Price cutting has arrived in a big way at such major retailers as Spain’s Cortefiel, which sells clothing, and France’s Decathlon, which provides sporting goods. Cortefiel, for example, decided to reduce prices on as many as 30% of its products, while Decathlon lowered the prices only on isolated items. These are just a few of the companies under pressure to deal with the current economic turbulence. Meanwhile, consumers have been feeling the economic pinch of rising interest rates, inflation, and the gradual rise in unemployment. Although the apparel sector was one of the first sectors affected by the current cycle, other industries have also begun to feel it.
“Generally speaking, during periods of economic recession, consumers are more attracted by discounts,” says Alejandro Mollá Descals, professor of marketing at the University of Valencia. “In fact, retailers have noticed that in recent months, people are more and more interested in various discounting strategies.” Nevertheless, other brands, including Carrefour, the French hypermarket chain; Inditex, the clothing company; and El Corte Ingles, the department store chain, have all announced that they have decided not to offer any special discounts. They are confident that their brands are strong enough to keep attracting consumers.
Consumers, however, are increasingly sensitive to prices, and are not ready to spend one cent more than necessary, even if it means buying from several different retailers or from more than one service provider.
One result of this trend is that companies in a wide range of sectors are looking more and more at the low-cost business model pioneered by the air travel sector. Ireland’s Ryanair exemplifies that approach. According to Rosario Silva, professor of strategy at the IE Business School, Ryanair is the leader of that sector in Europe, and a real headache for national flagship carriers because its model is 100% low cost. Basically, that approach means creating the lowest possible cost structure in the entire company: “Keep it very simple, very low, the minimum. This comes along with doing business in a different way; rethinking how to do things differently from the usual way in that industry.”
In its obsession to reduce costs, explains Silva, Ryanair “even manages to forbid its employees to recharge their cell phone batteries [at its installations]. The company has become extremely austere.” Not surprisingly, other low-cost European airlines are finding it very hard to compete with Ryanair when it comes to costs.
The low-cost phenomenon in Europe originated about 10 years ago in the airline industry when that sector was deregulated, according to Joseph Francesc Valls, professor of marketing at ESADE and the author of The Low Cost Phenomenon and its Impact on the Price Factor, a book that will be published shortly. Back in the 1970s, the U.S. air transportation market was deregulated in a process “that also created the first phenomenon of low-cost companies in that country,” he says. In the case of Europe, it wasn’t until the late 1990s that a number of airlines had the opportunity to launch operations. “Until then, it was very closed, very expensive, and it was monopolized by national flag carriers.”
This phenomenon has generated two waves that are currently advancing at great speed. First, notes Valls, “makers of goods and services of every sort, beginning with airlines and then in other sectors, offer lower prices because they are able to produce with lower costs.” On the other hand, “customers have become used to finding products that have lower prices, whatever kind of shopping they are doing. And no one ever turns down a bargain.” This, in turns, makes consumers more price-sensitive. At any moment and in any location or channel, a customer can get cheaper prices. “If I expect to make a purchase at a specific moment and in a special channel, I will find a cheaper price for it,” he says.
Valls adds that this phenomenon is the result of several new trends, including the globalization of the economy. Globalization “increases the number of products and services in the market, makes them more obsolescent and unleashes the price war as a strategy for penetrating markets. In addition, new products have been developed that enable people to try out radically different ways of doing business and offering products to consumers.”
As a result of this approach, airline passengers have become used to traveling with a bare minimum of service. They don’t get free meals during their flights, they land at second-ranked airports and they purchase their tickets over the Internet without help from a travel agent. More recently, other companies in the tourism sectors have also taken the low-cost approach, including rental car firms and large hotel chains. In these kinds of hotel rooms, you only have to pay for what you use, such as towel service, personal hygiene products and television. One of the pioneers in this sector is Travelodge, a British chain that offers rooms that cost only 20 euros and are reserved online. Now Travelodge is preparing to invest one billion euros to open hotels in Spain. Other chains are also getting into the low-cost hotel sector.
The automotive sector is also getting its feet wet in the low-cost sector, including the famous TATA Nano, which costs consumers less than 2,000 euros. Likewise, companies that provide utilities, telecommunications, legal services and even hospitals are getting involved in activities where, “until now, there has always been a person who works or is an intermediary.”
However, not everything that looks “low cost” really is. “Even less so these days,” warns Valls, “because this concept has been successful in itself and there is some confusion about terminology…. At any given time, we may find ourselves stocking remainders of a specific product.” In outlet stores, for example, one can find premium brands at reduced prices, but those products are not “low cost” products.
Silva agrees. In recent years, he notes, many companies have popped up, “calling themselves ‘low-cost’ so that customers associate them with low prices. Yet these companies are not really ‘low-cost’ companies. As a result, many of the companies that have tried to use this strategy have wound up failing.” Silva cites the example of Air Madrid, the Spanish low-cost airline that offered long-distance flights until it went out of business at the end of 2006.
The failure of Air Madrid seemed to reveal that it is impossible to operate cheap flights on long-distance routes. Air Madrid tried that but at the cost of squeezing as much as possible out of its small fleet and operating its fleet of planes for marathon 15 -hour days in order to amortize their value. However, any small delay because of a technical problem or weather emergency could spread to the rest of the network, multiplying the impact. Air Madrid was not entirely a low-cost company; it only appeared to be one compared with the other airlines in its class because of its pricing policy. Air Madrid operated through travel agencies instead of the Internet, it provided business class service and it made long distance flights within Europe and Spain. All of these factors made it impossible to comply with the fundamental goal of controlling costs to the maximum degree.
On the other hand, as Silva notes, some companies have understood that the low-cost model is based fundamentally on reducing service. “That is something easy to imitate; the hard part, which some companies have achieved, is to reconfigure all of their activities differently.” How can a company that wants to become low-cost avoid failure? Silva says that the first thing is to think about the fundamental service that customers want. “The first innovation is to redefine your service, and the second is to redefine your activities, which is something more difficult,” he says. These processes should not have too much impact on the way consumers perceive the quality of services. The fundamental risk in taking a low-cost approach is that your company can wind up lowering perceptions about the quality of its product too much or that the company cannot restructure its costs so that it can survive in the market while also offering the lowest possible prices to consumers.
For Valls, there are three keys to succeeding with a low-cost strategy. In the first place, you need to “make effective any drastic reduction in costs. This means streamlining the structure of the company.” Second, he notes, your prices have to be dynamic. “That means they can continue to change along with demand. Finally, you need to publicize your low prices as the image of your company.”
Conflicting Behavioral Patterns
Valls believes that, given negative economic trends, it is conceivable that the low-cost concept will become increasingly widespread. “For example, I notice that in the real estate sector, where I don’t know any low-cost structural models, some companies are adopting strategies that may wind up transforming them into low-cost companies.” In the not too distant future, he believes, we will see another series of companies adopt low-cost structures that enable them to deal with recessionary conditions that are fundamentally different from the growing markets they used to enjoy.
For Silva, this trend is independent of any slowdown. It is something more fundamental. “There is a change that is more structural, a change in the taste of customers. There is a new sort of consumer, and that has led companies in many sectors to consider this sort of approach. There are customers who only want the most basic services because they don’t want to pay any more, not because their incomes are low.”
Valls says that you have to contrast the world of companies that offer prestigious and exclusive brands with other companies that offer generic brands, second-tier brands and low prices. “This is today’s big conflict. It’s not the entire population that is moving en masse toward the low cost. It’s all about when and under what circumstances the same consumers who want low-cost products will want exclusive, branded products…. Executives are prepared to travel with a minimum of comfort — that is, without frills. But when they arrive at their destination, they stay in a very expensive hotel.” Valls explains that this leads to conflicting attitudes. “At times, consumers behave one way and, at other times, in a different way. There is a struggle, a sensitivity, to the meaning of quality and prestige.”
Actually, high-priced products and services continue to attract about the same number of customers, economic slowdown or no slowdown, explains Valls. “High-end products will continue to have the same success. With the open-skies agreement in the U.S. and Europe (which deregulates air traffic across the Atlantic), there are some high-end companies making flights between these two destinations.”
Transformation of the Low-cost Sector
These days, every company is trying to reduce costs. Nevertheless, it is a complex process to transform a company so that it becomes a true ‘low cost’ enterprise. “It must not be easy to create a low-cost company in airlines that provide long distance flights because you have to reconfigure those activities [the flights]. It is complicated and difficult to take a fresh approach in any activity that has been the subject of a lot of thought.” To achieve that goal, Silva adds, “It is better to forget about conventional practices in the industry, and to dispense with the heritage of the past, especially by not limiting the capacity of a company to set in motion a new business model and new way to configure its activities.”
In most cases where a truly low-cost company is created, says Valls, it’s because the company has already drastically reduced the number of people who work for that company. “So far, I don’t know of any cases of well-established companies that have transformed themselves into ‘low cost’ companies.” If a company wants to transform into a “low-cost” provider, the first step is to begin by making “a drastic reduction in costs, slimming down your structure; creating a presence on the Internet; and publicizing the fact that you have low costs and prices that are dynamic. These are the kinds of strategies that can permit any company to be successful. Although you have to reinvent the company, you can begin from zero and position your products as low-cost products.” A ‘low cost’ company, he states, “needs to have a critical mass.”