Dealing with Dual Strategies
When companies discover that the low-price customer segment is large, they often set up low-cost ventures themselves. Because of their years of industry experience as well as their abundant resources, incumbents are often seduced into believing that they can easily replicate cut-price operations. Moreover, the business models of such rivals appear to be simpler than their own. In the 1990s, for instance, all the major airlines launched no-frills second carriers—Continental Lite, Delta Express, KLM’s Buzz, SAS’s Snowflake, US Airways’ MetroJet, United’s Shuttle—to take on low-cost competition. All these second carriers have since been shut down or sold off, showing how tough it is for companies to use the dual strategy.
Although most executives don’t realize it, companies should set up low-cost operations only if the traditional operation will become more competitive as a result and the new business will derive some advantages that it would not have gained as an independent entity. For example, in the financial services industry, HSBC, ING, Merrill Lynch, and Royal Bank of Scotland have set up low-cost operations in the form of First Direct, ING Direct, ML Direct, and Direct Line Insurance, respectively, because the new and old operations generate several synergies. The low-cost operations offer customers a small number of products—term deposits, savings accounts, and insurance—through cost-efficient distribution channels such as the Internet. Since they reach out to consumers the flagship banks cannot afford to serve, the no-frills businesses protect the parents. The flagship operations combine the funds the subsidiaries raise with their own, which allows them to make investments cost-effectively. That approach helps both parent and subsidiary.
A successful two-pronged approach requires the low-cost business to use a unique brand name such as HSBC’s First Direct or at least a sub-brand such as ING Direct. A distinct brand helps communicate that fewer services go along with lower prices. It also allows customers’ expectations to form around the low-cost business model rather than the traditional operation. First Direct customers, for example, are more satisfied with their ATM network than HSBC customers are even though both use the same machines. Whereas HSBC customers demand ATMs at every corner, First Direct customers, who don’t expect so many machines, are delighted to see them.
Conventional wisdom suggests that because a low-cost operation’s sources of competitive advantage aren’t the same as those of the parent, the subsidiary should be housed separately. By setting up an independent unit, an established company can create a start-up operation with structures, systems, staff, and values that are different from its own. Because it is independent, the low-cost operation will be more accountable and is less likely to be smothered by the parent business’s worry that the subsidiary will cannibalize its sales. However, as the case of the airlines shows, independent units are necessary but not sufficient for the success of a dual strategy. That’s because common ownership often imposes constraints on low-cost operations. For instance, the trade unions didn’t allow U.S. airlines to pay employees of their low-cost subsidiaries wages as low as those at Southwest Airlines and JetBlue. Unsurprisingly, those subsidiaries failed to take off.
Another factor that affects incumbents’ low-cost businesses is the allocation of resources. When disruptors are new ventures, they face market tests of their capital needs. Subsidiaries face internal resource-allocation processes that optimize different criteria—both for legitimate reasons, such as higher margins and lower risk, as well as illegitimate ones, such as power and politics. Consequently, the parent may end up starving the new unit. Remember how Bausch & Lomb didn’t provide a budding business with enough resources to launch the disposable contact lenses it had developed? The new lenses were cheaper than the permanent lenses B&L then marketed. They also didn’t need to be stored in solutions, which contributed to the parent’s profits. Therefore, B&L left the field open for Johnson & Johnson to launch a profitable new business.
A two-pronged strategy delivers results only when the low-cost operation is launched offensively to make money—not as a purely defensive ploy to hurt low-cost rivals. Companies should let their old and new businesses compete with one another and incorporate cannibalization estimates into business models and financial projections. Dow Corning’s creation of Xiameter is an excellent illustration of how companies should use the two-pronged approach. Despite enjoying a 40% share of the global silicones market in 2000, Dow Corning found low-cost competitors entering the industry. Rather than slashing prices, it decided to set up a low-cost business. Two years later, after segmenting the market and identifying potential customers, Dow Corning created Xiameter. Compared with Dow Corning, which sells 7,000 products, the subsidiary sells only 350, all of which face intense competition from low-cost players as well as from the parent. Xiameter’s limited range prevents it from eating up its parent’s sales.
Dealing with Dual Strategies
When companies discover that the low-price customer segment is large, they often set up low-cost ventures themselves. Because of their years of industry experience as well as their abundant resources, incumbents are often seduced into believing that they can easily replicate cut-price operations. Moreover, the business models of such rivals appear to be simpler than their own. In the 1990s, for instance, all the major airlines launched no-frills second carriers—Continental Lite, Delta Express, KLM’s Buzz, SAS’s Snowflake, US Airways’ MetroJet, United’s Shuttle—to take on low-cost competition. All these second carriers have since been shut down or sold off, showing how tough it is for companies to use the dual strategy.
Although most executives don’t realize it, companies should set up low-cost operations only if the traditional operation will become more competitive as a result and the new business will derive some advantages that it would not have gained as an independent entity. For example, in the financial services industry, HSBC, ING, Merrill Lynch, and Royal Bank of Scotland have set up low-cost operations in the form of First Direct, ING Direct, ML Direct, and Direct Line Insurance, respectively, because the new and old operations generate several synergies. The low-cost operations offer customers a small number of products—term deposits, savings accounts, and insurance—through cost-efficient distribution channels such as the Internet. Since they reach out to consumers the flagship banks cannot afford to serve, the no-frills businesses protect the parents. The flagship operations combine the funds the subsidiaries raise with their own, which allows them to make investments cost-effectively. That approach helps both parent and subsidiary.
A successful two-pronged approach requires the low-cost business to use a unique brand name such as HSBC’s First Direct or at least a sub-brand such as ING Direct. A distinct brand helps communicate that fewer services go along with lower prices. It also allows customers’ expectations to form around the low-cost business model rather than the traditional operation. First Direct customers, for example, are more satisfied with their ATM network than HSBC customers are even though both use the same machines. Whereas HSBC customers demand ATMs at every corner, First Direct customers, who don’t expect so many machines, are delighted to see them.
Conventional wisdom suggests that because a low-cost operation’s sources of competitive advantage aren’t the same as those of the parent, the subsidiary should be housed separately. By setting up an independent unit, an established company can create a start-up operation with structures, systems, staff, and values that are different from its own. Because it is independent, the low-cost operation will be more accountable and is less likely to be smothered by the parent business’s worry that the subsidiary will cannibalize its sales. However, as the case of the airlines shows, independent units are necessary but not sufficient for the success of a dual strategy. That’s because common ownership often imposes constraints on low-cost operations. For instance, the trade unions didn’t allow U.S. airlines to pay employees of their low-cost subsidiaries wages as low as those at Southwest Airlines and JetBlue. Unsurprisingly, those subsidiaries failed to take off.
Another factor that affects incumbents’ low-cost businesses is the allocation of resources. When disruptors are new ventures, they face market tests of their capital needs. Subsidiaries face internal resource-allocation processes that optimize different criteria—both for legitimate reasons, such as higher margins and lower risk, as well as illegitimate ones, such as power and politics. Consequently, the parent may end up starving the new unit. Remember how Bausch & Lomb didn’t provide a budding business with enough resources to launch the disposable contact lenses it had developed? The new lenses were cheaper than the permanent lenses B&L then marketed. They also didn’t need to be stored in solutions, which contributed to the parent’s profits. Therefore, B&L left the field open for Johnson & Johnson to launch a profitable new business.
A two-pronged strategy delivers results only when the low-cost operation is launched offensively to make money—not as a purely defensive ploy to hurt low-cost rivals. Companies should let their old and new businesses compete with one another and incorporate cannibalization estimates into business models and financial projections. Dow Corning’s creation of Xiameter is an excellent illustration of how companies should use the two-pronged approach. Despite enjoying a 40% share of the global silicones market in 2000, Dow Corning found low-cost competitors entering the industry. Rather than slashing prices, it decided to set up a low-cost business. Two years later, after segmenting the market and identifying potential customers, Dow Corning created Xiameter. Compared with Dow Corning, which sells 7,000 products, the subsidiary sells only 350, all of which face intense competition from low-cost players as well as from the parent. Xiameter’s limited range prevents it from eating up its parent’s sales.
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Dealing with Dual Strategies
When companies discover that the low-price customer segment is large, they often set up low-cost ventures themselves. Because of their years of industry experience as well as their abundant resources, incumbents are often seduced into believing that they can easily replicate cut-price operations. Moreover, the business models of such rivals appear to be simpler than their own. In the 1990s, for instance, all the major airlines launched no-frills second carriers—Continental Lite, Delta Express, KLM’s Buzz, SAS’s Snowflake, US Airways’ MetroJet, United’s Shuttle—to take on low-cost competition. All these second carriers have since been shut down or sold off, showing how tough it is for companies to use the dual strategy.
Although most executives don’t realize it, companies should set up low-cost operations only if the traditional operation will become more competitive as a result and the new business will derive some advantages that it would not have gained as an independent entity. For example, in the financial services industry, HSBC, ING, Merrill Lynch, and Royal Bank of Scotland have set up low-cost operations in the form of First Direct, ING Direct, ML Direct, and Direct Line Insurance, respectively, because the new and old operations generate several synergies. The low-cost operations offer customers a small number of products—term deposits, savings accounts, and insurance—through cost-efficient distribution channels such as the Internet. Since they reach out to consumers the flagship banks cannot afford to serve, the no-frills businesses protect the parents. The flagship operations combine the funds the subsidiaries raise with their own, which allows them to make investments cost-effectively. That approach helps both parent and subsidiary.
A successful two-pronged approach requires the low-cost business to use a unique brand name such as HSBC’s First Direct or at least a sub-brand such as ING Direct. A distinct brand helps communicate that fewer services go along with lower prices. It also allows customers’ expectations to form around the low-cost business model rather than the traditional operation. First Direct customers, for example, are more satisfied with their ATM network than HSBC customers are even though both use the same machines. Whereas HSBC customers demand ATMs at every corner, First Direct customers, who don’t expect so many machines, are delighted to see them.
Conventional wisdom suggests that because a low-cost operation’s sources of competitive advantage aren’t the same as those of the parent, the subsidiary should be housed separately. By setting up an independent unit, an established company can create a start-up operation with structures, systems, staff, and values that are different from its own. Because it is independent, the low-cost operation will be more accountable and is less likely to be smothered by the parent business’s worry that the subsidiary will cannibalize its sales. However, as the case of the airlines shows, independent units are necessary but not sufficient for the success of a dual strategy. That’s because common ownership often imposes constraints on low-cost operations. For instance, the trade unions didn’t allow U.S. airlines to pay employees of their low-cost subsidiaries wages as low as those at Southwest Airlines and JetBlue. Unsurprisingly, those subsidiaries failed to take off.
Another factor that affects incumbents’ low-cost businesses is the allocation of resources. When disruptors are new ventures, they face market tests of their capital needs. Subsidiaries face internal resource-allocation processes that optimize different criteria—both for legitimate reasons, such as higher margins and lower risk, as well as illegitimate ones, such as power and politics. Consequently, the parent may end up starving the new unit. Remember how Bausch & Lomb didn’t provide a budding business with enough resources to launch the disposable contact lenses it had developed? The new lenses were cheaper than the permanent lenses B&L then marketed. They also didn’t need to be stored in solutions, which contributed to the parent’s profits. Therefore, B&L left the field open for Johnson & Johnson to launch a profitable new business.
A two-pronged strategy delivers results only when the low-cost operation is launched offensively to make money—not as a purely defensive ploy to hurt low-cost rivals. Companies should let their old and new businesses compete with one another and incorporate cannibalization estimates into business models and financial projections. Dow Corning’s creation of Xiameter is an excellent illustration of how companies should use the two-pronged approach. Despite enjoying a 40% share of the global silicones market in 2000, Dow Corning found low-cost competitors entering the industry. Rather than slashing prices, it decided to set up a low-cost business. Two years later, after segmenting the market and identifying potential customers, Dow Corning created Xiameter. Compared with Dow Corning, which sells 7,000 products, the subsidiary sells only 350, all of which face intense competition from low-cost players as well as from the parent. Xiameter’s limited range prevents it from eating up its parent’s sales.
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