Tool Box
Issue No. 12 - August/September 2003
Commodity Trap
How to Avoid Competing on Price
by Dr David Corkindale
As managers of a business we have to extract value from it. It is easier to do this in some industries than in others and it can change over time; what was a good business to be in can become one from which it is increasingly difficult to extract a satisfactory return. So, how can we ensure that we can always be in a position to extract value?
We need to understand why industries and the businesses in them can change from high margin to low — and what to do to keep the margins up even though the industry’s general margins have dropped. Let’s look at the history of markets to see how they evolve and how margins are grown. Markets have passed through three phases: commodity, good and service. A commodity is something that is extracted from or grown in the natural world and is relatively common like coal, copper ore, wool and fish. A bit of a problem with these are that they are not, and can not simply be, differentiated: price is driven by supply and demand. If the demand for nickel goes down because they are making less cars in the US then the price of nickel goes down and companies like WMC just have to wear it. A good is an item that is typically manufactured from raw materials, the commodities. It can be differentiated from others like it by things like design. The manufacturer of an individual good or product has a lot more scope to set and maintain prices that allow the extraction of value to them. A service is often an intangible act that is customised to the wishes of an individual or group of customers who value the benefits of this higher than they do the goods or commodities used in providing the service.
All three phases are alive today in the world even though there has been a migration of value from commodities to products and then to services as economies have become more prosperous and people can afford to pay for others to convert the commodities into goods and services, rather than do it themselves. Some companies still operate ...
