Published December 2001

Preserve profits,
product’s value through differentiation

Volkswagen’s Microbus was a 1960s icon. It was succeeded by the Vanagon, which was so popular that its loyal drivers have bonded with the vehicle and each other with near-cult intensity. The Vanagon’s replacement, the Eurovan ... well, let’s just say that it is a road rarity.

Sales of the Eurovan started weakly and quickly lost momentum. Consumer response was so bad, in fact, that in some years, Volkswagen didn’t even bother shipping new models. They decided to sell it only in the camper version — and managed to sell 995 of them in 1996.

Eventually, a few thousand of them were sold each year, but the numbers never climbed to the economic threshold where the distribution costs — marketing, maintenance and vehicle/parts inventory — could be covered by revenue. It was a deadweight loss.

What was wrong? It was simply overpriced.

Consumers, even loyal Volkswagen buyers who preferred its boxy, uncompromisingly functional design, found that it could not even come close to surviving a cost comparison, feature for feature, with the U.S. and Japanese competition.

This year, Volkswagen decided to address the U.S. market with a new Eurovan — which is pretty much the old Eurovan beautified by a sticker showing a 16-percent lower price.

For a company that has thus far monumentally botched this market, and this vehicle, the timing couldn’t be better. The U.S. economy is braking hard, and consumers are clearly looking for value in their purchases. This tends to make lower-priced goods more attractive, and, however accidentally, Volkswagen’s pricing strategy is right on target.

The latest retail sales data, for example, show most mall-based major retailers are seeing reductions of at least 6 percent compared with last year, while discounters such as Wal-Mart, Costco and Home Depot are seeing increases.

No one knows how long this economic downturn will last, but it is a safe bet that for the next year, at least, most businesses will be facing downward pressure on their selling prices.

When exposed to this pressure, it is generally smart to resist the temptation to slash prices immediately, because failure to hold and defend the prices of your product or service will ensure that the original demands for price cuts are followed by others.

However, in an economy and market like today’s, some strategic price setting can keep you profitable when others are floundering.

Instead of simply reacting to market demands for lower prices, though, you should, if possible, reposition your product in the market. It will carry a lower price, surely, but if done right, it is part of a customer-oriented value-price continuum that will support your business’ profitability.

The two economic principles behind this strategy are consumer surplus and product differentiation.

The first, consumer surplus, is the term that economists use to describe the fact that for any given product or service there are consumers who would be willing to buy it at a higher price than they actually had to pay. There aren’t as many, certainly, but they are there.

The second, product differentiation, refers to the characteristics of a product or service that make consumers perceive it as different from other, similar products.

A successful market strategy, then, will couple a price reduction with the introduction of a differentiated product — which could essentially be a new form of the existing product — which meets the demand for a higher-value version.

The higher-priced product might include some features that do not come with the discounted version. Depending on the product, these features might include direct and visible product enhancements and a new product name.

A power tool, for example, might come in the “professional” model, which comes only in silver and includes an extra battery and a carrying case.

In general, product differentiation can include anything that will differentiate that higher-priced product from the lower one and preserve the attractiveness of the brand to a significant number of customers.

The important thing for a business in these economic times is to take positive action and use your market strategy to address the already changed market. That way, your business can preserve its profitability in the face of softening prices.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

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