Attractive Thinking. Chris Radford
stranded. However, trains often have an effective monopoly on a route. Where a business can get monopoly control on a sector then the extractive approach looks irresistible. You can force customers to pay higher prices for a worse offer of product or service.
What is it that causes a business leader to choose between a value-adding approach and a value-extracting approach? There are three factors that will influence you:
1 the type of market and customer engagement with the product or service;
2 the existence of monopoly control over customers;
3 long vs short term and the commitment of management to building a sustainable long-term business.
Type of market
There are three market conditions that make the value extractive approach very risky and where more businesses will favour the ‘attractive approach’:
1 a market where consumers or customers find it easy to switch brands, no stress, no bother (think how easily you can switch your choice of chocolate bar vs how easy it is to switch bank accounts);
2 a market where people care about what they buy and what they choose (think of how you feel about which clothes you wear, or which drinks you consume vs how much you care which energy supplier you have);
3 a market where people enjoy the process of considering their choices e.g. buying clothes, choosing a coffee bar, restaurant or holiday.
Even though short-term gains can be had by saving costs, reducing quality, creating barriers to brand switching (loyalty programmes), in markets where the consumer is free to choose and it is easy to switch brands, the value-extractive approach is risky since the customers can easily ‘find us out’. The attractive approach is more obviously needed in markets where customers care about having the best product for their mood and needs and find it easy to switch (e.g. chocolate bars) whereas the extractive approach tends to arise when it is hard for customers to switch and also they don’t really care which brand or product they use and tend to feel that everyone is just as bad or as good as each other (e.g. bank accounts).
The converse is also true: That in markets where it is difficult or hard work for the customer to switch then the value extractive approach will seem more appealing. Customers generally do not enjoy spending time switching a bank account, shopping around for insurance, finding a new phone contract or switching their energy supplier. Most of us would rather be out enjoying ourselves, reading a book, meeting friends, watching TV, playing sport or whatever we really enjoy. If we know our customers are reluctant to switch, then it is tempting to find ways to make more profit from them as many will stick with you rather than endure the pain of a switch.
Another customer belief that encourages businesses to adopt the extractive approach is where people tend to believe that all providers are the same and just as good or bad as each other. If they switch, they are just jumping out of the frying pan into the fire. If the bank treats us badly, are we sure the next bank will be better?
Monopoly control over the market
The eighteenth-century economist Adam Smith was one of the first to note the conflict between the benefits of the free market that ensures economic prosperity for many and the desire of the business leader and property owner to exert control on the market so that they will not only obtain a price for their goods and services but can also ‘extract a rent’. By ‘rent’ he means the ability to charge for non-productive activity: ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.’ Adam Smith explained that in a perfect free market the self-interest of the business person will be harnessed to provide what customers need. Free competition will drive businesses to deliver what customers want. The one that does it best at a fair price will be more successful and this creates prosperity for the whole economy. This drives a productive economy that makes things and services that add value for customers and expands the wider economy. This is what underpins ’Attractive Thinking’.
However, Smith also identified that businesses will seek to find ways to ‘extract rent’ (i.e. charge more) from the population. The ability to ‘extract rent’ can come from various sources:
• Owning property – rent apartments, houses, commercial property.
• Securing patents – blocking competitors out permits higher prices.
• Legal monopoly – e.g. a rail line can charge extra for high-demand periods.
• A famous brand – enables manufacturers to extract higher prices.
These are tools used in ‘Extractive Thinking’. Rent in Smith’s view does not add value, it extracts value. It is not inherently bad, but it does not add to the total productive economy. My point here is that if our business can extract rent in some form, it encourages us to take an extractive approach to customers. We will see later that whilst the extractive approach looks easier and will produce short-term gains, it is not the best way to create long-term value and a sustainable business.
Long term vs short term
Short-term value extracting is an easier and cheaper way to raise short-term profits. Management are clearly tempted to extract as much value as possible. We have seen this in the food industry. Here are a couple of examples.
Food and consumer product companies can get carried away and use an extractive approach. In November 2016 Mondelēz decided it would reduce the amount of chocolate in each Toblerone bar rather than put the price up to reflect increased costs. They also ensured the bar looked the same size on the shelf when in its box. This required them to create larger gaps between each chocolate peak in the bar. This was to maintain the size impression and the price point whilst delivering less. There were so many complaints about this that in July 2018 they reversed this decision. In trying to extract from/deceive/confuse customers they were losing customers even if they made a bit more profit on every bar.
The Mondelēz/Toblerone example is an extreme example of an approach adopted by many food companies to ‘value engineer’ their products to make more profit in the short term. They were caught out because it was so obvious. Other food brands have not been explicitly ‘caught out’ but end up offering worse value and a product that is not as good therefore consumers become less attached to the brand and product and over time the brand either grows less quickly or goes into decline.
Early in my marketing career, I was involved in a case study where we did the opposite and added quality back into a famous brand. I worked in the McVitie’s marketing department and we were concerned about the amount of chocolate on the biscuits. We were worried the quality was not good enough. We had an idea the quality of the product was not as good as it used to be (this was hard to prove). This was a big concern when we were experiencing price competition from retail own-label products that were remarkably similar. We were asked by Eric Nicoli, the Managing Director of McVitie’s, to create a business case to increase the chocolate on each biscuit.
After considerable consumer research and financial modelling, we presented a case for adding £1m back into the annual costs of the product and showed the sales increases we would need to create more profit. We also argued that continuing to lose market share to private label was not a viable position. It was not an easy argument to win. It is much easier to present an argument on how we might save money by financially engineering the product. In that case the saving would be guaranteed, the risk of losing sales seemed slight. But the reverse argument of let’s add £1m to the cost and we might get more sales and we might get higher prices in the future was a harder one to trust. But it was the right decision and we won the day (in the end). Critically this argument would not have been won without the Managing Director championing the idea and the wider support from the board of directors.
Attracting vs extracting
We must recognise how we make decisions like this about what we produce, deliver and sell, how we price it, how we manage quality, how much this is led by customer need and how much this is led by short-term profit. Following this discussion of