What is the commodity magnet? And why is it so important to understand how it will influence your customers' behaviours and expectations?
The concept of the commodity magnet was first introduced in the Harvard Business Review in June 1994 by Professors Kasturi Rangan and George Bowman. The commodity magnet is a danger for any new product introduction. In their article, the professors outlined the cycle that products go through, on the basis of two dimensions:
- The cost to serve: how much money does it cost to reach the customer and to provide your service successfully?
- Relative price: how much does the customer pay for the product?
When a new product is introduced, the price and the cost to serve are usually both high. The innovation and marketing cost for a new introduction is significant, which companies seek to counterbalance (if they can) by initially charging a premium price for their newest brainchild.
At this point, the number of users will start to grow, and the cost per user therefore falls, but because the product still retains its newness and uniqueness at this stage, the price remains high. This is the phase when the innovation yields its highest return.
Of course, in the meantime competitors will have started to appear. They copy (part of) the innovation and launch a comparable product, which may have a lower price that allows it to quickly capture part of the market. The result is not difficult to predict: a price war breaks out. Both products become cheaper, but fortunately the costs remain low. This is the moment when customers become aware of fierce competition in the marketplace. As a result, their expectations rise.
To meet these expectations, service costs increase, although the price has to remain the same for competitive reasons. The product eventually finds itself in an impossible situation where costs are high but the price is low. Companies are sucked into this untenable position by market dynamics. This is the power of the commodity magnet.
How does digital impact the commodity magnet?
Automation creates the ability to offer some services free of charge. This is not a tactic in a price war. It is simply an expression of the potential to offer interesting services for no return in the world of AI.
In 2015, the British entrepreneur Joshua Browder launched DoNotPay, a website that helps people to contest parking fines. It is a very simple and completely free system. The consumer talks to the DoNotPay chatbot. The bot asks a number of questions and on the basis of the answers writes a letter that the consumer can use to contest his/her parking fine. The letter looks highly professional. In fact, it seems like it has been written by an expensive lawyer.
In reality, it has been written by the bot. The success of this service is phenomenal. In a period of just two years, the bot has successfully contested more than 375,000 parking fines at a success rate of 64%! In total, 9.3 million dollars of fines have not been paid as a result of this automated service.
On the back of this success, Browder decided to add roughly a thousand different categories to the service range. Customers can now demand money back from airlines and the makers of defective products, or even insist on things like the right to paternity leave from their employers.
During the third phase of digitalisation, the effect of the commodity magnet will become a harsh reality for many businesses. Digital forces not only put prices under pressure, but also increase the expectations of customers, so that costs rise. Seeking legal assistance used to be an expensive business. But now you can get good quality legal help free of charge, with 24/7 availability and no need to visit a lawyer’s office!
This is the digital commodity magnet at its strongest. Sectors that work with low margins today will be most vulnerable to the effects of the commodity magnet in years to come. The retail industry is a good example. Costs are already high and the price pressure is enormous. New competitors like Amazon, Alibaba and Zalando compete in a totally different way with a totally new philosophy. These new players have given huge boost to customer expectation. As a result, most retailers have been sucked into the bottom right quadrant of the commodity magnet.
The theory behind the commodity magnet is more relevant than ever. When the idea was first aired in 1994, the magnet was mainly activated by a (direct) competitor who introduced a comparable product to the market. In this scenario, it was only at the end of the product cycle that the customer became more demanding. But times have changed. Today, the main drivers for commodity forming are much more varied and more powerful than twenty years ago:
- The large digital platforms: Amazon, Google and Apple are actively involved in the purchasing decisions of customers. They influence the choice process from the front line. Products are given less chance to differentiate themselves, because there is an intermediary filter. Just as Facebook decides what news you get to see based on what they already know about you, Amazon, Google and Apple are building filters that do the same for the type of products you can buy. As a brand, it is becoming increasingly difficult to influence customers directly.
- Global forces: competition is more global than ever. For just a few euros, you can have products sent from China to Europe. Price pressure is fiercer and more international than it has ever been. Consumers are placing ever more trust in online players – even in companies they have never heard of. Their general (and generally positive) experience of online shopping is already so large that they are prepared to take the risk. In this way, convenient location and familiarity are no longer effective as weapons against commodity forming. What’s more, the service provision of the vast majority of ecommerce players is excellent, so that pressure is exerted not only on prices but also on service levels, which increases costs.
- Automation: consumers want things to be as easy as possible. Technologically supported purchases make the fewest demands for effort from the consumer. What they buy and who they buy it from are less relevant than the time and energy it takes. If a company wants to improve ease of use for its customers, it first needs to invest in new interfaces. Initially, this will increase costs, particularly in companies with an analogue DNA.
- Transparency: full information about most products is readily available online and the web makes it easy to compare this information. When this comparison task is delegated to a digital assistant, the customer will be less involved in the purchasing process. As a result, perfect transparency in price and quality will make it difficult to differentiate on the basis of classic marketing techniques.
- The demanding customer: in the past, companies were able to differentiate themselves by being outstanding in a specific aspect of the market. They were either the cheapest; or they offered the best service; or they had the newest product. You could make the difference through excellence in just one of these aspects. But not anymore. Today’s customers want top service and competitive prices. Being good at just one thing is no longer enough. Today, expectations for your non-differentiating aspects are also high. This means that the cost of serving the customer will increase, often without the possibility for any compensatory increase in price.
Prof. Steven Van Belleghem is an expert in customer focus in the digital world. He’s is an award-winning author, and his new book Customers The Day After Tomorrow is out now. Follow him on Twitter @StevenVBe, subscribe to his videos at www.youtube.com/stevenvanbelleghem or visit www.stevenvanbelleghem.com