Coffee, Cars, Cable, Content, and next - Computers!

A Study of Commodities in North America

North American’s are an odd, yet predictable sort when it comes to commodities, commercialization, and mass consumption. Probing deep within their continental psyche is a curious and seemingly conflicting imbalance, which can only be rectified and rationalized when analyzed over time increments of a decade or more.

The societal moorings of a latent Protestant work ethic drive this culture to unprecedented levels of invention and subsequent innovation. New products are introduced at a premium, and then gradually reduced in cost, as processes become more efficient, competition is introduced, and mass production enables a lower price point. Paralleling this reduction in price is a gradual erosion in profit margins until both price and profits flat-line at the lowest sustainable cost and margin. Price and profits remain here for a long time, at a place where success is determined by sales volume and market share, and competitors expend enormous resources fighting for a tiny slice of the diminishing profits that remain. At this point, the product has become ubiquitous, firmly entrenched in the fabric of our collective lifestyle. Readily available, these products have quietly transitioned from a luxury or novelty to an assumed commodity exalted (or reduced) to the status of a “hygiene” entity with all of the bland utility of electricity.

And then something happens. A pioneer in each product category, in a fit of rage or serendipity, suddenly decides to change all the rules. In the coffee industry it was Starbucks who suddenly decided to buck the rules in an industry focusing on selling a hot beverage as cheaply as possible. Starbucks determined that the “coffee experience” was more important to customers than low price. Starbucks believed that a hot, premium cup of joe could be sold for four times the going rate because, in the hustle and bustle of life, people wanted to feel pampered and “do something for me because I’m worth it.” Humans have the need to feel special and Starbucks created an environment where for $3.50 a day customers could reward themselves with a premium product in a classy setting. This branding soon evolved into its own caste system, where holding a Starbucks cup became a status symbol and mastering the complex beverage options a sign of sophistication. The result is an enormously successful coffee chain, which is now bringing their product, as well as their message of “entitlement,” to an international audience.

Studying the Starbucks case is baffling because of the apparent hypocrisy. Coffee is introduced, prices are driven down, coffee is available everywhere from gas stations to McDonalds for 75 cents, and it has settled into its own place and price in society. Then suddenly, otherwise rational consumers decide it makes sense to pay four times that amount for an incrementally improved product and are willing to stand in line 10 minutes a day to buy it. If Starbucks were the only example it would be an outlier, but this phenomenon has been repeated throughout various industries and as such delineates a predictable pattern. At a certain point in the maturity of a ubiquitous product, a statistically significant percent of consumers decide that “a superior product experience is more critical than price as the primary buying criteria” and prove this with their wallets. Legendary companies are the first ones in each industry to recognize this “tipping point” and position a product to capitalize.

The second example of this phenomenon is in the motor vehicles industry. In short, cars were introduced roughly 100 years ago with advances made in design and technology over the years. In the late 1970’s and into the 1980’s, market share for Japanese companies exploded with their introduction of vehicles smaller and cheaper than those offered by US firms. Soon, Toyota and Honda were fielding the top-selling vehicles in North America and eroding profits and prestige from Detroit’s Big Three. The tipping point for this industry came with the explosive popularity of the SUV beginning back in the early 1990’s. The SUV is an incredible story because in spite of being over-sized (for a nation of city dwellers), gas guzzling, in danger of tipping, and triple the price, sales started to soar. Like Starbucks, rather than focusing on marketing a utilitarian transportation device, SUV-makers decided to sell an “adventurous driving experience” designed both to pamper drivers with creature comforts and add some sizzle to the mundane chore of commuting. SUV’s quickly became a status symbol and the prices consumers were willing to pay created huge margins, spawning SUV offerings from everyone from Volvo to Porsche. Only now is this craze starting to approach rationality as smaller CUV’s are introduced, a more appropriate match for the soccer mom who just wants to put a little zest in her taxi duties.

Cable TV and Internet Content are two other examples of this phenomenon. TV was invented decades ago as a free broadcasting medium available to anyone with a television and rabbit ears. Cable TV was introduced in the 1970’s and HBO decided that people would be interested in paying for TV if they could provide a “superior television experience.” The rest is history.

We are seeing this same dynamic playing out on the Internet, where online content has reached the tipping point in the past few years as evidenced by this press release on Digital Media Wire:

“U.S. Consumers Spent $1.3 Billion On Online Content in 2002

New York -- Consumer spending for online content in the U.S. grew to $1.3 billion in 2002, a 95 percent increase over 2001's totals, according to a report released by the Online Publishers Association and Internet measurement firm ComScore. The number of U.S. consumers paying for online content grew 4.3 million to 14.3 million in 2002, although the average amount spent by these users increased only 4 percent year-over-year. Online personals drew the most money in 2002, with $302 million in revenues, up nearly threefold from $72 million in 2001. "The year 2002 will go down as the year in which the conventional wisdom about paid online content changed," said Michael Zimbalist, executive director of the Online Publishers Association. "Whether or not consumers will pay for content is no longer a matter of debate. Clearly, they will." The top five online destinations ranked by 2002 paid content revenues, according to the report, were Yahoo.com, Match.com, Real.com, Classmates.com and WSJ.com.” (Note: A follow-on statistic reports that in 2003 U.S. spending on Online Content was $1.6 billion, and surpassed $1.8 billion in 2004, according to the Online Publishers Association).

Consumers have determined that, even though they can get content for free in the vast expanse of the Internet, they are willing to pay for a “superior Internet experience.” It’s ironic how Michael Zimbalist picks up on the theme of this blog by calling 2002, “The year conventional wisdom about paid online content changed.” By recognizing the pattern of historical North American behaviors, this “unconventional wisdom” and “attitude reversal” can be quite predictable and beneficial to those positioned to capitalize on it.

Conclusion: Personal Computers are next

I believe that the next product to hit the tipping point will be the personal computer. The PC has quietly become a ubiquitous fixture in both the home and the office over the past 10 years and like the other industries profiled, is currently mired in a near zero profit margin environment characterized by competitors continuing to drive down costs to gain market share. As we sit on the cusp of both a major “PC replacement cycle” AND a major “New PC buyer cycle” (Gartner Group says PC owners will go from 1 to 2 billion by 2008) the market is ripe for the introduction of a new computing experience. Realizing their utter dependency on the PC for communication and entertainment, and the thousands of hours to be inevitably spent communing with their computer for their livelihood, buyers are now poised to reverse their price metric in exchange for a “superior technology experience.”

I predict the emergence of a product designed to expedite this rationalization by captivating buyers visually and emotionally, as well as intellectually and rationally, through the promise of comfort, performance, and reduced neck, back, and wrist pain. Like Starbucks and SUV’s, people are ready to be pampered in a luxurious “media rich cocoon” and to use this status symbol as a way of distinguishing themselves. The message is, “No, I don’t have to pay $5000 for a superior computing experience, but it makes me feel special and I’m worth it.” I believe that five years from now, such a product will also have transcended technology to become a ubiquitous hygiene product, only observable when it’s NOT there. Stay tuned.