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This chapter is from the book

The Causes of Commodity Hell

What's causing this rampant transformation of the market? Six key factors produce the Copycat Economy. Every leader must approach them with a combined sense of humility and urgency.

1 The Irrelevance of Time and Distance

Imitation can come from anywhere in the world. In an era of globalized free trade and accessible technologies, any organization from anywhere can combine local conditions (wages, tax, regulatory environment, and government incentives) with new technologies and new alliances to replicate what you're doing, often at lower costs.

Complete, unedited, free and low-priced downloadable bootleg copies of Star Wars III: Revenge of the Sith appeared on the Internet literally hours after the official release of the film on May 19, 2005. Talk about imitation and commoditization! On July 1, 2005, authorities (working under the appropriate moniker "Operation Copycat") arrested suspects in 11 different countries for masterminding a copyright piracy supply and distribution chain.

More than 90 percent of Microsoft products used in China are pirated—the ultimate form of imitation. Like the bootleg copies of the Star Wars film, freshly minted counterfeit copies of products like Windows 95 and XP were available in China on the same day they were launched by Microsoft in the U.S. Many computer retailers in China are gravitating toward Linux operating systems because their customers ask for Linux. And why are they asking? Because Linux is basically free (the ultimate form of commoditization), the total cost of the computer is less than if it was operated by XP. For some customers, that's "good enough." Others buy the computer, rip out the Linux operating system, and replace it with a counterfeit copy of XP. Even if you're a giant like Microsoft, these are pretty hefty challenges to overcome.

No time, no distance, huge impact. Low-cost manufacturing competition in Asia and Latin America creates havoc with higher-priced goods and jobs in Western countries, leading Patricia Panchak, the editor-in-chief of Industry Week, to note that for manufacturers, "the globalization of the marketplace means intense, low-cost competition, limited pricing power, and a high rate of structural change."

Global alliances and supplier relationships further accelerate the push to commoditization. In concert with international partners, some American companies are now manufacturing medical imaging equipment abroad and then designing, programming, and servicing it abroad, too—all at a fraction of the cost of doing it in the U.S. After American hospitals buy the equipment at reduced rates, they can, if they want, digitally zap x-ray or MRI images to reputable radiologists in India—reputable physicians who make their diagnoses and zap their conclusions back at one tenth the salary of their American counterparts.

At the same time, cross-border capital flows are funding corporate ventures and entrepreneurial start-ups that will force current market leaders into being commodity players. New VoIP (Voice over Internet Protocol) players like Skype (now part of eBay), Vonage (the fastest-growing phone company in the U.S.), VoicePulse, and Galaxy—all originally launched with international investment—have contributed to the commoditization of the entire long-distance telecommunications industry. More online music file-sharing sites, and Web gambling and sports-betting sites are moving to obscure international locations to escape the long arms of U.S. law and regulation. Their physical distance doesn't stop them from commoditizing the commercial CD to the point of irrelevance, or creating an easy-access low-cost gaming alternative to traveling to Las Vegas. Despite heavy pressure from American pharmaceutical companies and the FDA, Canadian companies like CanaRx and Canada Pharmacy allow American consumers to bypass the established drug supply chain and purchase quality-controlled generic and nongeneric prescription medication online at far lower prices.

2 The Rise of Glass House Transparency

Secrets, proprietary information, and closed-door management systems don't have the competitive edge they used to because new technologies have the capabilities to create total transparency. Today everybody has access to any information, talent, and resources, so it becomes a lot easier to copy anything, be it a product, a service, a marketing campaign, or an internal process.

Think about technologies like broadband, search engines, cable, e-mail, collaborative software, cellphones, satellite, fax, overnight delivery, browsers, file sharing, Wi-Fi, videotapes, video streams, videoconferencing, video discs, DVDs, Bluetooth, VoIP, cable TV, blogs, and podcasting. Think about the relentless movement toward global travel, free markets, and political democracy. Now imagine all these technological, social, and geopolitical forces converging to generate unfettered real-time news and information, and hence market transparency. All these factors make it easier for anyone, anywhere, to locate and access the information, talent, and resources they need at a better price. This, in turn, makes it easier for any current or potential competitor to copy, imitate, or improve a product or service—and leapfrog over any company's product, process, or marketing tactics.

Transparency relentlessly accelerates imitation and commoditization. The fabulously successful Apple iPod and Motorola Razr cellphone are spawning a slew of low-priced, ever-increasing-quality imitators because potential competitors can see the exact metrics of Apple's and Motorola's success every day, and they can readily deconstruct the entire business design and the underlying technologies. Low-cost private-label products in retail stores (with the same ingredients and similar packaging) are now formidable competitors to higher-priced brands. The fastest-growing segment of the pharmaceutical industry is the generic (i.e., copycat) drug business.

Competitors aren't the only ones profiting from the transparency and easy access of vital information. Customers benefit, too. Transparency allows them to find the most accurate and unvarnished information about any vendor or any product. The Web allows them to find the best deal anywhere, at any time, whether they're seeking a home loan or a car. The Web allows customers to read complimentary or scathing reviews of vendors and products—or post them, knowing that thousands or millions will read their comments. Such interactions wind up stripping away much of the high-gloss "value" that organizations believe ought to justify a higher price and brand loyalty.

Every business exists in a glass house, even when it tries to lower the blinds. In 2005, executives at both GM and Apple were shocked and infuriated when their ultra-top-secret new products were unveiled in magazines and on Web sites before their official launch. Why should they have been surprised? Secrets can't be kept in a market that is so transparent that pirates can access Microsoft's secret code and create counterfeit products at the same pace that Microsoft designs real ones.

The counterfeit trade is the ultimate, albeit corrupt, expression of imitation. It is fed and watered by transparency and is growing rapidly. Engineers and chemists in various countries can now reverse-engineer patented molecules to produce illegal pharmaceuticals and sell them at a fraction of what a legitimate drug company charges. In countries such as China, Vietnam, and Ukraine, the production of amazingly authentic-looking but bogus Calloway golf clubs, HP inkjet cartridges, Louis Vuitton handbags, Nokia cellphones, and Intel computer chips seems to grow exponentially. Ninety-one percent of DVDs and video discs in Chinese homes are counterfeit. The World Customs Organizations estimates that counterfeit products account for more than 7 percent of global merchandise trade, or $540 billion. None of this could occur without a glass house transparency effect in today's marketplace.

3 The Customer as Superpower

Customers, armed with the latest technologies and operating in a transparent environment, are now capable of reducing any well-promoted, well-packaged market offering to a bare-bones commodity. They can dig below the hype, bunch vendors together according to their generic products and services, and canvass the globe to find the best fit and cheapest prices.

Customers have taken full advantage of transparency-inducing information technology and increasingly open market climates. Individual customers now regularly bypass organizations' marketing plans and distribution channels, and instead compare, contrast, and critique products, prices, and companies on their own terms with a simple click of the mouse. The Online Publishers Association found that more than 90 percent of individuals between 18 and 54 years old turn to the Internet first for product information. The proliferation of Web sites has allowed customers to take more control over many sectors of the market, from travel booking and auto sales to music production and investment management.

As customers, we also collaborate on our own terms: With one click, we can e-mail messages and documents and files to a vast preset community of friends, family, and colleagues. We can create Web sites and interactive chat sites about products, prices, companies, issues, and trends. We can write opinion blogs and post commentary and dialogues with readers. We can podcast to get our ideas and creations to the immediate world. We can form ad hoc interest groups such as Angie's List, a virtual community of 425,000 subscribers who share critiques and recommendations about local service companies, like plumbers, car mechanics, and painters. In Shanghai, China, we can get together with other consumers in Internet chat rooms, agree to meet at a particular store (say, an appliance or furniture store), and then—as a group—converge on the store and haggle down everyone's price of a specific product up to 40 percent if everyone in our group buys that product.

All these activities yield more customer power and oversight over vendors, place higher expectations and demands on those vendors, and result in more beady-eyed assessment of their prices. As customers get smarter, they

  • Raise the bar on "good enough" performance (which itself becomes quickly imitated by vendors who want to survive)
  • Strip away the marketing hype of vendors and get to the unvarnished truth (how good is this product really, or this hospital, or this doctor?)
  • eliminate the value-add of many vendors (do you need a travel agent or stock broker as often as you used to?)
  • Reveal the hidden pricing foundation of many vendors (don't you know what that car dealer actually paid for that car on that lot?)
  • Shop around for the best fit of product features and prices—or just the cheapest prices
  • Get rid of middlemen entirely by ordering direct
  • Sell goods themselves on online auctions
  • Avoid online ads with pop-up blockers and TV ads with digital video recorders
  • Exchange information with like-minded souls in digital communities like craigslist.org, Flickr, and MySpace.com.

Everything that consumers are now doing accelerates the demise of traditional sources of value and bunches vendors into a more homogeneous, look-alike horde with less differentiated, commoditized offerings.

Opportunities for corporate customer power have also exploded, leading Industry Week's Patricia Panchak to conclude that nowadays "the customers rule, making lowest cost, fastest delivery, and highest quality a prerequisite for success." Competition for corporate telecom business, for example, has become so frenetic that John White, CEO of the financial advisory Public Financial Management, told me that he now uses a reseller of long distance. He says it was easy to negotiate a cut of more than $100,000 from an annual $800,000 corporate headquarters telecom bill, while at the same time receiving an increase in communications speed and capacity from the same vendor. If he hadn't gotten the cut rate and service improvement, he was ready to find another provider because, he says, "They're all pretty much the same."

Corporate customer power forces vendors to make huge changes in their very products and services. Companies like SAP, Siebel, and IBM were staggered when customers told them they were no longer willing to be bound to a business model built around a massive, installed base of proprietary software systems. They wanted choices. They saw options like cheaper, Web-based, on-demand vendors like little salesforce.com, and they caused SAP, Siebel, and others to make mammoth changes in systems, services, and pricing.

4 Cost-Crushing Technology

New and existing technologies allow for radical cost-cutting and operational efficiencies, which, in turn, lower barriers to entry and create more competitors in the pack—who can profitably charge lower prices for the same goods and services.

Ricardo Greco, CEO of the Mendoza, Argentina-based management-education company Alta Direccion, went even further than PFM's John White to reduce his company's telecom bill. He completely ignored the established vendors and installed peer-to-peer Skype Internet telephony in every Alta Direccion office throughout Latin America, thus reducing his company's annual telecom fee by more than 80 percent annually. Visiting Alta Direccion's Panama office, I was impressed by my ability to dial my family and my assistant back in the U.S. at local rates using a USB phone connected to a desktop computer. Had my home and office also been wired with easily downloadable Skype software, the calls would have been free. That's what I call cost reduction! It's also what I call the complete commoditization of conventional telecom's market offerings.

Small start-ups, bigger companies like JetBlue and Men's Wearhouse, and huge companies like Wal-Mart and Ikea are aggressively using state-of-the-art technologies to keep their cost structure down and thus profit from lower pricing. Coupling technology with low overhead (low wages, real estate prices, and local taxes in its Omaha, Nebraska, headquarters), Ameritrade's $9.95 Internet trade price showed it was actually profitable, and the company made life miserable for giant Morgan Stanley (with its key operations in expensive New York and San Francisco) and its Morgan Stanley Online.

Whether it's long-distance bills or many procurement and inventory-management charges, digitalization can reduce many costs to near-oblivion. New technologies can crush costs by breaking down old lines of distribution, bypassing middlemen and conncecting players at the end points to each other. Entire value chains can be eliminated. Using basic information technology tools, a musician can replicate and record the sounds of an entire orchestra. A publisher can create a low-cost, low-subscription-fee Web-based scientific publication that can effectively compete with a long-standing scientific journal with a $900 annual subscription—and, in fact, can surpass it because turnaround time for getting an article reviewed and posted, with analyses and commentary, is a fraction of what a physical journal requires. Intranets and expert systems can consolidate available knowledge to yield new innovations in cost reductions, not just revenue-line enhancement. ERP, CRM, and TLM software can radically reduce costs in back-office and administrative operations, customer relations, and product development, respectively. When these infrastructure changes occur, jobs and organizational functions that no longer add value are themselves commoditized; they can be eliminated in favor of cheaper automation and digitalization. (Yes, the pain of job loss to any individual is huge, but on the other hand, organizations that act prudently can eliminate fat and bureaucracy to become more cost-effective and agile—and thus eventually hire for more higher-end, higher-paying jobs.)

Barriers to entry crumble when startups such as JetBlue and the Canadian airline WestJet combine state-of-the-art technology with new management systems to unnerve huge, stumbling providers like United Airlines and Air Canada. Two-person shops with negligible overhead are accessing cheap, powerful technologies to become viable players in a variety of sectors, such as financial services, consulting, marketing, and publishing. They're building margins and market share even as they offer copycat services and lower prices than larger, higher-cost competitors.

There is also immense power in existing technologies when they are creatively applied. Fast-growing start-ups like netphone leader Vonage and search monster Google have been built on the backs of very cheap but very powerful servers and PCs cobbled together (and, in the case of Google, using free Linux software) instead of high-cost razzle-dazzle technologies that would quickly burn through precious capital.

The ultimate irony is that technology itself is getting cheaper. Critics like Nicholas Carr, author of the controversial book Does I.T. Matter?, point out three developments. First, software programs are quickly replicated by rival companies. Second, proprietary technologies are giving way to cheap open source infrastructures like Linux and Web-based applications like salesforce.com. Third, and most important, corporate customers are refusing to automatically pony up for pricey, glitzy next-generation products and forced upgrades because they don't see the value-add over today's "good enough." A brand manager at Sun Microsystems explained his company's woes: "Servers have become commodities and cheaper PCs have replaced $500 Sun servers for running applications. Customers are looking to our cheaper competitors to meet their IT needs."

Regardless of what products or services you're selling, Forbes publisher Rich Karlgaard believes that they will inevitably be part of what he calls "The Cheap Revolution." He says, "The industrial world has entered a period in which China, India, the Internet, and a tech glut will become platforms for shockingly cheap products and services." He's exactly right.

5 Mobs of Competitors

The interaction of deregulation, globalization, and technological advance breaks large, orderly, predictable homogenous market swaths into mobs of frenetic organizations seeking the same goals and trying desperately to avoid anonymity. Despite the efforts of some entrenched firms, markets are no longer ruled by a few huge players. Dell "owns" the global Personal Computer business, and its market share is a scant 13 percent. In the auto industry, Toyota's goal is a 15 percent global market share by 2010—a number which seems ridiculously modest but in that industry is positively audacious.

In industry after industry, the playing field has been fragmented as more players jump into the fray. The more lucrative and fast-growing the particular market, the more sharks are attracted to the waters. In these increasingly turbulent waters, barriers to entry slowly melt in response to the onslaught of technological advance, heightened availability of global capital, and the spawning of new partnerships and alliances around the world. One executive in a financial services firm told me that "the cost of entry in our business has become a phone, a computer, and a network of independent partners."

All this means an ever-growing number of competitors and a harder challenge to break free of them. Southwest Airlines' remarkable track record of multi-year profitability has spawned a growing, piranha-like cluster of low-cost, low-priced imitators who have doubled their collective market share to 15 percent over the past five years. Now add the low-cost imitation coming from the established big carriers, and suddenly Southwest is facing relentless pressures that it didn't have to deal with in the past. "There's a big bulls-eye painted on our backs" says one Southwest executive.

In the 1980s and early '90s, the music companies were on a roll. The marginal cost of producing a music CD was about 20¢, and the value chain was solid as a rock, delivering the product to Tower Records or Wherehouse, where customers would pony up $15 a pop for the privilege of hearing the one or two songs on the disc they actually liked. Multiply that CD by millions of products annually, all throwing off fat margins even after paying off artists and retailers. It was a darn good business if you were an executive, complete with the side benefits of hanging out with rock stars and wearing a ponytail even as you were balding.

The music labels became so fat and sassy that they began to consolidate to control the market completely. They did so for all the usual reasons: scale, scope, cross-marketing, and synergy. By the end of the 1990s, five companies controlled 75 percent of the market. The remainder they left for the scavengers: small, independent labels that scurried to find whatever business they could.

But ultimately, the darn market simply didn't cooperate with the music moguls' plans. New file-sharing and MP3 technologies—absorbed with delight by new obstreperous competitors and millions of customers—exploded their business model and reduced many of their assets to liabilities. Sales plummeted, market caps withered, and companies like Tower and Wherehouse sought bankruptcy protection. Today the entire music business is splintered into a manic mob of small and large competitors of every ilk, and the biggest players are now—when not suing somebody—desperately trying to shed "assets" and compete in a new ballgame.

Increasingly, that new ballgame in any industry is filled with more obstreperous competitors. The more players in the game, the faster traditional products and services become "me too" and lower-margin commodities.

The good news in the Copycat Economy: Anybody can play. The bad news in the Copycat Economy: Anybody will play.

6 A Zeitgeist of Irreverence

Zeitgeist is a German word meaning "the spirit of the times." The spirit of our times is irreverence, if not disrespect, for tradition, history, and the winners of prior battles. In your business, customers are constantly demanding, "What have you done for me lately?" Customer loyalty? You'll get it if you do a lot more and a lot more cheaply than the other provider can. Otherwise, you're gone. And that's true even if you've been your customer's supplier for 10 years.

And your competitors? Well, it's not simply that there are more of them; it's that so many are so darn irreverent. They don't play the game the way it's always been played. Vonage and Skype aren't interested in "improving" on what Sprint or Deutsche Telekom have always done; they're out to make the giants' business model irrelevant and to rewrite the rules. Skype's Web site says flatly that the company's goal is to reduce the price of a phone call to zero. By mid-2005, Skype had attracted more than 30 million users, adding 155,000 new users per day, which, no doubt, enticed eBay to buy the $60 million company for a substantial $2.6 billion later the same year.

Irreverance spills over into every market. Discount real-estate firms, commercial Web sites that cater to home bidders and FSBO's ("For Sale By Owners"), and companies that offer innovative referrals and rebates on sales are all launching grenades at the standard practices and the standard 6 percent commissions of conventional real-estate brokerages. Tiny Visto Corporation has built a wireless e-mail technology that aims to eliminate a lot of RIM's Blackberry value-add, letting people manage their e-mail on the cellphones at a significantly lower price. Already, Visto's technology is being rolled out by carriers like Vodafone and Nextel (a unit of Sprint).

Heart surgeons, who have seen their business drop by 20 percent, are unhappy with cardiologists, who historically have been their primary source of patient referrals. Many irreverent cardiologists have violated this cozy arrangement by treating patients themselves with a plethora of new medications, radical Dr. Dean Ornish–type diets, meditation and exercise regimens, and advancement in angioplasty and stent technologies that they can handle themselves. For patients and payers, that's a lot cheaper (and, in many situations, apparently, more effective) than open-heart surgery.

Small wonder that so many entrenched providers, when dealing with customers and competitors, feel like Rodney "I Get No Respect" Dangerfield. It's not simply that the pack has gotten bigger; the pack is irksome, iconoclastic, and unwilling to play the game the way it ought to be played, dammit! Many disrupters of various industries come from outside. The iPod/iTunes phenomenon came from Apple's Steve Jobs, a computer guy. Vonage founder Jeffrey Citron came from financial services. Skype's executive team started at Kazaa, the P2P music file-sharing company. Air Asia, which is offering JetBlue–type services in Asia, was founded by Tony Fernandez, also a refugee from the music industry. Industry insiders talk to each other in the same comfortable language, mimic each other politely, complain with one voice about insurmountable challenges that they all are dealing with the same way, and offer sympathetic excuses to each other as to why change is difficult. Meanwhile, full-blown crazies, often from outside the industry, come into the fray with no baggage, no excuses, and no preconceptions.

A Zeitgeist of irreverence creates dissatisfaction with the present, which spurs the spirit for genuine breakthroughs—which, in turn, accelerates the commoditization of everything that used to add value in the past. Combine this Zeitgeist with a meltdown of time and distance, glass house transparency, customer superpower, cost-crushing technology, and a mob of competitors, and you've got a nuclear-powered brew for imitation and commoditization.

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