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The Price Advantage of Reliability

We use the Customer Buying Hierarchy to evaluate many developments in a market. This Customer Buying Hierarchy argues that customers buy Function, Reliability, Convenience and Price, in that order, when making a purchase. The customer does not buy until he finds one company who can offer him a benefit in a category of interest to him that no other competitor can offer.

In many markets, leadership in Reliability is the hallmark of the best competitors in the industry. That has been true until lately with Toyota in the automobile industry. Their once vaunted reputation for quality and durability, in other words Reliability, enabled them to command a premium of $1M to $2M on cars priced in the $20M to $25M range. This pricing advantage came about because customers would pay more for better Reliability. (See the Perspective, “Reliability: The Hard Road to Sustainable Advantage” on StrategyStreet.com.)

This is a somewhat incorrect description of how the market actually works. Toyota did not intentionally price its products higher than those of its competitors. Rather, it set its prices and then its competitors determined that they had to offer discounts of $1M to $2M in order to entice sufficient numbers of customers to purchase their products over those of Toyota. This competitive price discount pulled some customer attention away from Toyota’s Reliability, where the competitors were at a disadvantage, to price, where they had an advantage. (See “Audio Tip #68: Producing a Net Value Improvement for Customers” on StrategyStreet.com.) Of course, Toyota’s higher price enabled that company to make good profits while many competitors, most notably the domestic automobile producers, were racking up large losses in the industry.

Toyota’s advantage in price is slipping away quickly. Some analysts have estimated that prices for the Toyota cars on recall have fallen from $500 to $1500. Low interest rate financing often accompany these lower prices, compounding the discount and Toyota’s margin pain.

Toyota can recover from this loss of Reliability. However, its recovery is likely to take several years. In the meantime, its competition can and will improve their Reliability performance. Toyota may be a while regaining its former pricing premium.

Posted 3/4/10

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