The Commoditization Conundrum
If there's one thing that
microeconomics has demonstrated, it is that it's hard to keep your profit
margins high if you're in the wheat-growing business. Wheat is pretty much
wheat, no matter where it grows, and it's pretty easy to grow unless the Dust
Bowl is raging. That means that the supply of wheat rises quickly to meet
demand, which, in turn, keeps a downward pressure on prices. Wheat, in other
words, is the definition of a commodity, and the market for wheat--absent
government intervention--is about as close to perfect competition as you can
imagine.
The same
would be true, one might think, of salt. If anything, salt is easier to produce
than wheat. And salt is the same all around the world. It should, in theory, be
impossible for a company to charge more for its basic salt than its competitors
do. And yet, Morton actually owns nearly half the American salt market, even
though its salt is more expensive--at least a few pennies more--than other
brands. If salt is a commodity, and surely it is, then American consumers
appear not to know it.
The lesson of Morton's success, obviously, is that even the
most mundane and undifferentiated of products can be made into something unique
with the right marketing strategy. Salt is salt is salt, except when it comes
in a blue canister with a little girl with an umbrella on it and the promise
that rain won't damage its pourability. Yet what's striking about American
business today--and in particular about the very industries that we now think
of as the heart of our economy, namely information technology and financial
services--is that the people in charge are not consoled by the thought of
Morton's successful "branding." Instead, they are haunted by the specter of
that wheat market. Luckily for them, though, we're much further from that world
of perfect competition than much recent hype would suggest.
What
corporations fear is the phenomenon now known, rather inelegantly, as
"commoditization." What the term means is simply the conversion of the market
for a given product into a commodity market, which is characterized by
declining prices and profit margins, increasing competition, and lowered
barriers to entry. ("Commoditization" is therefore different from
"commodification," the word cultural critics use to decry the corruption of
higher goods by commercial values. Microprocessors are commoditized. Love is
commodified.)
Without this fear, corporate America should be
in its heyday. Profits and stock prices are at record highs, and there's no
sign of any meaningful challenge--regulatory or otherwise. But analyses of the
prospects for the personal-computer industry or the banking industry or even
the clothing industry reveal a permanent anxiety. What companies rely on for
profits today they assume will most likely not be there tomorrow, because
tomorrow someone else will be making the very same thing for less. (Click for
one recent, emblematic account.) In this universe, even the paranoid may not
survive.
Insofar
as commoditization is a reality, it's all to the good for consumers. It is
witness to the enormous distance U.S. corporations have traveled from the
inefficiencies and quality-control debacles of the 1970s. Commoditization can
only take place, after all, in a world in which second-tier companies can
compete in terms of quality and efficiency with top-of-the-line companies. And
commoditization, or at least the fear of it, encourages innovation. Those
technological breakthroughs that allow a company to distinguish itself from its
competition and charge a premium for its product are more likely and fruitful
in an economy characterized by price competition than in one dominated by
oligopolies. Finally, and perhaps more dubiously, commoditization has furthered
the democratization of fashion and interior decoration. Whether you deplore or
welcome the Gap-ification of America, it is happening.
Still, this supposed ubiquity of commoditization is
difficult to square with one fact: A few large corporations dominate many, if
not most, major U.S. industries. From Coke and Pepsi to Compaq,
Hewlett-Packard, and Dell, to Intel to Gillette, companies have been able to
maintain high profit margins and market share in businesses that, in theory at
least, should be eminently susceptible to competition.
In some
cases, with the auto industry being the best example, commoditization has been
fended off by the enormous capital investment required to enter the business.
It takes a much smaller initial investment to make a new word-processing
program than it does to build a car. In other cases, like the soft-drink
industry, a curious confluence of taste distinctions and brand identification
makes meaningful challenges difficult to imagine. Coke does taste different
from Pepsi and RC, but that taste difference is reinforced by the all-American
mythology that has been wrapped around it. In still other cases--the
personal-computer industry, for example--the brand name becomes a kind of
surrogate for quality and reliability. It's possible, even likely, that XYZ
Computer makes a PC every bit as good as Compaq's. But because I recognize
Compaq's name, I'll buy its PC without bothering to check out what XYZ is
offering. If I pay extra for Compaq (which I probably won't have to), it's to
cover the opportunity cost I avoid by not having to comparison shop.
The greatest example of a company avoiding
seemingly certain commoditization is Intel, which continues to charge premium
prices for its microprocessors even though, by all accounts, its Pentium chips
are no more powerful than chips made by Intel's two main competitors, Advanced
Micro Devices and Cyrix. It's true that Intel's production lines have been
consistently more reliable and efficient than either AMD's or Cyrix's. That
makes PC manufacturers more comfortable putting Intel chips in their computers.
But other factors contribute to Intel's success. The mere fact of its
commanding position in the microprocessor market--a position it initially
achieved by technological superiority--has made computer makers leery of doing
business with its competitors, lest Intel fail to give them access to new, more
powerful chips in the future.
More
strikingly, Intel's successful "Intel Inside" ad campaign has created a brand
name for a product that observers once believed was the very definition of a
commodity. As one less-than-prescient ad exec put it in 1991 while labeling
Intel's advertising efforts "awfully stupid": "Most people that buy computers
don't even know that that chip is in there. They care about the performance of
the computer. It really doesn't matter what the chip is." Oh well. Cyrix and
AMD are now spending millions of dollars on TV-ad campaigns in recognition of
the fact that it really does matter.
More intriguing than Intel's success, though, is the
continued market domination of companies like Gillette and Campbell's soup.
While Gillette's razors are technologically superior to Schick's and Campbell's
soup tastes better than its competitors', the quality differences aren't big
enough to account for these companies' ability to combine premium pricing with
huge sales. (Gillette owns 67 percent of the U.S. razor market, and Campbell's
has more than 75 percent of the U.S. soup market.) Nor can we simply ascribe
their market dominance to advertising. What's going on seems to be something we
might describe as "the narcissism of small differences." In an odd way, the
more similar products become, the more telling the little differences among
them end up being. Branding successfully, in other words, can turn a small
difference between products into a huge difference in market share.
None of this means that
Gillette and Campbell's are not pushed by their competition, since all the
evidence suggests that they are constantly looking for competitive advantages.
What it does mean, though, is that commoditization does its work not by
becoming a reality (which would entail ever-shrinking margins and stagnant
stock prices) but by remaining a perpetually present threat. It's the idea that
perfect competition might be just around the corner, not the competition
itself, that keeps the paranoid prosperous. And alive.
