Published January 2001

Don't let product morph into commodity

Most businesses never see it coming. If you were to ask management, they would tell you it seemed like everything was fine, and then it was like they suddenly hit a wall. Profits began to disappear; customers became more difficult to deal with; and workers seemed harder to motivate.

What happened? They had been producing their own product or service. Suddenly, they were producing a commodity.

The differences between a product and a commodity are important to both economics and business management. The key characteristic of a commodity is that it is the same thing no matter who produces it. If you are selling copper or natural gas, for example, nobody knows, or cares, what mine or well it came from.

For economists, this means that if there are many producers in competition, each faces a “horizontal demand curve” — a situation that is great for the overall efficiency of an economy but a nightmare for the businesses involved.

What it means to a business is that it can move everything it can produce when it sells at or lower than the market price but can sell nothing if it raises its price higher.

Under these conditions, a firm’s profits quickly head south. Consumers no longer care much about which brand they buy or from whom. The market price often is pushed down by tanking firms that are thrashing around desperately for cash flow. Even under the best conditions, the only firm that does well is the “lowest cost producer” — and in today’s global economy, this often is a temporary situation.

Our economy is full of examples of products that morphed into commodities, sometimes gradually, sometimes overnight. Personal computers, televisions and many small appliances, such as microwave ovens, have each lost any real market impact for their brand identities. Manufacturers scramble to find profits in an environment of producer anonymity and declining prices.

Automobiles also are showing signs of decline in both brand consciousness and brand loyalty. Even the ultimate consumer purchase, the home, is showing signs of becoming a commodity, differing only in that it has resale value. Many consumers already discuss their homes in much the same language that they would refer to, say, their holdings of 1,000 shares of Perplex Corp.

For a long time, the service industry enjoyed considerable immunity to this process of what economists call “commoditization.” Today, highly branded services such as airlines, hotel rooms and banks have become largely interchangeable. Even services provided by doctors and lawyers have become, if not commodities, then something perilously close to them.

The market for laser eye surgery is a recent example of how rapidly market forces can transform a highly specialized, personalized service into a medical commodity. Initially branded through its attachment to a specific doctor, it has become a packaged, advertised “procedure” arranged at one of, literally, thousands of clinics (retail outlets) set up for that specific purpose.

For management, the transformation of your product or service into a commodity is about as pleasant as falling into the hands of the Spanish Inquisition and having Torquemada take a personal interest in your case. And, sadly, once the process gains momentum, because of its effects on profits, few companies will have the financial resources to turn it around.

The management art, then, is to get your thinking out in front of the process. If you begin to notice that your profit margins are declining even when unit costs also are going down, that could be a clue that your product is morphing. And if you find there are more competitors and your pricing decisions seem to be based more on their prices and less on your own assessments of customer satisfaction and demand, you may be drifting toward Commodityville.

The strategy to counter this process is called “product differentiation,” and it is your only hope. Your product or service has to be so closely identified with your company, your name, your brand, that it cannot be separated. This will mean spending time, effort and money on product design and development as well as intellectual property — and then pursuing these elements with aggressive marketing.

Unless you are the CEO, and sometimes even if you are, you may encounter resistance to this strategy, for it is entrepreneurial and includes risk. Many managers would prefer to “do what they are currently doing, only better.” This behavior reduces the element of risk, of course, by substituting the certainty of failure.

In today’s competitive world, you only have two options: create a strong identity for your company or wait around for somebody to put you out of your misery.

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

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