CHAPTER | TWENTY-THREE
The Five Great Marketing Sins
Early on in his career, Peter Drucker declared that there are only two basic business functions: “The first is innovation, and the second is marketing.” From 1975 to 1995, Drucker wrote a column for the Wall Street Journal. On October 21, 1993, his column was entitled “The Five Deadly Business Sins.”1 Confirming his assertion that marketing was one of the two basic business functions, all five sins had to do with marketing.
Drucker easily could have called them “The Five Deadly Marketing Sins.” This column was pure Drucker: He warned against what many experts were advising and other “beliefs” that “everybody knew.” And he hastened to demonstrate that their advice was false. According to Drucker, these are the five deadly sins:
- Seeking high profit margins and premium pricing
- Charging what the market will bear
- Using cost-driven pricing
- Focusing on past winners
- Giving problems priority over opportunities
Let's take a look at each, but call them what Drucker really meant.
Seeking High Profit Margins and Premium Pricing
This sin is easily the most common of the five; however, it sounds like common sense. Why shouldn't marketers seek high profit margins? I remember early on being told in an MBA class in marketing that one concept of marketing a new product was to enter the marketplace with a high price and then, as the market matured and competitors joined the marketplace, use the high profits won earlier to fight off the competition—for example, with increased advertising or some other good use of that financial advantage.
Drucker thought this approach was extremely dangerous, and he illustrated his reservations by example. For instance, the fax machine. The strategy of the American inventor company, Xerox, was to keep the profits high by staying ahead of the competition with a “better” product. Sounds good—and right out of a marketing textbook.
Xerox continually added new features to justify increasing the price. Unfortunately, it was clear to sales prospects that many of these new features did little to add value and were largely unnecessary. At best, they contributed only marginally to the product's performance. Xerox might have at least made them optional, so that customers would have a choice. But they didn't. Their eyes were on keeping the margins and profits high, so they could later use that cash to fight off competitors, just as taught in B-School. Moreover, they failed to heed Drucker's cautionary note that it is not what the manufacturer values, but what the customer values that's important.
The strategy was wrong, proven by the fact that the Japanese took over the market, not just in the United States but also worldwide. The Japanese looked at this breakthrough product and did a little reengineering. However, they recognized that the key to capturing the market was not advanced features and high price. When they got it right, they entered the market with a product that did the job well at a much lower and more reasonable price. The Japanese fax machines may not have had all of the bells and whistles, but they captured Xerox's market with great ease. We may still incorrectly ask an employee to “Xerox” a copy for us, but chances are the individual is “Xeroxing” on a Japanese-made fax machine, which today may be Korean or Chinese made.
While it may seem obvious and intuitive that wider margins should lead to higher profits, total profit is margin multiplied by sales. So what the marketer should be seeking is an optimum profit margin that, when combined with sales over time, will equal maximum profits. This still allows for the accumulation of profits with which to take on oncoming competitors, but it does so without creating a market for those competitors.
Drucker considered this sin the worst part of the whole business. He found that the strategy of high profit margins, combined with tactics of premium pricing, invariably creates a market for the competition and can result in loss of the entire market to a competitor.2
I would like to add a caveat here: Avoid simply and arbitrarily freezing an original price and always seeking a low price, blindly and forever. Henry Ford kept Model T pricing low and sold millions of cars, not even allowing deviation from his one color (black). Drucker even quoted Henry Ford: “We can sell the Model T at such a low price only because it earns such a nice profit.”3 However, Ford did this for too long. As prospects grew more willing to pay for options, even color variance, the Model T sales declined. Ford didn't lose his entire market, but his determination to focus on standardization and low price caused him to slip to number two in sales, behind General Motors, for forty years.
While this caveat doesn't alter Drucker's cautionary warning in the opposite direction, especially since he spoke of the worship of high margins and premium pricing, it does tell us that unlike diamonds, strategies are not forever.
Charging What the Market Will Bear
Let's say that you have a patent or a secret formula. Conventional wisdom says to charge as much as the market will pay. The rationale is the same as for the first sin. As your competition appears, you can use the extra cash you accumulated through charging the maximum to fight off any and all competitors that try to enter the marketplace. Or you can then lower your price below that of your competitors. This way, they can never catch you.
Many consider charging what the market will bear to be a guaranteed marketing strategy when entering the market before the competition and when you have some leverage to keep competitors away. But is it? It is similar to, but not the same as, seeking high margins and premium pricing. Here, you just keep increasing the price because you can—and the customer is willing to pay, or may need or want the product so badly that he feels he must pay it. But this is worse than premium pricing. At least the latter has a little finesse, and is supposedly involved with finding customer needs and filling them. But charging whatever the market will bear is a brutal strategy. It's damn the customers and full speed ahead!
The only sure thing about charging what the market will bear is that you will lose your market—and a lot sooner than you might think. A very high price creates an almost risk-free opportunity for your competitors to jump in and seize your market. All they need to do is fill the same need. Business risk is always present, so when a nearly risk-free opportunity presents itself, it is a wonderful incentive. Moreover, the higher your price, the lower is the competition's risk and the even greater incentive to jump in and compete.
When DuPont patented and introduced nylon, it sold it at a price that it anticipated it would keep selling it at for at least five years. What were these DuPont people—economic psychics? How could they know what price they would have to charge in five years to keep competitors in check? Easy. They had the history of previous products like nylon. They could estimate the improvement in manufacturing techniques, the buying in higher quantities, and other advantages of the economy of scale. They could also factor in mistakes they would no longer make as they gained experience and expertise. Boeing used the same techniques a few years later to estimate the cost of building thousands of B-17 bombers during World War II, even though they built only one prototype.
Drucker estimated that DuPont's price was less than half of the price it could have sold the product for successfully at the time. However, with this advanced pricing, DuPont had no difficulty keeping its competitors out of the market. In the process, DuPont made nylon affordable to millions of women and kept the competitors away for years.4
Using Cost-Driven Pricing
Cost-driven pricing means that you simply add up all your costs, and then add the desired profit, and there you are—the price you should charge. It's all very logical, but it is also simply wrong. (By the way, this is how the government insists contractors price the products that they buy. It's supposed to ensure both competition and a “fair” price. All you need to do is look at government cost overruns to see how well the cost-driven pricing approach is working, even when insisted upon by the customer.)
Drucker said that instead of cost-driven pricing, you needed to do price-driven costing. That is, you need to start at the other end with the right price, and then to work backward to determine your allowable costs. Drucker blamed the loss of the consumer-electronics industry and the machine-tool industry in the United States directly on this deadly sin. (One begins to understand why Drucker called these deadly sins, and not simply marketing mistakes.)
Focusing on Past Winners
Drucker actually called this “slaughtering tomorrow's opportunity on the altar of yesterday.” He wanted to emphasize how managers commit this sin in the name of past successes. Drucker's label is more flamboyant, but mine is more succinct. After IBM recovered from its immense gaffe of missing the PC market (mentioned in Chapters 19 and 20), it still insisted on subordinating its newly won PC business to its old winner, the mainframe computer. Not only did resources go primarily to the mainframes, but the new IBM PC marketers were discouraged from selling their product to mainframe customers, lest those customers mistake what business IBM was really in. The net result was that IBM did not reap the fruits of its amazing recovery in taking leadership of the PC market away from Apple. Instead, its “achievement” was mostly in encouraging other newcomers to create IBM clones—and this major marketing blunder didn't help its mainframe business in any way.5
Giving Problems Priority over Opportunities
Drucker saw that many companies put their best-performing people to work solving old problems with businesses or products that were already on their way out. During WWII, many Allied aircraft companies spent their resources trying to make old reciprocal engine piston planes fly faster when they had just about reached their maximum. It wasn't that they didn't know about jet engines or rocket-engine technology, but they applied most of their resources to gaining relatively small advances in speed—in essence, doing the best they could with the tried-and-true. Meanwhile, the German aircraft industry forged ahead despite terrific environmental problems from Allied air superiority near the end of the war. As a result, Germany had both jet- and rocket-engine aircraft in combat before the Allies had done much but fly and experiment with prototypes.
Those committing this last marketing sin frequently assign new opportunities to those lacking experience or ability, and put their first team on solving old problems. This frequently occurs, as is the case with many things, because we let our egos get in the way. Otherwise smart marketers pour a lot of resources, money, and people into fending off someone's encroachment into one of their established markets. Sure, it may be declining, but this is their turf and they won't surrender it easily. So ego is involved in defending what may be barely worthwhile, while real opportunity is seized by a competitor.
When Peter Drucker claimed that these were sins, and not mere mistakes, he wasn't exaggerating. Sinners take heed!