In the 1990s I argued that globalisation and technology’s advances were rendering competitive advantage unsustainable. Today, many companies are in the grip of an even more virulent form of hypercompetition – the commodity trap.
A commodity trap is where a company’s competitive position is eroded so that it can no longer command a premium price in its market.
Falling into your own trap
Tempting as it is to blame cheap producers in China or some other external factor, most commodity traps are very much related to how managers act or do not act.
The reality is that commoditization rarely happens to a business. It is usually the result of a failure to act early enough. It most often results from managers failing to innovate, issuing bad products, or denying trends already in motion.
Managers don’t see commoditization coming. Many are so focused on achieving short-time goals they could be said to be incentivised to ignore its onset.
What’s more, companies can be guilty of setting their own traps. Typically, they continue to fight against low-end competition by discounting higher-value offerings, inadvertently increasing the depth and severity of the trap.
Conventional wisdom argues for either cost and capacity reduction (without sacrificing margin) or increased differentiation (to maintain a higher end position).
But there’s little advice on how to identify the root cause of commoditization so it can either be avoided or turned to your advantage.
The Three Commodity Traps Framework offers strategies that have been proven to work in companies often caught up in fearsome price and proliferation wars.
To win that war, companies first have to understand what created the trap.
Trends that lead to traps
There are three common patterns that create commodity traps — deterioration, proliferation, and escalation.
A good starting point is to analyse the three trends using hard data on which movement you’re seeing in your market. This can be the ice-breaker and may finally acknowledge the elephant in the room that everyone’s been ignoring.
- Deterioration: Low-end firms enter with low-cost/low-benefit offerings that attract the mass market.
- Proliferation: Companies develop new combinations of price paired with several unique benefits. These attack part of an incumbent’s market — as Japanese and American motorcycle-makers have done to unseat Harley-Davidson.
- Escalation: Players offer more benefits for the same or lower price, squeezing everyone’s margins-as the iPhone did in mobile devices.
But the recession has created a fourth, particularly pernicious kind of commodity trap — evaporation. Evaporation occurs when demand declines substantially. - Evaporation: Reduces proliferation as companies cut back on product variety. But it encourages deterioration and escalation as over-supply pushes down prices.
In a recession, customers become even more price sensitive, and may postpone purchases as they expect prices to decline. If demand evaporation gets out of hand then companies may be forced into a destructive cost-cutting cycle, with the accompanying pain. So most markets abandon escalation, and simply deteriorate.
But it doesn’t have to be this way.
To sustain success, companies must be able to influence the momentum, threats and market power posed by rivals driving commoditization. By improving their power over real prices, managers can actually beat their commodity trap rather than simply trying to outpace it.
