Archive

Archive for March, 2008

Calvin Klein, Grapefruit Pricing and Professional Service Firms

March 28th, 2008

I read lots of journals. But Vanity Fair is typically not one of them. However, I hang my head in shame and fess up to glancing at the April 2008 that was sitting on our coffee table. I noticed an article about Calvin Klein’s recent sale of his business for $400 million and some change ($30 million) in Phillips-Van Heusen stock.

A paragraph about Klein’s early life jumped off the page and once again reminded me that irrespective of the business you are in the fundamental rules—truths if you like—are much the same in all industries.

Klein, like most extraordinary people, came from a rather humble beginnings. His father was a very hard working owner of a grocery store in Harlem. From an early age Calvin would spend a lot of time at the store helping out and talking to his father about the business and especially the cost and pricing of things.

“I would see grapefruits in the fruit-and-vegetable department, and some of them were 29 cents a pound and others were 49 cents,” he recalls. “I’d ask ‘What’s the difference between the two?’ My father said ‘Some people like to pay 29 cents and some like to pay 49 cents.’ I thought, Hmmm, I learned later that that’s the fashion business to a great deal. You pick the spot where you want to be, where you want your products to be.”

After reading this I could not help reflecting on something we have been advocating for as long as I can remember. And that is … you decide what position you want be on the industry value chain and then build your entire product, pricing, communication and delivery strategy around that position.

If you want to be in the 29 cent grapefruit market then you’d better make sure you can sell a lot of them and your costs are less than 29 cents each. On the other hand, if you want to focus on 49 cent grapefruits you won’t need to sell nearly as many given the same cost structure. In fact, let’s assume, just for fun, that at 29 cents Calvin’s Dad was making a GP of 9 cents then he could sell 60% less grapefruits at 49 cents and make just as much as his 29 cent offering.

Now, you might be tempted to say that Mr Klein Snr. was meeting the wants of a wide customer spectrum because that essentially defined the walk-in market he faced, like it or not. So if there’s a lesson to be learned from this it would be that it makes sense for a small local professional service firm to do the same? This is a good point.

Here’s my response. In the 40’s and 50’s small local stores like Mr Klien’s were common and by necessity did have to meet the market which included a wide customer spectrum of people who lived within walking distance of the store. But that was before people moved into the suburbs and began to patronize suburban shopping centers featuring Wal*Mart and the other major supermarket chains. The face of retailing dramatically changed in a relativey short period of time. The big guys are the ones that now sell grapefruits for 29 cents and although there are still businesses like Mr Klein’s in the inner cities the ones that are doing well (e.g. Seven-11 stores) have implemented a different strategy. They no longer sell 29 cent grapefruits, they sell convinience which is the generic industry name they have assumed. Because they sell “convinience” they are now firmly entrenched in the 49 cent grapefruit business. These stores would not even think of trying to compete against Wal*Mart et al.

The most successful small firms I see today as measured by net profit per owner and growth, are smaller firms (generally in the $1–$10 million fee range) that know exactly where they are on the value chain—the upper end. They do not deal in the 29 cent grapefruit market but provide a wholesome, client centric, value priced range of services that many customers are willing to pay for; those people who do not want to pay are referred elsewhere. These firms do not try to be all things to all people, they are focused on creating value for people who acknowledge the value they offer.

There are four lessons I think we should learn from this story.

First, when industry structure changes the firms that recognise the direction of change early and adapt will thrive.

Second, it’s amazing how changes that occur in one industry can be observed in the evolution of other industries. This is a valuable learing opportunity.

Third, as the distance between buyer and seller shortens (whether because of location, transport infrastructure or communication technology) the best performing small service providers are the ones who specialize in a niche (market or product) that is hard for large firms to cost-effectively replicate e.g. one built on an intimate relationship with the client.

Finally, and most important, as Calvin Klein discovered, “You pick the spot where you want to be, where you want your products to be” then build your business operating model around that position. If you want to simultaneously be at another point on the industry value curve then create another brand with a different price point and a different value proposition.