Business Strategy Blog

Spirit Successfully Pulls Off a "Ryanair" in the US

According to the  WSJ, (download pdf here: Download Spirit) Spirit Airlines, the ultra-low-cost carrier that derives its inspiration from Ryanair in Europe, is now the most profitable airline in the U.S. (on a per-plane basis). In fact, Spirit's market valuation is nearly the same as that of US Airways, an airline that is nine times the size of Spirit! How does Spirit achieve this? A combination of low costs + high fees!

Over 30% of Spirit's revenue comes in from fees for baggage and other services (even water is not served for free aboard Spirit), compared to 6% on average for the industry.  In fact, Spirit recently announced that it would start charging $100 for a gate-checked carry-on bag (you read that right!). I would think that initiative would probably help them by providing an incentive for passengers to pay the check-in bag fee early, and thus avoid having to gate-check their bags, which would end up speeding up the boarding process, and reducing turnaround times for their aircraft.

PS: I made the mistake of flying them once - never again!

Image courtesy: www.politicalcartoons.com

Zip It!

Many of you may have noticed the term "YKK" on the zippers used in many of our clothes. I have often wondered what this term stands for, and also who exactly is the firm that makes these zippers. Turns out that YKK, which stands for Yoshida Kogyo Kabushikikaisha, has more than 50% market share in the zipper industry (annual volumes of more than 7 billion zippers!). One would think that zippers are largely commodities, so there should be rampant price competition (with buyers asking for a base level of quality).

According to this piece in Slate, YKK has managed to maintain dominance of this market by providing very high levels of consistent quality and quick turnaround times - how does it achieve this? It is not really clear! They are fully vertically integrated and their "secret sauce" seems to be well protected. 

The buyers (usually production managers at apparel firms) are not that price-sensitive - the cost of a zipper (30 cents) is miniscule compared to the cost (and esp the retail price) of an average garment but it is crucial that it works reliably (you dont want your zipper to break down at work, or at home for that matter!). While the market has a lot of cheaper options available, none of them offer the same reliability that YKK offers. I suspect this enormous scale implies YKK has a cost advantage as well (possibly scale economies in purchasing and maybe manufacturing), but clearly the firm is able to charge a premium due to its differentiation based on quality and reliability. 

Is YKK a "vertical architect" like Coke or Intel? Probably not - end-buyers dont base their apparel buying decisions on the brand of the zipper, so there is little "demand pull" (pun unintended!). However, YKK clearly captures value owing to its reputation of being able to produce reliable, high-quality zippers. 

An interesting read throughout.

Barriers to entry for online businesses: is it time for Pets.com 2.0?

Pets.com is one of the pet (!) case studies of b-school profs looking to illustrate the (failed) economics of online businesses started during the initial years of the dot-com boom. Why then are folks trying to resurrect this business model and looking to get back into selling pet food online? This article (download pdf here: Download Pets.com 2.0) argues that one of the reasons why such businesses are seeing a rebirth is that the barriers to entry (in the form of fixed costs) have gone down substantially. 

For example, firms are now able to use Amazon's cloud services rather than set up servers of their own. The cost of marketing has gone down with the increased effectiveness of internet based marketing. Plus, with the increased penetration of broadband internet in the US, the PIE for this industry (and other online businesses) has likely gone up. 

All that being said, some of the critical limitations of this business (selling pet food online) persist - like the high cost of shipping - so the amount of value capture presented by this industry might be somewhat limited.

Mattress Wars!

This great article (download pdf here Download Sealy nyt) on rivalry between mattress manufacturers Sealy and Simmons touches on a lot of interesting concepts we have discussed in the course till date. Mattress manufacturing is a fairly concentrated market with the top four firms making up nearly 60% of the market.  For a long time, this has led to fairly "soft" competition with price not being much of a factor at all. 

Price comparison was close to impossible, as the major manufacturers called the same models by different names at different retailers. And mattress companies rarely advertised directly, since retailers demanded ad dollars from them for their own circulars or promotions.

However, with new entrants coming in, and the increased prevalence of comparison shopping among consumers (aided by the internet), the industry has been experiencing a greater degree of price competition.

In addition, there is an interesting element of value chain management as well: mattress retailers used to be very powerful as they completely owned customer relationships and influenced purchases (consider the similarity here between the role played by the retailer in this industry and the reseller in the Dell case in terms of influencing buyers). 

New entrants (like Tempurpedic) have poured money into advertising targeted heavily at end-users (creating end-user demand for their products) and have started selling direct in order to mitigate influence of retailers. These brands are also focused a lot more on differentiation enabling them to support higher prices.

They introduced new technologies, sold directly from their Web sites, and used the same model names at various retailers. They also poured money into television advertising, encouraged research and charged more than $2,000 for many beds

Overall, this is a great example of how many of the concepts we touch upon in class are widely applicable across various settings.

PS: Just to give you some more incentive to read, this article is a nice example of the type of "mini-case" that is usually used in the exam (midterm or final) :)

A great example of creating a strategic barrier to entry

Here is an interesting Wall Street Journal article (download pdf here: Download License) on the growth in licensing requirements across occupations and how this has been driven by the lobbying efforts of incumbents (i.e. industry associations). Why would occupations want to be licensed? Here is the economic view (from the article)

"Occupations prefer to be licensed because they can restrict competition and obtain higher wages."

Licensing enables supporting higher prices (by making it harder for new firms to enter). A study cited in the article found that licensed workers earn, on average, 15% more than their unlicensed counterparts in other states. Clearly, it can make the industry quite attractive for incumbents

"If you go to any statehouse, you'll see a line of occupations out the door wanting to be licensed."

The clincher is that these regulations often exempt existing providers (incumbents) from being subject to these requirements (emphasis below mine).

"In Michigan, for instance, it will soon be a felony to practice massage without a license. Newcomers to the field must take 500 hours of classes and pass an exam to get that license. But a grandfather clause exempts most current massage therapists, including those who may never have taken a class at an accredited school."

Clearly, this action by Incumbents raises barriers to entry and makes the industry more attractive to them - now that is a great example of an Endogenous (or Strategic) Barrier to Entry.

How much does Industry Matter?

As discussed in class, only part of the variation in profitability across firms is explained by industry effects - in other words, we see a lot of variation in profitability even across firms within the same industry, and industry analysis is limited in its usefulness in explaining this phenomenon. One of my colleagues at the Strategy department here at Anderson, Richard Rumelt, was one of the early thought leaders in helping to establish the importance of firm strategies in determining variation in firm performance.

In a lovely blog post, he details how he came upon this idea in the first place (many years ago) and his attempts to get his research published and accepted by his academic peers. Makes for a great read!

PS: If you havent read it already, I would also highly recommend getting a copy of his latest book, "Good Strategy, Bad Strategy"

Independent Bottlers to play larger role at Coke

In an announcement timed to coincide with their first-quarter earnings results, Coke said yesterday that it is going to increase the role (Download article:  Download Coca-Cola Unveils New U.S. Bottler Deal - WSJ) played by independent bottlers in distributing its beverages. This was seen as the first step towards ceding greater control to its franchisee bottlers, which would allow Coke to reduce the impact of the asset-intensive bottling business on its financials.

As we had discussed in class, recall that Coke (and Pepsi) had purchased their biggest bottlers just over a couple of years ago. The reasoning behind that move was to re-consolidate the bottling business which had become inefficient over the years, and to present a more unified front while bargaining against retailers. Also, the existing bottling franchise system was ill-equipped to handle the distribution of newer non-carbonated beverages (which have registered the strongest growth in the recent past) forcing Coke to use other third-party producers to handle them. Over the years, Coke has been working on bringing those drinks in-house as well and is now on the path towards eventually giving independent bottlers control of distribution again. 

Thanks to Manish, Erika and David for forwarding this article!

Managing partners in one's value chain: Netflix vs. Comcast

 

Over the last few years, Netflix has seen a surge in its base of "streaming" customers, with the latest figures indicating that the company has thrice as many streaming subscribers as as DVD subscribers in the U.S. (Of course, quite a few subscribers, myself included, have both options at the same time, so I am not sure how this figure accounts for those). This rapid growth in streaming has increased the importance of the role played by ISPs such as Comcast in Netflix's value chain - think about Comcast as being the "retail/distribution" outlet for Netflix, in a sense.

With Comcast now entering streaming in a big way through Xfinity (in direct competition with Netflix - download WSJ article Download Comcast Takes Aim at Netflix - WSJ), that clearly drives up Comcast's bargaining power vis-a-vis Netflix. The latest chapter in this battle comes in the form of Netflix CEO, Reed Hastings' public complaint against Comcast for favoring its own service, Xfinity, over rival streaming services (such as Netflix) when it comes to imposing bandwidth caps. In other words, if you were to watch a program through Netflix on Xbox 360, then Comcast deducts the data used against the user's monthly allotment (of 250 GB). If you watch it using Comcast's own Xfinity service on Xbox 360, this does not count against your data cap.

Thinking back to our discussions on value chains, this is a situation where a firm needs to manage its downstream partners in a way that maximizes value creation, and also value capture. How would a successful vertical architect handle this situation? Clearly, one option for Netflix to increase its power in the value chain is to create more "demand pull", i.e. create a strong demand for Netflix among end-users who may start switching ISPs if they run up against Comcast's data caps. Netflix's efforts to increase the size of its streaming video library and its push to create original and exclusive content (e.g. the recent hit series "House of Cards" as well as the May release of new episodes of Arrested Development) should all help in this regard, but are probably longer-term fixes.

In the short-term, Netflix is also turning to the powers of lobbying to ensure that its voice is heard in the debate on net neutrality.

Is this a losing game for Netflix? The next few years will tell.

Image courtesy witproductions.wordpress.com

Pizza Wars!

 

Following in the footsteps of Cola Wars, presenting Pizza Wars from Manhattan! Here is a great article( download pdf here:  Download Pizza) from the NYT that illustrates price competition between two neighboring pizza joints in Manhattan. The outcome is very different indeed from what we saw in the rivalry between Coke & Pepsi - the firms are slowly sinking into a price war with prices falling by 50%. Why do you think outcomes are so different here when compared to the Cola wars case?

Is there any way out of the price war for these guys? It looks like at least one of the two firms seems to recognize that the situation needs to be rectified:

For his part, Eli Halali made it clear that 75 cents was a temporary price point. He said he could not make money at that level and eventually would return to $1. He said that if Bombay/6 Ave. Pizza went back to $1, he would as well.

However, that is easier said than done. In fact, things could take a turn for the worse

“We might go to free pizza soon.”

Eli said: “We have enough power to wait them out. They’re not going to make a fool of us.”

A classic case of rationality taking a backseat to emotion (Escalation of commitment, maybe?)

Note how the history of interactions plays a key role - when we discussed the interactions between Coke & Pepsi, we made a note of how they understood each other's strengths and weaknesses very well based on their long history of competing against each other. That clearly doesn't hold here!

Any thoughts on what these firms can do to get out of this competitive death spiral?

 

 

On Bargaining and Shelf Space

 

On the subject of colas, this article neatly illustrates the tug-of-war that goes on between different players in the value chain when it comes to bargaining. Clearly, Coke & Pepsi derive bargaining power vis-a-vis retailers based on their strong "demand pull" (i.e. the extent to which end-buyers demand coke & pepsi to be stocked in stores) but as we discussed in class, shelf space is another important factor in this game! Coke products returned to Costco eventually, but this incident sheds light on the intense price negotiations that go on behind the scenes!

Apparently, relations between Coke and Costco are still sour, probably explaining Costco's recent move to switch Coke for Pepsi in their food courts. Remember we discussed the buying power of the "Fountains" channel in class - the manifestation of that is clear according to this quote in the article

As BevNet points out, this could be a huge coup for Pepsi, which never seems to be able to catch up to Coca-Cola’s market dominance. Even if the company makes little to no profit on the deal, it will be putting 31 million more gallons of its beverages in the hands of consumers each year