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Innovation, Globalization & the Perils of Commoditization

Commoditization, the steady erosion of value in higher-priced products, is banging furiously on doors at electronics OEMs. This holiday season, we'll see how well these companies can successfully stave off the scourge.

Interestingly, product and technology innovation — the same weapon OEMs rely upon to help secure high profit margins — is also partly responsible for price declines. Not even {complink 379|Apple Inc.} is immune to the problem of value erosion. In fact, Apple's business strategy is based on finding new ways to keep customers engaged, primarily with design-oriented updates to its products. Next-generation iPhones and iPods, for instance, often involve aesthetic improvements and software add-ons meant to create the impression of significant technological advances.

Staying ahead of the commoditization curve is certainly a priority for Apple executives. The company made this clear in its latest annual filing with the US Securities and Exchange Commission. Here's how Apple puts it:

    The company's products and services compete in highly competitive global markets characterized by aggressive price cutting, with resulting downward pressure on gross margins, frequent introduction of new products, short product life cycles, evolving industry standards, continual improvement in product price/performance characteristics, rapid adoption of technological and product advancements by competitors, and price sensitivity on the part of consumers.

How should an OEM respond to these demanding market conditions? Apple said it has “to ensure a continuing and timely introduction of innovative new products and technologies to the marketplace.” That strategy has worked brilliantly so far, but competitors are nipping at Apple's heels and in most cases using the same technique to increase their market shares, as Apple noted in the SEC filing:

    By contrast, many of the company's competitors seek to compete primarily through aggressive pricing and very low cost structures. Additionally, the company faces significant price competition as competitors reduce their selling prices and attempt to imitate the Company's product features and applications within their own products or, alternatively, collaborate with each other to offer solutions that are more competitive than those they currently offer.

Recently, even Apple has had to cave in to the pricing pressure in a bid to keep market share in the smartphone market. As competitors crowd into the smartphone segment with a wide range of offerings, Apple is coming under pressure to also be a player in the low end of the market; the company is now selling the older version of its smartphone, the iPhone 3G, at a giveaway price while churning out higher-margin products like the iPhone 4S for its richer customers.

While news reports often focus on surging demand for the iPhone 4S the reality is that, even as customers in China wait anxiously for it, demand is even higher for Android-based devices, many of them selling at a heavy discount to the Apple product. Apple has therefore authorized {complink 502|AT&T Inc.} to offer the iPhone 3GS free to subscribers in the US so it could play in the lower-end of the smartphone market.

This development masks the unpleasant truth that the process of innovation also holds the kernel of commoditization; that is, pricing for high-end products tends to decline within months of release, throttling margins and forcing companies to accelerate the update process. It's a vicious circle — in order to stay ahead of pricing erosion, companies must introduce new products, a process that in itself further drives down prices in most cases.

Where does globalization come in? As more people around the world seek to get connected to the Web, pricing is sliding, too. While consumers in the West queue up to pay hundreds of dollars for the new iPhone 4S, for instance, consumers in other parts of the world can't imagine paying anything close to this. So, OEMs and researchers in poor countries are developing stripped down PCs, smartphones, and tablets that perform essentially the same functions.

These products, including the Aakash tablet PC developed by Indian technologies, lack the brand name or proprietary software of companies like Apple, Google, or Samsung. They use basic components offered by many of China's equally less known suppliers, driving pricing down to a point where some of the poorest people in a country like India can afford the same products available to Western buyers. For an interesting take on this phenomenon, see “The Last Person,” an article by Thomas Friedman in The New York Times.

Someday, many buyers will find the Aakash tablet or another similarly cheaper device appealing, lured perhaps purely by the pricing but, who knows, perhaps by the functionalities, too.

7 comments on “Innovation, Globalization & the Perils of Commoditization

  1. prabhakar_deosthali
    November 16, 2011

    Yes! there is a huge market for the commoditised products in the developing world. And many times the quantum of sale from such products can offset the low volume high priced premium products. Today in India the loest level labourers earning a mere $2 a day, can be seen engaged in hour-long conversations with their near and dear ones on their mobiles. These devices are not those hi-fi Iphones or Blackberries but some unbranded products coming from China, serving their purpose at the price they can afford.

    The coomoditization of PCs has helped the student community in developing countries like India , where they can now afford to have their own desktop/laptop instead of waiting for their turn at the college lab for the precious computer time.

    Like the Fshion industry is driven by innovation all year around, but the consumers for this designwear are only a select few. The masses wear only the commoditized designs.

    So actually the maases are getting benefitted when the pace  of innovation increase as they get better products much sooner at affordable prices.

     

  2. jbond
    November 16, 2011

    No company or product is above commoditization, and to think so is foolish. The best anybody can hope for is to stave this off for as long as possible. I think Apple is making a good move by getting involved on the low end of the market. There are still plenty of consumers not able to spend big dollars on the latest models. These people will also spend money on apps and still bring in a revenue stream.

  3. Barbara Jorgensen
    November 16, 2011

    I'm a big fan of having a choice in the market when it comes to the low-end versus high-end. I can certainly understand a company that wants to create a high-value product that holds it value–luxury cars is a great example. I think Apple can continue to succeed with this strategy but they'll have to sacrifice a product here and there, such as the phone you mention that is priced competitively. But it's tough to see which way the market will trend, and developing new products at the pace Apple has to to maintain leadership will eventually lead to a price war.

  4. Himanshugupta
    November 16, 2011

    the premium price that we usually pay for the new product is for the niche technologies so that the company can recover the RnD cost asap. And the price difference between a new product and an old product makes sure that the company can cater to a wider range of customers. By doing so, the company puts more pressure on its supply chain as the parts used in an upgrades version are almost same/similar to the previous version. So, doesn't it make sense to analyze how to free up the supply chain by stop producing one/two generation older products? 

  5. bolaji ojo
    November 16, 2011

    @jbond,Interestingly, after I wrote the article I saw a report about Apple that the company may have to lower the price of its iPad tablets. The report (iPad 2 price slash incoming analyst insist) may not be correct but it points to a possible trend. Some other analysts have questioned the veracity of the report. We'll find out soon how true this is. Knowing Apple, it's a challenge that must be countered.

  6. dalexander
    November 26, 2011

    Bolaji, I really like your definition of what a commodity is with regards to declining price trends. I think most of us know that if we can wait 6-9 months after a company introduces a new product, we will have the benefit of that price erosion usually in excess of 20-25%. I waited for my first digital camera, Dimage, announced at $2500, and bought one about 8 months later for $999.00. 6MP. Can you say WooHoo? Alas! My new Samsung Galaxy II Skyrocket only has 8MP rear and a measly front facing camera at just a few MP. I can't wait for my next phone with a side facing camera of 16MP. Should be out in about 6 months at $299.00.

  7. dalexander
    November 26, 2011

    Jbond. I have several expensive toys that are sooooooo 10 minutes ago! You are absolutely right. Product life cycles as released seem to be getting shorter and shorter…especially the hand-held goodies.

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