The Great Balancing Act

PCLs strategy to plunge its prices has helped it control 90 per cent of the PC market. But have volumes come at the cost of profitability? A close look at the PCL game plan and the possible pricing trap in the strategy.

Sometime in early 1996, Pertech Computers Ltd (PCL) set into motion an ambitious and audacious strategy. In an industry known for its cut-throat pricing, PCL decided to sell its wares at a prices that would be difficult to match by even the most ardent cut price practitioners.

The calculations were simple enough and as old as Henry Fords gamble on the Model T in the early 1920s. Offer bargain basement prices to grab massive volumes. Use those volumes to send production costs plunging. And use the lowered costs to further cut prices. And so on until you had the total market in your pocket.

 

In September 1996 the start of the season for computer manufacturers the plan was put into play. The results till date can be best termed as mixed PCL moved from being the best selling PC company to one that practically controlled 90 per cent of the PC market. But many of the assumptions it had used to lower prices also went awry. And much of the massive volumes came at the cost of profitability.

PCL still claims that its basic formula was excellent and that it is well satisfied with the results. It also claims that the changes in its schemes in the subsequent months was only a refining of the basic plan. But rivals claim that PCL inability to execute its plan with sufficient finesse, in fact, helped the other players to boost up their own sales.

The final judgement can, of course, be passed only when PCL closes its books for the current fiscal. But a close mapping of the way PCL put its schemes into operation tells a fascinating story of how prices can be slashed to rock-bottom levels as well as the pitfalls one must negotiate while trying out the strategy. But first, a quick scan of the market as it was when PCL decided to charge ahead with its low price PCs.

The market configuration

The PC market has always been skewed towards institutional selling, even though it has evolved from selling of boxes in the eighties to the selling solutions in the nineties. Predictably, the distribution channels too were geared to tap only the bulk customers. Direct selling is the norm, though over the past few years, several of the bigger players have been experimenting with other channels like value-added retailers, office automation distributors etc.

In early nineties, PCL was one of the first to start a new channel experiment. It trained and funded entrepreneurially minded people as its re-sellers. Most of them operated from their homes with low overheads. Consequently, they could do with lower margins. The whole apparatus took the shape of PCL Access, a 500-strong re-seller network which was ideally suited to exploiting the First Time User/Small Office Home Office (FTU/SOHO) market, whenever it emerged.

The FTU/SOHO segment of the market had till then been serviced largely by the grey market operators. The price differential between their offerings and that from the branded marketers was in excess of Rs 5,000, model for model. The branded PC sellers had to remain content with the Government/PSU market, which was again price sensitive, and the corporate market, which was relatively price-flexible.

The reason most manufacturers were not interested in the FTU/SOHO segment initially was that it was relatively minuscule. The household penetration of the PCs was abysmally low in India. The early attempts at cracking open this segment of the market by HCL with its Beanstalk range, and followed by Compaq, IBM, Wipro and PCL, had yielded little result. The price was just too high - at over Rs 80,000 for a machine to get into the average home. Moreover, the problems were compounded by the fact that the FTU/SOHO segment looked for very different machine configurations from the institutional segment. While the institutional segment always wanted the most powerful, the very latest in terms of state of the art, the FTU/SOHO segment wanted cheaper, more basic machines to do some routine and standard work. With the bigger margins on the higher priced machines, it made all the more sense to concentrate on the institutional market than to chase individual buyers who bought machines which had ultra-thin margins.

There is small segment of this market which wants PC with specific applications in mind and is slightly flexible when it comes to price. But thats at best around 5 per cent of this segment, points out Ashwani Agarwal, marketing manager, Hewlett-Packard India. The major chunk of the market is into edutainment (education + entertainment) kind of usage. But with this segment the biggest block, however, was the high price.

The gameplan

The idea was pry open this market by delivering a price that matched that of the grey market. The logic was simple: A branded product at gray market price was a fair bargain and should help snatch customers from the friendly-neighbourhood vendor. That required cutting price by half. Such large price cuts demanded concomitant cost cuts. And the way PCL saw it, those price cuts could be achieved by using the following steps.

Standardisation

First, what it needed to do was to offer standard product specifications. PCs have generally been sold as per customers specification. The great advantage of standardisation is that it offers the economies of scale and can slash production costs and times enormously. So PCL needed to figure out a few basic configurations and stick to them assiduously.

The first scheme gave the customer choice between a 486-based machine with 4MB RAM, and a Pentium-based product with 8MB RAM. The aim was to cut costs especially the bill of material (BOM), which according to the company, was to contribute to half of the 50 per cent reduction in the prices.

How? There were three ways this was supposed to help cut costs. One, this meant higher volumes (as it bought more of the same) hence better negotiating power with its suppliers abroad. Two, it helped increase productivity. The machines were put together in batches. Greater the number of configurations, lower the productivity due to greater changeover time etc. And three, since standard configuration meant fewer types of components, it made inventory management easier.

Tele-sales

The company also shaved off two-thirds of its marketing costs - which according to Sameer Kochar, national marketing manager, were around 12 per cent by switching to tele-sales. A large chunk of marketing costs in a normal computer company came from repeated calling on the customer going to his place three-four times to get the order and then again going to collect the bills.

Even in PCL, these sales calls were earlier done by company executives who traveled in expensive taxis and spent their time soliciting orders. Now, the same job was turned over to BEs (business executives) trainees who were paid Rs 2,000 a month and who had their own bikes and channel members. The BEs took telephone enquiries from the customers and collected the money or, the query was passed on to the channel members. Over the years PCL had developed a 500-strong PCL Access team.

The new method had another advantage. Earlier, the same person who took the order also collected the money. As his performance was judged by the number of orders booked rather than the amount of money collected, he rarely showed the same enthusiasm chasing customers for money as he showed chasing them for orders. All this meant a burgeoning recievables problem.

Collecting money upfront

The third step was collecting money in advance, which also solved the receivables problem. Moreover, it helped save on the money cost which varied between 4 to 6 per cent per month. Since the average waiting period was going to be roughly two months, the company could save as much as 8 to 12 per cent on its cost of funds, which came in handy while cutting costs. Moreover, the cash collected could be used for advance payment to vendors, which would in turn give them a leverage to bargain for better prices.

Cut margins

Further, as it anticipated higher volumes, it pegged down its gross margins to a lower level - from 15 to 10 per cent. Whatever it was giving as margins, it hoped to make up from the increased volumes.

Calculations

As the target customer was from the FTU/SOHO segment, the standardisation strategy was supposed to work well as his requirements were not application-specific. And, of course, s/he was highly sensitive to price which PCL was playing on.

A bit of help

The low cost business model of PCL was further supplemented by Chidambarams slashing of import duties from 22.5 per cent to 12 per cent in the last budget in July 96. And, this lowered duty was applicable to the already falling input prices. Between May and July 1996, the 486 processor and 630 MB hard disk lost half of their value (price) while the monitors lost a quarter.

Thus factors both external and internal combined to help PCL bring down prices by some 50 per cent - or so it appeared at first sight. This was the biggest single drop in the recent years. Significantly, for the first time a PC fell in the same price bracket as other consumer durables like TVs, refrigerators etc. And the reduced duty rates made PCLs offerings cheaper than those of the grey market making it a fairly attractive bargain.

Hitting the market

Now was the time to test the strategy in the market. The ad-campaigns all in print were naturally to scream about the low prices.

The schemes

PCL came up with a string of schemes. The first such scheme was in September which offered the 486-based machine for Rs 23,500, almost 25 per cent lower than even the grey-market prices for a similar product. And the Pentium-based machine was offered for Rs 32,500. The punch-line read, You will rub your eyes in disbelief...after seeing PCLs new prices.

For 45 days, there was no response from the competition. That gave PCL the leverage to increase the price in the next offer.

Despite the price increase, the October offer challenged, If you think anyone can match PCLs October offer, forget it. The same 486 configuration now was priced at Rs 499 more and the in case of 586, the price was upped by Rs 3,499 with slightly altered features.

And then, others began to retaliate. HCL-Frontline introduced a stripped down 486-based machine at Rs19,999 (excluding taxes) and deliveries promised in 7-10 days . PCL came back with a Diwali offer a similar configuration machine at Rs 18,999 - with of course deliveries only after 6-8 weeks.

What took HCL-HP so long to react? We could have come up with similar offers at the same time as PCL but we decided to get our manufacturing act together before aggressively entering the market, claims Sharad Talwar, marketing manager, HCL-HP.

The right price

We started to test the market at various price points at this stage, explains Kochar. It had to arrive at the right price point one that the customer was comfortable with. This, the company did by trial and error, he says. Different schemes, with different prices were launched. The basic Pentium model which was offered at Rs 24,999 in October was tagged up to Rs25,499 to Rs 27,500 in end-November.

When the machines were priced around Rs 24,999, PCL found that many customers ended up paying around Rs 5,000 extra in add-ons. The average transaction value was working out closer to Rs 30,000. And there was no significant jump in order volumes either.

However, the frequent price revisions may have been prompted by the emergence of reference price as the competition came up with their price. Now, PCL had a ceiling price the price offered by HCL etc below which every price was competitive. As long as it could deliver, of course.

Settling the doubts

For the first time, the Intel Inside logo appeared in the ads. This was in response to the queries that customers had relating to the 586 machines whether it came with Intel chip? From then onwards, the prices kept on going up Rs 500 and Rs 2,000/2,500 for the Pentium machines in the next two schemes. At the same time, it offered a 486 PC at Rs 18,999.

PCLs last scheme (in December) bundled in printers with the PC.

The bait

The company was aware that a PC purchase is a highly postponable purchase. Every ad had some element of finality built into it. The initial one came with an offer of two years warranty instead of the usual one year one for the early bird those who booked before the 20th of September. The Diwali offer was valid for only four days while the next two emphasised that prices were going up, so hurry. This was backed by the price increases. These were meant to persuade the consumer to make up his mind.

The Result

While the initial market response was overwhelming, the subsequent schemes did not make significant impact. Kochar refuses to part with figures for months after September, but some market estimates put the figure at around 30,000 machines (Millennium) in the last five months as opposed to the 20,000 snapped up in September itself. Kochar says that the figures for the later months was more than being estimated by rivals but admits that it didnt match up to the original start. He attributes the less enthusiastic response to lesser price differential for market to expand substantially, prices have to fall below the Rs 20,000 mark.

However, there is more to it than that. First, as Raj Saraf, chairman and managing director, Zenith Computers Ltd points out, after the first scheme, the novelty of such the exercise was lost and the customer typically adopted a wait and watch approach to see what prices will the market settle at. Secondly, after other PC makers began to come out with similar schemes (Wipro-Acer too launched a model at around Rs 30,000 for a Pentium-based machine), it started becoming clear that the PC prices will indeed remain low. And, the word going around about delays in delivery has not made it easy for the company either.

PCL had rightly calculated that to open the market, the prices will have to be brought down substantially. And gearing up its business model to deliver the lowest possible cost was how it chose to go about it.

Delivery problems

Yet, it ran into difficulties, mostly on the delivery front. It had promised to deliver the machines within four to six weeks. According to the company, there is a backlog of around 100 orders from the September bookings at the time of writing this article (last week of January) - a full four months later. Of course, market sources put the figure to be much higher.

On an average, the company says that there has been a delay of 15-21 days. It attributed delay beyond this period to the customer going for non-standard configurations and colour monitor. First of all, the demand was more than we had anticipated. And, on that increased demand, the percentage of people who went in for colour monitors and 1 GB hard disks was higher than thought. Therefore, the short supply, says Kochar.

The company while buying and planning by the quarter kept on coming up with schemes by the week. It tried to do many things at the same time. Kochar concedes that company couldnt resist the temptation of serving customer asking for non-standard configuration but puts the percentage of people who bought non-standard configurations at around 10 per cent.

At the same time, as part of its numerous schemes, it began experimenting with different price/configuration, to arrive at the right price point. For instance, a 630 MB hard disk was followed by a 1.2 GB one which later on was followed by a 1 GB hard disk. Wasnt standardisation given a go by?

That bore a hole into the very strategy that the company had so smartly formulated. Multiple configurations led to delays in the delivery of machines. True, the company is compensating its customers for delays beyond eight weeks at the rate of two per cent per month. However, that is adding to the cost.

And, what about the reduction in the BOM which hinged on the standardisation according to Kochar? As the reduction was directly proportional to the (standardised) volumes, logically the costs reductions would not have materialised to the extent envisaged.

Assumptions - not at work

It appears that a much higher percentage of customers went for ad-ons and other non-standard features than PCL had anticipated. Further, customers are no longer used to delays in what is just another consumer durable. The company rushed in to take advantage of being the first which may have made it difficult to plan its operations in greater detail.

Whatever the reason, PCL faces tough times ahead especially with HCL offering a Pentium 133 MHz at comparable prices and off-the-shelf delivery. As it is, the company had cut its margins. With money cost going up (payment of interest for delays) and lesser reductions in BOM, how profitable the whole exercise turns out in the end is difficult to say.