Saturday, March 20, 2010

How Harley Fell Into The Commoditization Trap

As Published in Forbes

by Richard D'Aveni

In January Harley-Davidson announced higher-than-expected losses of $218.7 million for the final quarter of 2009. The motorcycle legend also announced that it anticipated sales of between 201,000 and 212,000 in 2010. Compare that with sales of 349,000 in 2006, and you get an idea of the ills that have beset the company.

Now, you might presume that Harley, with its premium-priced, iconic product, could not, definitely not, be affected by the phenomenon called commoditization, where a product becomes indistinguishable from its competitors. You would be wrong. The long straight highway has had a few hidden potholes, and in those potholes commoditization has lurked in the guise of both cheaper Japanese competitors like Honda and sexy upstarts at the top end like Big Dog.

Based on an in-depth study of more than 30 industries, I have identified the three most common patterns that create commodity traps: deterioration, when low-end firms move in with low-cost, low-benefit offerings that draw away the mass market; proliferation, when companies develop new combinations of price and unique benefits to attack part of an existing market; and escalation, when competitors offer more benefits at the same or a lower price, squeezing everyone's profit margins. Sound familiar? It certainly would if you were a Harley executive.

The company has faced two out of those three woes: deterioration and proliferation.
Harley first fell prey to commoditization in the 1970s, when it was undermined by a reputation for poor quality, lack of innovation and inadequate customer service. Japanese rivals such as Honda, Suzuki and Yamaha took advantage of its weakness and offered motorcycles at lower prices with better reliability. It was a textbook example of deterioration.

The outcome was predictable, if not inevitable. In spite of its legendary status, Harley's market share shrank from 39% to 23% between 1979 and 1983. The company could either slash prices to hold onto its market share or hold prices but concede share. Neither move would lead to financial health, given the firm's fixed costs.

The company's future looked grim at that point. But after a leveraged management buyout in 1981, Harley's leadership turned the company around. They kept its classical advantage in engine power but also emphasized a valuable secondary benefit: branding based on its rebel image and iconic status. This made the Japanese rivals' advantage in reliability less important as an inducement to purchase and value motorcycles. Rebels care more for role models than reliability.

Key to this was the launch in 1983 of the Harley Owners Group. HOG became the largest factory-sponsored motorcycle club anywhere and now has over a million members. HOG helped Harley develop a brand that could be extended to apparel and collectibles and reinforced the brand's adventurous, bad-boy image. The company roared back. During the 1990s buyers had to wait in line for months to get their bikes. In 2003, its centennial year, the company announced record revenues of $4.6 billion, up 13% from the year before.

My research found that in 2002 Harley customers were willing to pay on average 38% more for a Harley-Davidson motorcycle than for a similarly equipped bike from one of the big four Japanese companies, Honda, Yamaha, Kawasaki and Suzuki. Harley commanded this premium even though a Japanese bike at the same price offered 8% to 12% more power, measured by engine displacement. Harley customers were willing to pay more for less than purchasers of the most popular Japanese models.

A feeling of victory was understandable. Harley's turnaround showed how a company could--initially, at least--fight back successfully against commoditization by differentiating its products.


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