March 2008

Tools for Thought

Inflation & The New Competitive Pricing Intelligence
Federal Reserve Chairman Bernanke must blanche a little when he looks at the cover story in this month's WIRED magazine. Here he is working day and night trying to keep the banking system afloat, trying to keep the deflation in housing and mortgage prices from spilling over into the rest of the economy, trying to massage confidence into the domestic markets and into his fellow Central Bankers abroad when along comes a loud Chris Anderson of "Long Tail" fame, editor in chief of Wired magazine, with a louder cover story called "FREE: Why $0.00 Is The Future Of Business."

I mean, that's just what Ben and his predecessor Alan have been trying to prevent for many years, at least since 9/11. FREE does not today connote good things in a central banker's mind. FREE connotes deflation. FREE connotes disorderly markets with sellers and no buyers. FREE connotes the price that JP Morgan just paid for Bear Stearns. FREE connotes not the "R" word but the "D" word. And FREE or the bundling of FREE can often mean a seismic shift in a business model.

So what did Chris Anderson have in mind when he wrote that story? The article is not as radical as the cover makes it sound, no surprise there. He starts off with the canonical business school case of King Gillette giving away the durable, the razor, so that customers will repeatedly buy the consumable, the blades. This is the classic tale of a cross-subsidy and an attempt at vendor lock-in. But one of the interesting things he contributes in the story is a "taxonomy of free." He identifies six ways that companies seek to incorporate free into their marketing. They are: "freemium", advertising, cross-subsidies, zero-marginal cost, labor exchange, and the gift economy. There may be others, and some of these are related, but it is a good start for looking at the concept.

So how does all this add up to the professional who has to anticipate competitive knowledge flows? Returning first to the subject of your tax dollars at work: billions of dollars are being created to bail banks out of bad mortgage loans and poorly thought out derivative securities. That means money supply growth is outstripping growth in the real economy. And that means more domestic inflation, sooner or later, even if China and India weren't growing rapidly, which they are.

We haven't had to deal with inflation for so long that we have forgotten what it can mean for our business models and our value chains. Inflation is a shift in relative price. Some goods get more expensive relative to other goods. Conversely, some goods lose their relative value. If part of the story is inflation for essentials like food and energy, that means less spending power is available for discretionary goods and services, impacting your value proposition. In short, look for inflation to accelerate changes in your business model and your value chain.

Here are a couple of implications of FREE and inflation that the article didn't cover. Increasing inflation will likely mean that the cross-subsidies or other pricing combinations that have been stable contributors to your product and service portfolio will come under pressure, perhaps needing to be updated or eliminated. Second, you and your competitors will be raising your prices, eventually setting off executive requests for better pricing competitive intelligence. You've now been warned. Competitive strategy professionals should anticipate these requests and review their tools and methods for acquiring competitive pricing data.

Please contact us at: 913-712-9136 or email Tom Davis at tdavis@cygnusassociates.com