Product Cannibalization: A Risky Business?

Ladies, are you saving your pennies so you can afford to buy a Coach bag? Well, save no more! Recently, to reassure investors that they were taking steps to adjust to the recessionary environment, the folks at Coach trumpeted their new low-cost (but still highly fashionable!) Poppy line.

And just a few days ago, Sprint Wireless announced the acquisition of the low-cost prepaid cell phone business Virgin Mobile. Although Sprint already managed a low-cost prepaid cell phone service called Boost, Virgin Mobile represented an even lower cost service for Sprint.

On the one hand, it certainly makes sense for firms to adjust to troubled economic times by lowering their prices. But on the other hand, shouldn’t they be wary of product cannibalization? In other words, wouldn’t these strategies be counter-productive if customers who would otherwise purchase the costlier brands all decide to trade down for the cheaper version?

Going Downstream: A Risky Business

History is cluttered with the stories of firms that tried to go downstream and offer cheaper versions of their own core products, only to face catastrophic consequences. The New York Times and most other newspapers, for instance, saw newspaper sales plunge when they began posted free online versions of their stories on the internet. United Airlines, similarly, discontinued their discount airline Ted out of concern that it was simply too costly to try to run a full service airline alongside a no-frills airline. And who can forget IBM’s PCjr, an ill-fated stripped down desktop computer for the kiddie set?

History is also cluttered with the stories of firms that refused to go downstream and continued to thrive in the marketplace. Apple, for instance, has heeded the lesson of its own legendary but ill-fated hand-held Newton device; it has refused to cannibalize its lightweight laptop lines by jumping into the low-cost netbook market. And McDonald’s, for example, has actually driven upstream during the heart of today’s grinding recession by challenging Starbucks with its high end McCafe line.

But are there any examples of firms that have prospered by selling cheap brands alongside luxury lines? Hasn’t any one solved the cannibalization problem?

Yes, indeed … history is also cluttered with the success stories of firms that followed this strategy. General Motors, for example, prospered for decades by selling luxury Cadillacs as well as inexpensive Chevrolets … and filled in every price category in between with Pontiacs, Oldsmobiles, and Buicks. In fact, many believe that it was their abandonment of the low-cost end of the automobile market that precipitated their business collapse. And similarly, hotel chains like Holiday Inn have reinvigorated their brands by rolling out low-cost properties with names like Holiday Inn Express.

Avoiding The Risk

Any good risk manager knows that the best way to avoid a costly situation like cannibalization is to take action that lowers the probability that the situation will occur. In other words, even if it is impossible to completely eliminate the possibility of cannibalization, there appears to be several steps that can be taken to make it far less likely.

Make it Youthful. General Motors didn’t want wealthy parents to ogle their children’s inexpensive Chevrolets and say “I want one for myself,” so they made classics like the ’55 Chevy into youthful hot rods. Similarly, Virgin Mobile was specifically targeted to teenagers and young adults from the start of its existence. Although these firms never quite hung up signs on their low-cost products that said “people with money, stay away!,” they might as well have hung up signs that said “young people with very little money, we want you!”

Differentiate the Features. Holiday Inn knows that the one service feature that affluent travelers truly need is a well-stocked bar in which to entertain clients and enjoy vacation happy hours, as well as a full service restaurant to feed them after they’ve become too inebriated to drive elsewhere. That’s why none of the downstream brands of the major hotel chains – not the Holiday Inn Express, nor the Marriott Fairfield Inn, nor the Hampton Inn, etc. – will ever, ever, ever maintain full service restaurants.

Protect the Brand. Late last year, Steve Jobs indirectly slammed the entire netbook market by declaring that “we don’t know how to make a $500 computer that’s not a piece of junk.” The unspoken suggestion, of course, is that Apple might indeed leap into the netbook market if it could figure out how to produce a low-cost device that lived up to its high quality brand reputation. In other words, low cost versions that are perceived as low quality products and services may create problems that are worse than cannibalization; instead, they may lead consumers to question the underlying image of the core brand itself.

Reasonable people may differ, of course, about how to manage the risk that a downstream product differentiation strategy may lead to cannibalization. But if history can serve as a guide to the future, then these simple steps – targeting the marketing strategy to downstream consumers, omitting the produce features that are desired by affluent consumers, and ensuring that the firm’s brand image is respected – may prove useful indeed.