Chapter 1: Setting Your Core Business Strategy

There are three possible core business strategies, and I highlight why you should be a low-cost leader.

In the Fall of 2004, I bought a business suit on eBay. The suit, made by Italy’s Ermenegildo Zegna, legitimately retails at my local (and fancy) men’s store for $1495. That’s right—$1500 (plus $116 in tax)! My eBay price? Including shipping and insurance, $309. This instance illustrates a few key points:

EBay, which will undoubtedly be one of your sales channels, is really setting the market price at the wholesale, not retail, level. Sure, we’ve all heard the stories of someone buying a Barbie doll for $20 and selling the doll on eBay for $600. These “feel good” stories do not apply to you and your new business. You will be competing with other businesses at the wholesale–and lower–price levels.

2. Therefore, you need to be able to buy product below wholesale—much, much lower. You accomplish this by purchasing bulk goods from China or another low-cost source. More information on buying by the container load will be provided later in chapters 5 and 6.

3. I bought the suit online because of its low price. I would not have bought this item online if the price were close or equal to the local retail price.

This final illustration is important: the customer won’t risk their money on a large purchase unless the savings are significant from the off-line, traditional “store.” The amount of difference is subject to debate because many times it is an emotional decision, and also includes many variables such as shipping timeframe.

Consider the following scenario: you are looking at a fancy Viking stainless steel refrigerator. It costs $4200 at your local, high-end kitchen appliance store. How much would you pay if you bought it online? Here’s a good summary of how each channel would relate to each other:

Local high-end store: Highest

Nice, crisp website which sells only refrigerators: Medium

Crappy website selling lots of appliances: Lowest (approximate tie)

eBay: Lowest (approximate tie)

Here are some conclusions I’ve drawn with my experience in this area:

If buying online, you would pay a little bit more from a website that looked professional; loaded fast and was clearly navigable. This is no surprise. A ‘crappy’ website tends to connotate that the product quality—and definitely the service–is and will be somehow less.

The price you would pay from the nice, crisp website is (sometimes slightly) higher than eBay. Why? eBay as a channel has commoditized the buyers and products (but not sellers). Buyers want and usually get low prices on eBay, and it’s easy for buyers to sort by price, compare products and model numbers, and buy low. Also, the generic worry about “fraud” on eBay pushes down the Average Selling Prices (ASPs) across the board. Unless a specific website or company has gotten bad press about fraud (like TJ Maxx), you worry just a little bit less. For instance, if I buy that refrigerator on eBay, I have to worry about a) the seller, b) eBay itself, and c) PayPal. Something can go wrong in either of those three areas, or so I think. In contrast, if I buy from ‘Crazy Eddy’s Viking Refrigerators’ online, I really only have to worry about Crazy Eddie’s employee capturing my credit card number. In short, buyers will pay a little more from a nice online store than buying the same item on eBay.

You would pay a little bit more at your local retailer. But not much! Again, this is a function of many variables, like whether the item is in stock; warranty and return policies; how much extra you have to pay in taxes; the availability of financing; and so on.

As you consider your own conclusions here, translate those conclusions into a definition of your own biases.

Selecting Your Core Business Identity

Let me take a step back, for the moment, and describe a key concept from the off-line world that really sets your core business strategy. Put forth in detail by the wonderful book Discipline of Market Leaders,[1] the authors’ argument is that you must be either a

Product Leader (Ferrari, Intel, and Rolex);
Total Solution Provider (Saks Fifth Avenue and Xerox); or
Low-Cost Leader (Wal-Mart, Fry’s, and Dollar Tree).

The idea is simple: examination of market leaders lead the author to conclude that each company listed above was successful because they were extremely good at focusing and executing on one of the three values. Ferrari cars are typically faster and cooler than anyone else; Saks has people that remember your name, computers that remember your preferences, and a nice culture of ass-kissing; and at Dollar Tree, everything is, well, a dollar. These are good brick-and-mortar examples of product, solution, and low-cost leaders.

Who are the online-only leaders of today? Who do you hear most about? Here are a few:

Product Leader (Google, MySpace, CNN);
Total Solution Provider (Amazon, CNET); or
Low-Cost Leader (?).

The lack of a “house-hold” name in low-cost leadership (online only) does not mean that they don’t exist; rather, low-cost is a horizontal value proposition across most online-only businesses, and therefore don’t get the press that other leaders have. For instance, Skype sells telephone minutes that cost less than half of what the incumbent telephone carriers charge; carried 4.4% of all international telephone calls last year[2]; is not re-branded and re-sold by other companies; and yet, has less than 5% brand recognition in the U.S, according to Interbrand[3]. My previous “dot-com” shipped 450 pound objects to 46 states, Mexico, Canada, Aruba, Belgium, and Poland. We had $600,000 in sales the second year and $1M the third year, and yet the established offline leader had not even heard of us. Online-only low-cost leaders do exist, and you’re going to be one of them.

If you’re still not convinced, consider the latest available eBay Buyer Segmentation Study from June 2006[4]. eBay themselves segment as follows:

Shopping Driven Passionate
Convenience Driven Enthusiast
Value-Driven (Low Price)
Bargain Seekers (Low Price)

As eBay looked at each segment’s spending patterns in their “Share of Wallet Tracking” research[5], eBay concluded that the latter two segments shop online 160M times per month; buy around 60M items per month; and shop twice as often as the other two segments. Finally, eBay’s “Top Buyer Lapse/Decline” June 2006 research[6] found out that “the deals [on eBay] just don’t seem to be as good as they used to be.” eBay as a marketplace has commoditized many of the products; you have a better way, however. Let’s move on.

Going back to the Discipline of Market Leaders for a moment: the book points out that these category leaders develop and focus on their value proposition, while only being mediocre in the other values! These are my words, not theirs, but I love the concept. Not paying heed to this principle is a big reason why online low-cost leaders fail.

For illustration, Rolex is an effective product leader because the customer believes that if they buy a Rolex, they are getting the world’s best quality watch.[7] When buying from a product leader, the customer does not expect low prices from the dealer. In fact, low prices would weaken the product leader image that I am expecting when I “hire”[8] the product. Finding low prices at the Maui Ritz Carlton; on a Tiffany ring, or on a new Mercedes actually goes against your (the buyer’s) expectations. Similarly, when a customer shops at Wal-Mart or Fry’s, that customer is primarily expecting low prices. They do not expect Nordstrom service or E. Zegna suits.

Therefore, when you select your core business “discipline,” you must focus on providing that discipline and that value alone. If customers are not expecting Nordstrom service, then you should neither fund nor provide Nordstrom service.

If it is not obvious yet, let me say that I believe that you should be a low-cost leader. Here’s why:

You do not have the resources to be a product leader, at least at this point. In the structure I outline in the following chapters, you cannot make or buy camcorders better than Sony. Also, legitimate multinational companies who are product leaders will not likely sell you product—just so that you can turn around and sell online right into their dealer territories. Being a product leader does not mean having a wide and deep product line offering. In fact, this is a bad idea primarily because it is not competitively defensible. For illustration, if you decide to focus on technical computer books and touted your “wide selection as a product leader,” the current category leader can always match and beat your product line depth by offering more selections than you can.

Because of economies of scale, resources, and dealer agreements, you cannot be a product leader online. What about the second value proposition, namely being a total solution provider?

Xerox is an effective total solution provider because Xerox Business Solutions knows your business better than you do. To prove their point, Xerox has recently agreed to come in and manage your entire printer, copier, scanner, and fax machine fleet—and will do so at 80% of your cost[9]. Your yearly costs (toner, paper, maintenance, network drops, and so on) are agreed upon. If you spend $5M a year on these items, then Xerox will agree to take over the whole ball of wax for $4M. How can they do this and still make a profit? Because Xerox understands “managed document services,” end to end, better than you do.

Here’s the issue regarding you and your new business: You can’t provide the appropriate levels of warranty and repair service remotely. If you sell Jacuzzis, for instance, how are you supposed to fix the heater or repair the cracked fiberglass—in all 50 States—from your hammock in Maui? Additionally, for reasons that will be evident soon, you will be selling a product, not a service. “Product solutions” are sold more effectively by a local, off-line presence. Maui CEO does not speak to service-based businesses; I believe successful online service businesses will either be based on product leader reputation (like Johnny Cochran offering legal services), a new category that can thrive and be a killer app (such as ‘career coaching’), or being the exchange itself that all other service businesses integrate with, through, and/or on top of. Low cost is not sustainable in the services businesses, at least at this time. For instance, using videocams, why can’t you help students with their math skills from Maui? Because someone in India, Malaysia, or Russia will do it cheaper.

The remaining strategic option for product-based businesses is, of course, low-cost leader. As opposed to the services space described above, low-cost leadership works for our purposes in the product space. Customers buying online expect a good deal, and you have designed your organization from the ground up to deliver. A successful low-cost leader does not sponsor the local polo match or have a marble lobby, and they do not over-invest in presentation and service. They are disciplined about low-cost leadership.

You have just completed the first step in your business plan. Our mission is to be a low-cost leader. Low-cost leader in what? you might ask. We’re going to decide what kind of product to sell in the next chapter.

[1] Michael Traecy and Fred Wiersma, The Discipline of Market Leaders: Choose Your Customers, Narrow Your Focus, Dominate Your Market, (Perseus Books Group, 1997).

[2] Telegeography survey December 1 2006. See http://www.telegeography.com/cu /article.php?article_id=15656

[3] http://www.brandchannel.com/boty_results/us_2005.html

[4] “Lessons from eBay Buyer Research,” Jeff Resnick of eBay, at the 2007 eBay Developer’s Conference (Boston)

[5] Quoted and referenced in “Lessons from eBay Buyer Research,” Jeff Resnick of eBay, at the 2007 eBay Developer’s Conference (Boston)

[6] Quoted and referenced in “Lessons from eBay Buyer Research,” Jeff Resnick of eBay, at the 2007 eBay Developer’s Conference (Boston)

[7] Interestingly, Rolex is considered by experts to be inferior in product quality to the products of a dozen other manufacturers. Similarly, Steinway is not considered by experts to be the best-made or sounding piano, nor is Volvo considered to be the safest automobile. However, all three companies have successfully branded their products so that images of heavy watches, concert pianos, and safe cars “pop” into our minds in relationship to those brands.

[8] Clayton M. Christiensen and Michael E. Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth (Harvard Business School Press, 2003).

[9] Based on several conversations between me and Xerox employees.