grocery retailers in their markets but they have become a thorn in the side of fast-moving consumer goods (FMCG) manufacturers such as P&G, NestlĂ© and Unilever. The hard discounters carry almost no, or a limited range of, branded products. Their own private label products account for most of the inventory in their stores. Given the high market share of hard discounters in several countries, many FMCG manufacturers have lost a significant degree of exposure to their potential consumers. Even worse, in some respects, has been the response that these hard discounters have provoked in the other retail customers of FMCG companies. Many of these other customers have introduced a range (sometimes more than one range) of their own private label products in an attempt to be more competitive with the hard discounters. This has resulted in the FMCG companies facing a private label challenge from a majority of their customers.
In many clothing categories, the low cost retail chains such as Zara and H&M are competing effectively with traditional, higher end manufacturers of fashion clothing like Liz Claiborne. These low cost competitors have been expanding rapidly and many are reporting very good financial results. To compete more effectively with the well-known and more expensive fashion brands promoted by Liz Claiborne and others, the low cost retail chains are increasingly introducing exclusive lines endorsed by such celebrities as Madonna and Kylie Minogue.
In all these segments of the retail market, executives and managers at the traditional retailers must figure out how to respond effectively to this low cost competitive threat. It is also a major issue for the branded manufacturers like Nestlé, P&G and Nike that supply traditional retailers and, in some cases, their low cost competitors.
Airlines
The first major low cost airline, Southwest Airlines, was launched in 1971. Two key elements of Southwestâs operating model were the use of only one type of aircraft (the Boeing 737), which simplified many aspects of its operations, and the use of a âpoint-to-pointâ system rather than the âhub-and-spokeâ system favored by many major airlines. Southwest also preferred secondary airports that often had lower charges and less congestion, which allowed planes to be turned around more quickly. Since that time, Southwestâs concept has spawned numerous airlines that have copied key elements of its business model. Today there are over 50 low cost carriers in Europe including such giants as Ryanair and easyJet, several in India and many others in major aviation markets worldwide. In Europe, where the low cost airlines have been particularly successful, well over 100 million passengers per year fly with them, accounting for about 30% of all scheduled intra-European traffic.5
The leaders among the low cost airlines are some of the most profitable airlines in the world, and they have created significant shareholder value. Southwest has been the most consistently profitable of all the large US airlines, and by at least one measure - net margin - Ryanair has been in several recent years the most profitable major airline in the world.
Executives at some of the traditional carriers have now been struggling for more than a quarter of a century to find an effective way to deal with this threat. Some approaches have been more successful than others, but the low cost carriers keep growing and expanding into new market segments, thereby increasing the pressure on the traditional players.
Banking
Modern direct banking first appeared in Europe in the late 1980s. In the UK, Midland Bank launched its 24-hour, seven-days-a-week telephone banking service (with its toll-free phone number 0800 24 24 24) in 1989. In the late 1990s, the Internet became an additional channel and, ultimately, the main channel for customers to access their direct bankâs services. ING Groep, the large Dutch bancas-surance group, has been most successful in capitalizing on the interest of many consumers in a bank that offered high interest rates on savings and low interest rates on mortgages and loans. From a successful pilot of ING DIRECT in Canada in 1997, the bank rapidly expanded its direct banking service into a number of other countries. By 2008, the bank had operations in nine countries in Europe, North America and Australasia. In many developed banking markets, such as the US, Canada and several countries in Western Europe, there are now a number of direct banks in operation.
Direct banks have had a significant impact on the industryâs competitive dynamics in several markets. Traditional âbricks and mortarâ banks, such as Citibank and HSBC in the US, have been forced to open their own direct banking services with competitive offerings to prevent further erosion of their customer bases. For ING, its aggressive entry into direct banking resulted in about âŹ700 million of before tax profit in 2006. One investment bank valued the ING DIRECT bank component of ING Groep at âŹ10 billion in 20076 - not bad for a business less than ten years old!
Fast-moving consumer goods
In a wide variety of consumer product categories, the traditional branded manufacturers are facing serious low cost competition. As mentioned in the discussion above about retailers, the hard discounters put a heavy emphasis on their private label products. Often, these private label grocery products are of high quality; in many cases, the companies that have the number three-, number four- or number five-ranked brand in a market produce them. These manufacturers have come under increasing pressure as many traditional retailers have decided to allocate their limited shelf space to the number one and number two brands and perhaps their own private label brand or brands. Many of the producers that have lost their position on traditional retailer shelves are mid-sized manufacturers in desperate need of orders to keep their manufacturing plants operating at high levels of capacity utilization. This makes them very receptive to the hard discounters who promise very high and predictable volumes on a very small number of stock-keeping units (SKUs). Some industry observers estimate that Aldi sells about 150 times the volume per SKU that Wal-Mart does giving it, and the other hard discounters, tremendous purchasing power. The quality of these products is often excellent. In independent product testing, they often match or even outperform the brands of the leading FMCG companies. While the hard discounters demand high quality and very low prices, they are usually relatively inexpensive to serve because they buy centrally on long-term contracts, need little support, want delivery in truckloads and are not interested in promotional activities. Many of the hard discounters are also loyal to manufacturers that live up to their commitments.
Consumer electronics
In Switzerland, the market leader in units for fixed line telephone handsets sold to consumers in 2007 was not Swisscom (the leading Swiss telecommunications company), Panasonic, Siemens or Sony but a small Swiss company called Telgo - operating under the brand name of Switel. Telgo was launched in 2001, and it soon became a leading supplier in Switzerland of both fixed line handsets and a variety of other related consumer telecommunications products; it also began expanding into other European markets. The company takes advantage of new technology and has been quick to enter new emerging product categories such as Voice over Internet Protocol (VoIP) telephone handsets. It is a low cost competitor and, according to its CEO, it is perceived as the market leader in its home market in terms of âvalue for moneyâ. 7 It has strong relationships with a number of major retailers, and the Switel product is often their âvalueâ line in the product categories in which Switel competes. While its sales and product line have expanded quite rapidly, Switel has been able to accomplish this with only about a dozen employees. Most of the development and all of the manufacturing is outsourced to partners in Asia. We will discuss in Chapter 2 how the appearance of focused companies that specialize in innovation, product design and infrastructure activities, such as manufacturing and logistics, has allowed small companies like Switel to focus on building relationships with customers. Sometimes these small players have grown into significant forces in the markets in which they compete. The extensive outsourcing has allowed Switel to grow very rapidly, and in the product categories in which it operates, it is a significant competitor for large global companies such as Philips, Panasonic, Sony and Samsung.
In North America some of these same leading consumer electronics companies are being challenged with regard to LCD flat-panel TVs by another competitor Vizio. In early 2004 Vizio was a six-person company with sales of less than $ 20 million per year. By the last quarter of 2007 Vizio had annual sales of almost $2 billion and had captured 12.4% of the US LCD TV market, just behind Sonyâs 12.5% and Samsungâs 14.2% market shares. Again, Vizio managed to do this by working very closely with a focused manufacturing partner in Asia, who had also bought an equity stake in the company.8
Business-to-business products and services
The threat posed by low cost competition is at least as strong in many business-to-business product and service categories as it is in business-to-consumer categories.
One industry being threatened in a number of product categories is the chemical business. Not surprisingly, for many of the commodity chemical products the low cost challenge is coming out of the Middle East and other regions with access to very low cost energy and feedstock. But the challenge is also strong, and growing, in specialty chemicals and pharmaceuticals, which have traditionally been dominated by European and North American manufacturers as well as those from the most developed Asian economies. These companies have invested heavily in research and development to create unique, patented products. In some cases, considerable process expertise is required to produce these products efficiently and to meet the demanding quality standards of their customers. However, some of these companies are...
