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Lessons From Peter Drucker

Drucker’s 5 Greatest Marketing Sins

Cohen
Posted: 05/31/2017

Drucker wrote a column that ran in the The Wall Street Journal for two decades. One titled “The Five Deadly Business Sins” was important enough to be incorporated into his book Managing In a Time of Great Change and timeless enough to be republished in The Wall Street Journal in 2005. 

I took a deep dive into these business sins in my own book, Drucker on Marketing. It was a pretty good fit because his five deadly business sins all deal with marketing. Don’t forget: Drucker said the two most important functions of any business were innovation and marketing. 

Here are the five deadly business sins:

1.   Worshiping high-profit margins and premium pricing

2.   Charging all that the market will bear

3.   Using cost-driven pricing

4.   Slaughtering tomorrow’s winners on the altar of yesterday’s successes

5.   Giving problems priority over opportunities

Let’s dive a little more into each sin.

Worshiping High-Profit Margins and Premium Pricing

Drucker said this was easily the most common of the five sins that he uncovered. 

Premium pricing is selling a product at a higher price than competitors to make your product appear higher in value. You can get to that appeal in more than one way. 

Drucker cited Xerox as an example. The company invented the fax machine but allowed a Japanese competitor to take the majority of the market. 

According to Drucker, this happened because Xerox kept adding features in order to raise the price of its product. At first this idea worked and Xerox profits increased. 

But since the consumers just wanted a simple machine to do the job of copying and faxing without the frills, this high price eventually attracted significant competition. The Japanese entered the market with a product that did the job at a much more reasonable price and captured Xerox’s market with great ease. 

Charging All That the Market Will Bear 

This principle seems smart, yet Drucker showed it was so wrong. Take this common situation: You invent or discover a new product. No one else has it. Maybe this is a patent or a secret formula, or something no one else can duplicate. You could charge whatever you want! 

According to common marketing knowledge, when your competition finally catches up, you can use all the extra cash you have accumulated to defend yourself. 

You can advertise or add “bells and whistles.” You can sink the money into research and development to make your product even better. You can even lower your price at this point and go lower than your competitors. It sounds good, but Drucker said, “No!” 

He maintained that charging what the market will bear endangers your market share—and a lot sooner than you might think. 

The high price creates an almost risk-free opportunity for your competitor to jump in and take over. With the right strategy, a competitor can quickly take the market away from you. 

Going back to the example of the fax machine: Americans invented the product, but Japanese companies took over the market by setting their price point 40% lower Xerox without using cheap materials or lowering quality.

Instead they used the learned from Xerox’s mistakes. They didn’t use current manufacturing costs to price their product. Instead they leapfrogged ahead and priced their product as if they had learned all the ins and outs of manufacturing and were selling it in high quantity—not at the quantities sold or cost of production as when they first started out. 

Of course, this meant that they had to actually learn how to reduce costs, which they eventually did. Xerox didn’t stand a chance.

Now this does not mean that you need to charge such a low price that you kill your advantage. Drucker recalled that the Hyundai Excel once was selling at the rate of 400,000 cars per year—the fastest of any car in the industry. 

A brilliant example of underpricing success, right? Then in two years, the car nearly vanished. With insufficient profits, there was no money for promotion, service, or product improvement. 

As Henry Ford said, “We can sell the Model T at such a low price only because it earns such a nice profit.”

Using Cost-driven Pricing 

Drucker warned that cost-driven pricing was a sure road to disaster.

He blamed the loss of the consumer electronics and machine tool industries in the U.S. directly on this deadly sin. 

Cost-driven pricing means you add up all your costs, add a fair profit,

and get the price you should charge. It’s all very logical, but as Drucker said, it is wrong, wrong, wrong.

Drucker maintained 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 back from price to determine your allowable costs. Then you start working to make those costs. 

Sure, the U.S. Government and many large organizations require you to justify your price on a form, which develops pricing in exactly the way Drucker said not to do it. 

Those organizations feel that if they allow you a certain “reasonable” profit, this prevents excessive profits. However, I’m willing to bet that you still know what the customer is willing to pay or what you need to win a competitive contract. 

So you can still work backward on the form and decide what you need to do to meet that price. If you can’t, you better not sell that product. You’ll lose your credibility with hard-nosed customers. 

Forgoing the Future to Honor the Past 

Drucker originally called this sin “slaughtering tomorrow’s opportunity on the altar of yesterday.” It creates a dramatic, but admittedly effective metaphor. 

Anyway, though Drucker’s more bizarre label is more entertaining, my version describes more succinctly what he is talking about. 

There is a human tendency to assume that any past success most be holy, and therefore will continue forever. As a result, organizations actually fritter away opportunities and their futures by focusing on past winners. 

Drucker pointed out that after IBM had accomplished the remarkable feat of catching up with Apple and recovering from its immense research gaffe in missing the demand for personal computers. 

But IBM still insisted on subordinating its newly won PC business to its old winner, the mainframe computer. Not only did most resources go to the main frames, but the new PC marketers were discouraged from even selling their product to mainframe customers. 

The net-result? IBM would not reap the fruits of its amazing achievement in coming from nowhere and taking leadership of the PC market from Apple. Instead, IBM’s primary achievement was to create IBM clones—this hurt its product and didn’t help its mainframe business either. 

Giving Priority to Solving Problems, Rather Than Taking Advantages of Opportunities 

There will always be problems. Some are discrete and need to be taken care of immediately. If a competitor is suing you over patent infringement, you may not have the luxury of focusing resources on efficiently developing a new market in Zambia or elsewhere, even though the opportunity is terrific.

That’s not what Drucker was talking about. His issue arose when he discovered that many companies he advised put their best performing people to work solving old problems in sinking businesses.

Meanwhile new opportunities were frequently assigned to those who lacked experience or ability. 

Why do marketers do this? Sometimes it’s simple ego. Someone sinks a lot of resources, money, and people fending off someone’s encroachment into established an market, which you’ve always owned.

Sure it may be declining, but this is your turf, right? So your ego is involved and you allocate all sorts of time to defending what may be barely worthwhile, while your real opportunity in Zambia or elsewhere is picked up by a competitor. Better to go after Zambia. 

A marketing sin is a transgression against a higher, maybe even a divine, law. Marketing sinners take heed!

 

*Adapted from Drucker on Marketing (McGraw-Hill, 2012)

 

 

Cohen
Posted: 05/31/2017