Recessions have always produced a certain amount of trading down – often merely transient. But, in 2008, things might well prove to be different. For the first time, the UK consumer has real choices to make between established brands and a range of highly credible, easily available, low-priced alternatives. In the last recession there was no easyJet in air travel, in clothing there was no Primark (to speak of), in supermarkets Aldi, Netto and Lidl had a minimal presence and, in hotels, budget brands like Travelodge and Premier Inn barely existed. All came to the UK in the 1990s.
This growth in availability of low-priced alternative brands has taken place during a decade characterised by a renaissance in the performance of traditional standard and premium-priced brands. In a climate where price inflation has only recently become a factor, the leading players have done an excellent job of growing their sales via astute 'mix management'. For example, P&G has repositioned Olay away from its roots as 'Oil of Old Lady' to a modern skin care regimen whose highest price points reach up to those of Clinique and Clarins. Reckitt Benckiser has migrated the humble dishwasher tablet from a mono-functional block of compacted powder to the multi-functional, all-singing all-dancing Finish Quantum. In retailing Tesco has premiumised its own-label offer via its highly successful 'Finest' range, while Marks & Spencer drove its product-led turnaround on the back of premium private-label apparel brands such as Per Una and Autograph.
This premiumising model has been strikingly successful. The result of the model's ability to expand margins has been that an industry, condemned by investors as terminally 'mature' at the peak of the dotcom boom in early 2000, has been comprehensively re-evaluated. A portfolio of the leading UK consumer staples companies, such as Cadbury, Unilever, Reckitt and Imperial Tobacco, traded on an average price: earnings multiple 64% below that of the FTSE 100 in early 2000. In November 2008, they traded at a premium of 25%.
As we enter what might prove to be a vicious downturn, the potential for the market landscape to be reshaped is dramatic. Because value brands barely existed in the 1991 recession, there are limited precedents for speculating about how fast they might grow market share. The early evidence of market re-shaping is significant – Aldi has recently reported like-for-like sales growth of 22% in the UK. Primark has bucked the trend of the depressed UK apparel sector in posting 4% like-for-like sales growth, while Marks & Spencer and Next have reported 6% and 4% like-for-like sales declines respectively.
But just as value brands pose a challenge to markets, they pose a challenge to the practice of marketing itself. The core task of 'classical' marketing, as we all know, is to 'identify consumer needs and meet them (at a profit)'. While there is nothing in this definition that is at odds with the concept of value, observation would suggest that it represents first and foremost, a manifesto for product and service differentiation.
What classical marketers tend to obsess about is gaining an edge, either from improved features and benefits, or from a superior image. Something that you can charge a bit more for, for something that's just a bit better.
Value marketers don't think this way. What they are interested in is the power of low pricing, not product and service differentiation, and how a business system can be designed and sustained to deliver this at a profit. Value marketers tend not to have had a classical marketing training and tend to eschew much of the paraphernalia of the classical marketing approach, such as heavyweight media investment and intensive market research. What, then, has made them successful?
PRICE, RATHER THAN DIFFERENTIATE, TO GAIN ADVANTAGE
Pricing has arguably been a neglected tool in the world of classical marketing. Read any marketing textbook and you will find limited wisdom on it.
The pricing decision is one that tends to get made at a late stage after many of the fundamental decisions around the product, its formulation, packaging and launch budget have been taken. And, because of the premiumising impulse, prices inexorably move upwards by a few per cent, rarely down.
Value marketers challenge these conventional wisdoms and reject the accompanying incrementalist mindset. They are not interested in charging 5% less, but 50% less, or more. Pricing differentials between the premium, standard and value segments are now huge.
Pricing differentials between 'cheapest' and 'best' (the latter a definition that many value marketers might dispute) are between 3x and 22x across a sample of categories researched for this article.
While the price points of most conventional brands might be clustered within, say, 10–20% of each other, value brands seek to overturn the category pricing paradigms entirely and set radically lower price floors.
The resultant differentials are beyond the experience of conventional price elasticity analysis. The inverse 'sticker shock' created by value brands has the potential to force consumers to rethink how they consume a category – and overcome the occasional disadvantages and inconveniences that choosing the value alternative imposes (like flying from Luton rather than Heathrow, unless, of course, you live nearer Luton).
GROW MARKETS, NOT JUST MARKET SHARE
Classical marketers look to grow market share. Value marketers look to expand markets by creating markets where none existed before. Figures 1, 2 and 3 show the long-run impact of value brands on the size of the relevant product category in airlines, clothing and hotels.
Viewed through the classical marketing lens of gaining market share, value brands have been demonstrably successful. No-frills airlines have grown from nothing in the early 1990s to take 40% of the market for air travel between UK and Europe. Budget hotels have expanded their share of UK branded hotel rooms from 23% to 35% in six years. Value clothing retailers like Primark have grown their share of the UK apparel market from 9% to 25% in ten years.
But what is striking about these markets is that growth in value brands has largely not been at the expense of existing standard brands. Instead value brands have expanded markets – on the one hand by reaching out to segments that couldn't previously afford to access the category and, on the other, by changing fundamentally the way people consume categories.
The anecdotal evidence corroborates this picture. Weekend breaks in Maastricht and stag nights in Prague are now de rigueur since the advent of budget airlines. And, further upmarket, budget airlines helped create and support a growing market of second homes in France. In Germany, Aldi inspired the 'Audi and Aldi' phenomenon whereby the affluent middle classes have started to unbundle their grocery purchases between pantry-filling for the basics at Aldi and more discriminating purchases elsewhere. Back in the UK, Primark and others have stimulated a market for fast, affordable fashion that has driven clothing more towards a frequent, grocery-style purchase rather than an infrequent 'destination' one.
UNDERSTAND COSTS, NOT JUST FEATURES AND BENEFITS
Classical marketers focus on features and benefits, and the price premium required to afford them. Value marketers focus on lower prices and the cost structure required to sustain them. This represents a fundamental difference in both focus and skill sets.
In the case of easyJet/easyGroup, founder Sir Stelios Haji-Ioannou's critical insight was that incumbent players in capacity-sensitive industries like airlines were failing to price aggressively and creatively enough to fill that capacity. Unlike in consumer goods, the marginal cost of a sale is zero. So it makes no economic sense to fly an empty airline seat anywhere; easyJet and Ryanair therefore recognise the 'perishability' of their product and price flexibly to fill their capacity. The driving goal is to have sold 100% of the seats by the day of the flight at the best possible prices. According to easyJet, when sales open – about 200 days before the flight – they price tickets on a costplus basis; 100 days or so before the flight, a series of escalating pre-set fare classes are made available, triggered either on a days-to-go or demand-level basis. Close to departure, the customer pays a peak last-minute fare. Figure 4 shows this strategy in action on the basis of a return flight from Luton to Glasgow.
Value marketers also adopt a parsimonious approach to their product and overhead costs. Primark was one of the early adopters of outsourcing manufacturing to the Far East, with resultant ability to keep prices low. Aldi has been opportunistic in exploiting over-capacity in the European food industry to find low-cost sources of supply for its portfolio of mainly tertiary brands. In-store, cost-consciousness also prevails. Aldi favours a basic store fit with minimal displays and other accoutrements. Shelf-ready packaging is used to minimise in-store handling. At Primark there are no changing rooms, check-outs are concentrated in a single area and the store fit is kept simple.
But the importance of high volumes and resultant cost efficiencies in the value marketing model means that value marketers are prepared to invest big to secure these benefits. Primark favours flagship city centre locations, not out-of-town sheds, to drive the footfall that its model requires. Aldi's stores may be basic, but they are clean and bright with good car parking. easyJet has one of the 'youngest' aircraft fleets in the business (at an average 3.5 years) in order to reduce maintenance costs and exploit the latest fuel-efficient engine technology.
The general point here is that value marketers demonstrate an acute understanding of how costs behave in their business, and understand where adding cost is sensible to support the consumer proposition and where it isn't.
In contrast, classical marketers tend to lack such an acute understanding of the tradeoffs between different levels of features, benefits and their costs, with the result that the overall customer value proposition can be sub-optimal.
FOCUS – RUTHLESSLY
Because value marketers understand cost/benefit trade-offs so well, they focus ruthlessly on delivering only those attributes of the product and service that are either strictly necessary and/or consistent with a low price positioning. In contrast, classical marketing can fall into the trap of a too-disparate, too-inclusive approach to products and propositions.
In the budget hotel sector, brands like Travelodge and Premier Inn have recognised that, in city centres, the availability and diversity of eat-out options now means that an (often indifferent) hotel restaurant imposes significant additional costs that are not commensurate with its benefits. Similarly, there are no more than minimal in-room toiletries and no mini-bars, with resultant savings in the costs of housekeeping. However, the room fit is to a high and consistent standard, and must-have features like in-room internet are widely available.
At easyJet many of the conventional elements of the airline business model have been done away with; easyJet don't sell through travel agents, in order to eliminate commissions. There isn't a Club Class cabin and there aren't any executive lounges. Where differentiated services are provided (e.g. a faster check-in), these are charged for.
In terms of consumer perceptions of features and benefits, value marketers might be said to be happy with high ratings on just one feature and low on others, whereas a classical marketer is more inclined to optimise the offer around a bundle of features and benefits. While this may maximise the appeal to the middle market, the clarity of the proposition (and the cost of delivering it) can get compromised.
LOW PRICE NEEDN'T EQUAL LOW MARGIN
If value products and services are 50% or more cheaper than the competition, how can they possibly make money? This is a natural reaction of both observers and direct competitors to value brands. However, the reality is that value brands frequently have higher, not lower, margins than their established competitors. How so? (See Figure 5.)
Two principal factors explain this apparent paradox. First, value brands have lower overheads and, second, they spread their costs by sweating their assets harder. Low-cost airlines make for the perfect case study here.
Ryanair, thought to be the least-cost carrier in Europe, sustains a cost per available seat kilometre (the standard measure of unit cost in the industry) less than a third that of the top three carriers. This dramatic advantage is achieved in a number of ways.
The biggest advantage accrues from lower product, distribution and overhead costs. As we have discussed above, the focus on online ticket sales, disintermediation of travel agents and elimination of Club Class and other frills lowers unit costs substantially. Ryanair also get a big advantage from lower infrastructure costs (principally landing charges) as it uses secondary airports (easyJet prefers to use primary airports and accepts a cost penalty relative to Ryanair for doing this). Lower aircraft and fuel costs are also an important factor, reflecting a younger, lower-maintenance and more fuel-efficient fleet. Finally, there is a material benefit from higher seat density (spreading fixed costs over fuller aeroplanes).
THINK LIKE A CHALLENGER
The emphasis in this article has been on the economics of value marketing and how much better value marketers understand business economics than classical marketers. But a final – and striking – contrast is the different background of value marketers. Crucially, this seems to have imbued them with a 'challenger' mindset and willingness to both think and act differently to their more traditional counterparts.
While there are few similarities between the profiles of easyJet's Sir Stelios Haji-Iaonnou, Ryanair's Michael O'Leary and Primark's Arthur Ryan, significantly, none of the three comes from a classical marketing background. Instead all came from professional and managerial disciplines of high relevance to a value marketing mindset – Stelios in shipping, O'Leary in tax accounting and Ryan in buying and merchandising. All three have demonstrated a willingness to be entrepreneurial and think differently to their incumbent competitors. And while their three businesses are now powerful brands in their own right, they have eschewed many of the techniques of classical marketing.
IN CLOSING: HOW TO RESPOND?
The argument of this article has been that, as we enter the first consumer recession in the UK for 17 years, we do so with a very different and more diverse pricing landscape than we did in 1991. There is therefore a major window of opportunity for value brands to make further advances. Whereas to date value brands have served to expand markets, the next couple of years look much more like an oldfashioned fight for share. What is a window of opportunity for value brands is a corresponding threat to traditional ones. So how to respond?
1. Be prepared for change: despite the economic turmoil, the evidence for decisive shifts in market share between traditional brands and their value counterparts is still tentative. Primark's recent strong LFL performance has been impressive, but implies that it has gained something like a quarter of 1% of the UK clothing market. Worth having but not as spectacular as its sales growth might imply. Aldi and Lidl are thought to be growing their sales by 20–30% in the UK, but still have less than 5% of the grocery market. But we are likely to see further share migration into the value sector given the magnitude of the pricing differentials on offer.
2. Beware the perils of 'followership': 'if you can't beat them, join them' is the knee-jerk response to value brand insurgency. But the success of value brands resides in distinctive cultures and cost structures that are fiendishly difficult to replicate inside traditional companies.
The textbook example of failed 'follower-ship' is Continental Lite, which failed to emulate the US low-cost carrier, South West Airlines, in the 1990s. Continental Lite was ultimately too embedded in the infrastructure and labour practices of its parent, Continental, and lost $140m in its two-year existence. When British Airways attacked easyJet with the launch of Go in 1998, it avoided some of the pitfalls of Continental Lite by putting Go under its own leadership team and basing the operation far away from Heathrow, at Stansted.
3. Play to your strengths: this article has been written – consciously – as a paean to value marketing and a critique of classical marketing. The thrust of the argument has been that, by ripping up the classical marketing textbook and focusing on price and cost economics, value marketers have had notable competitive success. None of this is to say that classical marketing is dead, but it is to say that its mettle is going to be strongly tested in the coming years. What classical marketers need to rediscover and re-celebrate is the power of the single-minded proposition, and the value of strong functional and/or emotional benefits, strongly communicated.
The vulnerability of value brands is that they lack inherent loyalty (for example, Ryanair and easyJet were voted people's 'least favourite airlines' in a TripAdvisor poll in 2006) and have proved to be vulnerable to economic shocks (such as the high price of aviation fuel).
Value brands are also vulnerable to reputational risks unless they ensure that their low costs are consistent with ethical sourcing and employment practices. But classical marketers would do well to adopt some of the same ruthless single-mindedness that characterises the value sector. It's going to be an interesting downturn this time around.
Figure 1: UK–EU Passenger traffic by carrier type, 1986–2007
Figure 2: Development of UK clothing market
Figure 3: Development of UK hotels market
Figure 4: Price of a return flight to Glasgow
Figure 5: Operating margins: value brands and standard competitors