I was meeting with the owner of a company that sold levels of services priced from $20 to $50. While the price was low, the owner typically sold 50,000 services a year from a very small location that was almost labor-free. In an effort to increase his customer base, he shifted many of his services into the quieter hours from 8-10 a.m. and 6-8 p.m. by lowering the price of the low-end service, setting it at $15 during those time periods. He felt very strongly that this was a great plan since the number of services sold was up but his revenue was down slightly. He also said that a few customers liked this low price so much that they used this service two or three times a week.
Cannibalization is a business concept in which you devour your own sales to preserve or increase market share. BlackBerry is a firm that really understands this concept. It continues to roll out new BlackBerries knowing that by offering new products, some of their existing phones are going to suffer losses in sales. However, by offering new products in new markets, they cover the cost of this cannibalization with the new sales, and they stop competition from entering the market.
It is vital that you understand that you must run the numbers to determine whether cannibalization or market expansion makes sense. For example, if you are going to offer a new product and you know that you are going to lose 50 percent of your revenue on an existing product line, the new product must be able to generate a return high enough to cover the cannibalization cost.
The one exception to this rule, however, is that sometimes you just have to eat the cost of cannibalization simply to maintain market share. For instance, BlackBerry came out with the Storm, a touch sensitive phone, to compete with the iPhone. They knew that they just could not afford to let Apple keep grabbing up market share, and they were not worried about the cannibalization cost. In this case, maintaining market share and market presence was the goal.
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When considering cannibalization, ask yourself whether it is actually necessary. With the service example at the beginning of the column, it turned out that this entrepreneur was not really bringing in more customers by offering the lower price at certain times. Instead, he was just shifting customers to an earlier time for a significant drop in price and margins. Customers would have come in anyway and paid $20 for the service, but for the lower price, it was worth it to them to come in during the specified hours. Bottom line, the reduced price was not serving this entrepreneur at all.
Cannibalization is an important business concept to understand when you are introducing new products or services. You must recognize this as a cost you incur with new product or service offerings. Now go out and make sure you have a way to evaluate this cost in any product line expansion.
You can do this!