In 1993 Peter Drucker published a column titled The Five Deadly Business Sins, a copy for download is available here.
Here, I want to shortly summarize them and see how they relate to what is going on in our current business world.
1. Premium pricing and high profit margins
Drucker criticizes that companies falsely assume that high profit margins equal maximum profits. The profit equation of course suggests otherwise: Total profit equals profit margin multiplied by amount of goods or services sold. Additionally he argues that premium pricing always creates a market for lower-end competitors. He gave two example for this sin: Xerox and GM. Xerox, over-engineered its copier and, therefore, raised its prices into the premium segment creating high profit margins for Xerox. However, as consumers only needed a basic version, Xerox lost significant market share to Canon who entered the market which such a basic copier. Further, Drucker argues that the U.S. automobile industry (including GM) lost market share due to its fixation on „big cars“ as opposed to Volkswagen and Japanese competitors with their small, fuel-efficient cars. U.S. competitors followed their competitors, but not soon enough, due to the low per car profit margins. This sin is undoubtedly still prevalent. One example for that is the smartphone industry: From 2010 to 2015 the average the average selling price of smartphones fell by roughly 30% from 440 to 305 US Dollar. This coincides with the raise of low-end smartphone vendors such as OPPO, Huawei, vivo and others. Other examples can be found in Clayton M. Christensen’ Innovator’s Dilemma who actually elaborates on the very same idea under the term disruptive innovation: „a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors“.
Nevertheless, there is more to it than Drucker claims: Premium pricing does work, however, companies must keep in mind three fundamental principles: Sustaining innovation vs. disruptive innovation, differentiation and selling value instead of price.
2. Market-Skimming pricing
Drucker describes this as charging „what the market will bear“. Meaning that companies who price their product at the highest price they can get will eventually lose. The issue with that, so Drucker, is that, similarly, to the first sin, this creates an opportunity for competitors to offer a product at a lower price. As a consequence they can keep the competitors out of the race and made up for lost margins through volume. Drucker goes even so far as to say that even if you have a patented product you cannot charge the highest price possible because competitors will find a way around. I personally do not think that it is that simple: Your product’s price, as part of the marketing mix is part of your positioning; A high price (think of Rolex) indicates premium. Consequently, if you want to serve the upper segment of the market you have to take the risk that new entrants will undercut you. However, if you clearly position your product as premium you should not worry about the customers switching to your competitors because they are not your customers. Naturally, you have to ensure that your product’s values reflect the higher price: If you charge a higher price for the sake of charging a higher price you will certainly lose to competitors. If, however, your customers get what they pay for, they will not even consider your competitor’s products. Again, it comes down to sustaining innovation vs. disruptive innovation, differentiation and selling value instead of price.
3. Cost-driven pricing
In cost-based pricing you start with your product’s cost: you make the product, sum up the costs for it, add a profit margin and get your price. It’s then up to the marketing department to convince buyers that you product is worth the price. If the company can sell at the set price everything is fine, however, if not, the firm will risk selling less than expected, might have to cut prices or redesign the product. The only thing then that works, according to Drucker is price-driven costing or as Kotler calls it customer-value based pricing. (You can get a basic overview of cost and value-based pricing here) What this means is that companies first have to find out what the market is ready to pay for your product and then figure out how to achieve that price to right design, production and sales. This strategy is one of the reasons behind IKEA’s success (See Strategic Management: Concepts by Frank Rothaermel for details on how IKEA does it)
4.Focusing on past successes
What Drucker means here is that companies must not concentrate all its resources on past successful products in the face of new opportunities. As an example, he listed IBM who deprioritized its PC business for the sake of its mainframe products. In theory the idea is splendid: If you have product A which has been selling good and product B which will sell fantastically you surely should go for the latter. But in practice, it is not all that black and white. Knowing what the „next iPhone“ will be is not that easy. Even if Jim Balsillie, former co-CEO of BlackBerry was of the same opinion and used to quote forme ice hocke player Wayne Gretzky saying Skate to where the puck is going to be, not to where it is (quoted in Strategic Management: Concepts by Frank Rothaermel) BlackBerry certainly underestimated the iPhone’s potential even though its former CEO shared Drucker’s view on new products.
5.Feeding problems and starving opportunities
What Drucker means by that is that executives tend to assign its best people on problems rather on opportunities. According to Drucker, problem-solving results in damage-containment, opportunities, on the other side, however, create results and growth. Interestingly, Jim Collins, found evidence of that in „great“ companies. In his book Good to Great: Why Some Companies Make the Leap and Others Don’t he says that „The good-to-great companies made a habit of putting their best people on their best opportunities, not their biggest problems. The comparison companies had a penchant for doing just the opposite, failing to grasp the fact that managing your problems can only make you good, whereas building your opportunities is the only way to become great.“
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