Wireless Without Profit

Your client is a manufacturer of handheld wireless devices. The client is gaining market share but seeing declining profits. Why? What should it do?

Revenue for a manufacturer is a function of sales volume multiplied by sales price. The interviewer has already tipped us off that sales volume is increasing (that is, market share is going up). Logically, in order for profits to fall in this situation, prices must be declining or costs must be going up. The other possibility is a combination of these two situations.

Interviewer: Our client has been dropping prices, and expenses have been trending higher.

Zeroing in on the client’s pricing is probably the best place to dig in for further questioning. Pricing is a conscious decision by the client, and it is possible that the client has decreased its prices intentionally to gain market share. Or the client might have been forced to drop prices in order to follow competitors’ lead.

Candidate: What is the client’s pricing strategy?

Interviewer: Our client’s pricing strategy is based on matching the low-price leader in the market.

Now you are starting to get valuable information. If companies in this market are lowering prices, there could either be an oversupply of handheld wireless devices, or certain competitors might have lower cost structures which enable them to earn a profit at a lower price. Certainly it would be helpful to develop a comparison of the cost structure between our client and its competitors.

Candidate: How many low-price leaders are there?

Interviewer: As it turns out, several new entrants to the market have successfully established positions as low cost producers.

This is where the client’s broader strategic objectives come to bear. To deal with this problem, the client has two basic choices: it can either attempt to reduce costs in order to be competitive with the new entrants, or it can focus attention on strengthening its presence in customer segments in which it has stronger product differentiation. Of course, to determine either, you first need a clear idea of what the client does!

Candidate: What does our client make?

Interviewer: The client makes wireless-enabled tablets, much like the Palm Pilot.

Candidate: How are these products distributed?

Interviewer: The client sells most of this hardware to large corporate buyers through a direct sales force. About 20 percent is sold to smaller companies and individuals.

While you are not overly familiar with this type of product and its applications, a possible method for segmenting the market is to consider potential purchasers:

  1. Fortune 500 corporations (aka large corporate buyers)
  2. Small and mid-sized companies
  3. Sole proprietors and individual consumers

Clearly, these segments exhibit diverse buying behavior, based on different needs and budget resources. It’s time to state an assumption and see if it flies with the interviewer.

Candidate: I assume that our large corporate buyers value strong after-sales support, are willing to pay for the most advanced machines, and buy larger volume orders with less price sensitivity.

Interviewer: That’s true.

The Fortune 500 corporate market is very desirable, and probably the strongest long-term position for competitors in this market. Therefore, it’s important to find out how the client’s product/service bundle matches the needs of this segment, and what the new competitors are offering.

Candidate: What is our after-sales support like? And can you discuss our R&D (that’s research and development) capabilities?

Interviewer: Yes, the client is noted for a very strong service department and its R&D capabilities consistently generate new features. The new low-price entrants have mimicked most of the technology features of our client’s product, but the competitors’ products are marketed through retail channels where little after-sales support is provided.

This is enough information to reach a tentative conclusion. The client seems to be pricing its products incorrectly. While it is matching the new entrants’ aggressive prices, the product/service mix is superior to the low-price competitors’ offerings.

Candidate: Market share is probably increasing simply because the price drop increases the value proposition to customers because the firm offers a superior product for the same price as its competitors. The fact that profitability is declining indicates that demand is fairly inelastic, since the increase in sales is not making up for the decreased margins. Therefore, our client may want to raise its prices and focus on maintaining a strong niche with the large corporate buyer market.

You’re not done yet – don’t forget the expense side of the problem (remember back to the original question?). It’s important to determine why expenses are increasing.

Candidate: Have R&D costs increased as a result of the competition?

Interviewer: No, they have remained stable.

Candidate: Has the company opened up any new plants to supply the increased demand?

Interviewer: No, our current plants are not yet at capacity and are functional, modern facilities. Our client’s costs have increased because management has aggressively added new sales and support people to keep pace with growth.

Candidate: Increased sales and support staff gives the company advantages in servicing its primary market segment, but there is a risk in raising cost structure too high, to a point where end-users can’t justify the premium pricing. It would be worthwhile for the client to perform a study on the size and activities of its sales staff, comparing costs to benchmarks from within its industry and other industries.

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