How to win a commodity business war (without resorting to price)

Okay, so you’ve realised your business is in a good place- it’s building a product people clearly want and it’s growing rapidly. The problem? What you’re selling is a commodity and other companies are hot on your heels selling the exact same thing. You tell yourself it’s not the ‘exact same’, you have ‘extra features’ that differentiate you, you have a better design or some other thing like that, but deep down you know you’re just splitting hairs, and that effectively you’re just Expedia and Priceline, and for all the multiple brands you own and market, you’re just selling the same airline tickets and hotel rooms. What do you compete on here?

First things first: Pricing

The golden rule: You don’t want to be competing on price. Not because you can’t. In fact it’s probably the most effective way. Walmart built one of the most enduring retail empires of all time based on it. But because price is easy and it hits you where it hurts the most (your margins). You already know that if you have lower prices than your competitors you’ll attract more users. You didn’t need to read this post to find that out.

Charlie Munger finds the whole conundrum a real head scratcher:

If it’s a pure commodity like airline seats, you can understand why no one makes any money. As we sit here, just think of what airlines have given to the world—safe travel, greater experience, time with your loved ones, you name it. Yet, the net amount of money that’s been made by the shareholders of airlines since Kitty Hawk, is now a negative figure—a substantial negative figure. Competition was so intense that, once it was unleashed by deregulation, it ravaged shareholder wealth in the airline business.

Yet, in other fields—like cereals, for example—almost all the big boys make out. If you’re some kind of a medium grade cereal maker, you might make 15% on your capital. And if you’re really good, you might make 40%. But why are cereals so profitable—despite the fact that it looks to me like they’re competing like crazy with promotions, coupons and everything else? I don’t fully understand it..

At the risk of explaining something Munger feels he doesn’t ‘fully understand’, my take is: When price is your only differentiator, that’s what you’ll compete on. Any kid in America will tell you there’s a world of difference between Cinnamon Toast Crunch and Reese’s Puffs. It doesn’t matter that they’re both cereal, with about the same amount of sugar, retail right next to each other, and cost roughly $4 a box. When you want one, you want THAT one. (The real head scratcher to a Reese’s Puffs guy like myself is who would ever choose Cinnamon Toast Crunch, but that’s probably an investigation for another time). Versus, a seat on Delta is pretty much the exact same seat on United or American, and long as they’re going to the same city the average buyer pretty much cares about how much it’ll cost (time sensitive frequent flyers exempt ofcourse).

Now anything can change in business and Munger said this in 1994 and a quarter of a century later airlines in America M&A-ed to the point of being more profitable than ever (with sizeable Berkshire holdings in almost all of them), while changing attitudes towards nutrition and sugar means that traditional breakfast cereal revenues are in a gradual decline. But airline seats are still commodities that primarily compete on price, so what changed? Here’s my thoughts on the ways to compete and differentiate in a commodity market beyond the obvious sticker tag:

Switching Costs
It might be cheaper and better for someone to use your competitor’s service, but inertia hits hard in the business world. And there’s no better form of inertia than switching costs. This could be anything: Spotify already knows your music taste, not being able to take your number with you to a different phone carrier, too lazy to fill in your billing and shipping info on a new ecommerce site when it’s easier to just buy from Amazon, this new CRM seems promising but you remember what a pain the last integration was and don’t want to deal with another migration, or you’re just too comfortable with your iPhone’s interface to want to deal with the Android learning curve. If your product’s built right your user will be letting go of a lot that they’ve invested just in their regular use of your product. And if you’ve truly done it well, the pain of switching compounds the longer someone uses your product (eg: your Netflix recommendations get better over time).

Most products are serving a simple utility, and overwhelmed with choices most consumers have a ‘If it ain’t broke, don’t fix it’ mindset to their purchases. This also consequently means that any new entrant to a market doesn’t just need to be better than the competition, it needs to be so much better that users are willing to go over the Activation Energy required to start using this new product. [The Activation Energy required for new products needs its own separate post (something I’ll eventually get to) but if you remember your AP Chemistry, you probably already got the gist of it].

Infrastructure Advantage
You think you make a better burrito than Chipotle? Get a food truck or set up a shop and you’re in business. But think you can do FedEx better than FedEx? Well it probably won’t matter because most people will never have the funding and scale to truly compete and build a rival shipping and logistics business. This is why cable companies have been so entrenched despite seemingly everyone hating them- maybe you have a better mousetrap than Comcast but who’s going to lay all the new cable/fiber/network, pony up all the cash to get licensing rights to distribute channels, and invest in all the engineering and overhead that comes with running a cable company and servicing millions of users? This is why Tesla was only the first US carmaker to go public in more than 50 years. Many have had ideas for better cars since then, but most haven’t been able to put together the capital, engineering talent, production facilities, distribution networks, and consumer desire; all at the same time.

Infrastructure advantages at scale are also historically one of the most easily understood differentiators in commodity products, and the main reason the Vanderbilts of the world rushed to be the first ones to lay down railroad tracks in new territories during the Gilded Age. But it doesn’t just hinder potential new entrants: big CapEx outlays act as a natural bulwark against current market competition too. The recent ski resort wars between Vail Resorts and Alterra Mountain Company has a very clear message to every mom-and-pop owned ski resort: If you can’t afford to keep up with our expansions, lift investments, and cheap season pass prices, your options are basically down to joining our alliance or getting bought out by a private equity shop (who’ll probably turn around and eventually sell you to us anyway).

Network Effects
The rise of social networks have made network effects one of the easiest competitive advantages to understand. Airbnb seems like a simple business- get people who want to rent out their place to list on your site for free. In a certain way, this was already happening, from timeshares to vacation rentals to furnished apartments to Craigslist sublets. But aggregating all of these niches on a single platform breeds a whole new set of advantages: Everytime someone rents they get a site-specific score, and so overtime the platform evolves from renting rooms to complete strangers to renting to verified users with a history of previous stays and positive host reviews, de-risking and reducing friction (and thus adding value) on each side of the transaction. And so today even if the host could get $10 extra per night from a guest from another source, most would prefer the ‘verified’, peer-reviewed, liability insurance covered, Airbnb guest.

If you ever remember saying the phrase ‘It’s Verizon to Verizon, it’s free’, you remember the literal embodiment of network effects, and how hard it was for a third phone carrier to break through, how expensive the AT&T-Verizon duopoly was for consumers, and the pain of aligning your significant other with the correct phone network. (To international readers or those under 20: In the ancient days of not having unlimited cellphone minutes (and even texts), you actually had to care about what mobile network your friends/family were on because in-network communication was usually free while out-of-network was metered, thus making you much more likely to choose the phone network the people around you were already using).

With everyone from HBOGo, to a renewed Hulu Plus, and now a new Disney offering, it’s the perfect time to revisit this: You can start a million Netflix rivals and they can be everything from cheaper to a better streaming experience, but what any potential showdown will come down to is this: which one has the better content? (the proverbial ‘Content is King’). [Amazon and Netflix both realise this too of course, which is why they’ve been pouring billions into original programming they’ll own forever rather than always be on the hook for shows they’re not sure they’ll be able to renew]. You might be in a commodity business (and when everyone has access to the same media, it IS a commodity), but not all commodities are distributed or available evenly.

On the local level this can be a rival car dealership locking up an exclusive deal with Toyota in a 10 mile radius. And on a national scale this is all of us suffering through TicketMaster each time we need a ticket to a mass market event- ticketing platforms might be a dime a dozen, but when only one of them has official NFL tickets, that’s what most fans will turn to.

Increasing Marginal Utility
Yeah I could stay at the Hyatt Regency, arguably slightly nicer and more convenient than the Westin I ended up booking, but if I’m two Starwood nights away from unlocking Platinum status I wouldn’t think twice about it. This is why hotel loyalty programs have been a massive success: once you’re staying with a brand you’re likely to double down on it, and the marginal utility with each successive stay increases as it brings you ever closer to that most elusive next tier of a rewards program. Hotels get repeat customers, and customers get the benefits (and to some, the prestige) of a higher rewards tier.

This might seem a little similar to increasing switching costs and in some ways it is (loyalty programs after all are a key play in any switching cost strategy). The main difference is that by deciding to lock yourself into a platform or product, the benefits of repeat usage accrue to the user themselves. This is also one of the main ways in which travel agencies and family owned corner stores survive in an era of and big box retailers- they provide a personalized service that gets better the longer you’ve known them, often to the point where you look forward to catching up with the proprietor as much as using their product or service, and maybe even end up depending on it (where they’re telling you where to go on vacation or what cheese to buy).

User Experience
Maybe Eventbrite just loads faster on mobile, or perhaps it presents event information in a more straightforward manner, or perhaps it’s just the fact that they don’t stick you with a $20 ‘convenience fee’ on the checkout page- almost anyone will say they have a better experience on Eventbrite than TicketMaster. Google Flights’ flexible dates view is my personal favourite, others prefer Kayak’s Hacker Fares, and still other used to use Hipmunk to ‘minimize Agony’ (whatever that is). Design, ease of use, visual aesthetic, familiarity with layout, features offered, good customer service; these are just few of the ways companies selling otherwise undifferentiated products can stand apart from one another.

User experience is not limited to just software or digital design, every step of the user journey has the potential to offer a differentiated experience. A Marriott Courtyard and a Hilton Garden Inn might be pretty similar to most of us, but frequent travelers might have quirks they prefer in either chain, from brighter lights in one’s conference room, to the likeliness of encountering loud families in another, down to the choice of lobby music, or even just how soft the pillows are. Often these small user experience ‘quirks’ can end up forming entrenched brand loyalties, and smart business operators are always on the lookout for how they can incorporate their user’s feedback to create an experience customers swear by.

There’s polos and then there’s Ralph Lauren. Anyone can buy a t-shirt with a collar, but a Polo shirt is different from a polo shirt. A brand is a shortcut to saying something about you. It’s the story the customer identifies with. ‘I need my Starbucks in the morning’ ‘I swear by these Nikes’ ‘I would love to buy that new Tesla’; it stops becoming just coffee, shoes, or a car- it’s what they stand for and by extension you as their user. Consumer goods obviously seem easier to ‘brand’ but it doesn’t need to be limited to them- power Bloomberg terminal users swear by it, despite its ridiculously high cost and the best attempts of numerous competitors to dislodge it over the years.

Brands can stand out in multiple ways, from higher quality signaling (some might prefer sticking to just Bose or JBL speakers, others are perfectly content buying a well-reviewed generic Chinese model from Amazon), specializing in a niche (there were lots of granola bars when RxBar first started, but they were the only ones focused entirely on CrossFitters and a Paleo diet), in opposition to another brand (wearing Outdoor Voices says one thing about you vs wearing Lululemon says entirely the other), or simply just consistency (every Uniqlo offers the same dependable basics in a classic aesthetic, making it an easy option while traveling). [Consistency and standardization of quality, in fact, is where the earliest brands in this country came from].

Your fast food of choice might be In-N-Out, but when there’s nothing but a McDonalds for miles of exits and you’re starving, a Big Mac is what you’re going to be eating. Convenience matters a lot for everyday products- this is why DNVBs (Digitally Native Vertical Brands, eg: Bonobos), born out of a direct to consumer model, still end up on retail shelves. You’re just a lot more likely to buy one of the 5 toothpastes on a shelf in Whole Foods than go home and search for the best natural, organic option, bulk order, and wait a couple of days for it to ship.

Companies like Coke and McDonalds obviously understand this better than almost anyone and have made ubiquity a core part of their business model, not just in ease of purchase but even in their constant advertising, making sure they’re always top of mind in a potential consumer’s mind (both particularly trying to conflate the theme of ‘happiness’ with consumption of their products). The less a user cares about a specific product in a category, the more availability and ease of access is likely to matter. If you’re the kind of person who ‘can’t tell the difference between Coke and Pepsi’, whichever vending machine is closer is the one you’re most likely to get.

Mergers & Acquisitions
The investment bankers preferred route. And it makes logical sense: fewer competitors = decreased competition. To came back around to the airline industry we started with, just in the last decade Delta merged with Northwest, United merged with Continental, American merged with US Airways, Southwest bought AirTran, and even Alaskan merged with Virgin. Long as you have the balance sheet (and sometimes not even that), and more importantly can get the FTC to agree, this is a very popular and lucrative route.

This doesn’t just have to be for large public companies with established business models though. In the tech world: Zillow acquired Trulia for $3.5bn which was more than half its market cap at the time, Elance and oDesk recently went public as the combined behemoth UpWork, Grubhub and Seamless have been on a tear post their merger (even despite the most recent dip), and Didi Chuxing’s joint effort (from Didi Dache and Kuadi Dache) was a major reason that Uber couldn’t get the foothold it wanted in China despite spending more than $2billion there. If you can’t beat ‘em, join ‘em; and it might just be better for both of you.

Parting Thoughts
Lastly, if despite all of this you are going to get in a pricing war, that’s okay; just make sure you’ll be able to last through it. If you’re a startup that means having enough in profits (probably not likely) or fundraising like there’ll be no tomorrow (much more likely; that’s why everyone from Uber to Lyft to Didi seems to raise a billion dollars every six months or so- for all those subsidized rides we’re enjoying). And if you’re a public company that means convincing shareholders of the importance of market share over profits today, or having other lines of business that’ll let you paper over the losses in the meanwhile. [Amazon has been a phenomenal example of both; a good example being when Amazon was able to cower into selling itself to Amazon as it kept slashing prices of baby products to the point just couldn’t afford to keep up].

To all the others- pricing wars are easy; honestly anyone (with the cash) can get in them, and it’s convenient to be able to blame the undifferentiated nature of your industry. The more prudent (and profitable) strategy however, is to remember that your ‘offering’ is not the same thing as your ‘product’, so even while the latter’s commoditized, there’s ways to compete, and even stand out with an overall unique offering. It’s certainly not easy, but in that I hope you find this post handy.