In the February 12, 2011 Issue of The Economist, the lead article in the Business Section discusses the recent history of the cell phone, particularly focused on the fall from leadership of Nokia (http://www.economist.com/node/18114689). The charts on cell phone market share and profitability share (below) tell a remarkable story... Asian competitors like Samsung, HTC and LG have been eating away at Nokia’s market share for years, however, the entry of Apple and its iPhone has been a disaster. Apple rapidly took half the industry profitability (a position that Nokia held in 2007) and have crushed 75% of Nokia’s profitability. This reminds me of another business lesson I learned in the mid-1980s.
In 1986, I was at Bell Labs, supporting new service introduction for AT&T Long Distance. AT&T was just emerging from decades of rate of return regulation and was learning how to manage for profit and deal with anti-trust regulations. Their 80%+ market share in long distance telephone service caused intense scrutiny by DoJ and the FCC. I attended a seminar by one of the AT&T business leaders that described the market position of IBM at the time... 40% market share and 60% of the market profitability. He asserted that AT&T’s goal should be to manage our share down and our profitability up until we reached a similar position in our marketplace. Only then would the intense scrutiny and pressure on AT&T subside. AT&T tried and failed to execute this strategy.... market share did come down, however, profitability came down at the same time.
One of the great difficulties companies in telecommunications have, and this applies to both carriers and to equipment providers, is getting pricing right. I think of pricing as a capability maturity model... the lowest level of pricing maturity is ad hoc: try a price and see what happens. The next level up is cost-based pricing. This requires a product manager to have access to accounting information of sufficient quality to fully understand the loaded cost of the product, including customer service components, and how cost varies with volume. The next level of sophistication is competitive pricing, i.e., understanding your cost structure and the cost structures of your competition so that the behavior of competition can be understood as prices are raised and lowered.
The next level up in sophistication is value-based pricing. Understanding the value a product or service brings to the customer by understanding the customers’ cost structure and alternatives to your product or service. Not just a competitive substitution, but architectural and operational alternatives. The highest level of sophistication is normally called Brand management, where manipulation of perception, through advertising, drives up value of your product in the mind of the customer and allows higher levels of price and profitability to be achieved.
Most of telecommunications products and services pricing operates in the cost-based or competitive pricing levels of maturity. Apple, a supreme brand manager, operates a couple of levels higher in the Pricing CMM hierarchy. Consequently, they were able to price high and maintain their perceived difference in value while their competition were starved for profits. They taught the smart phone market some tough lessons that are forcing companies like Nokia to change or die.
What are your thoughts on the smart phone competitive marketplace? How do you react to the remarkable history of market share and profit share in mobile phones?
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