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Why some companies are flourishing as middle markets collapse.


Consumer markets are polarising and the poorly differentiated middle ground is being pulled apart. Substitution is the name of the game, says Neil Gibb. Learn how to rethink your business strategy from two very different firms’ success stories.




Two success stories have consistently stood out in the pink pages over the past few years.

Rosalia Mera

Rosalia Mera, Inditex, passed away in 2013

The first of these is Inditex, owner of expanding fast-fashion retailer, Zara. In 2013, it showed five per cent annual growth, on top of 2012 figures that revealed a year-on-year surge in profits of 22 per cent on a 16 per cent increase in sales.

Any fears that this reduced 2013 growth represented a long-term slowdown were dispelled by an upswing in early 2014 sales, said the company, which also owns the Pull & Bear and Bershka brands that are fast pushing their way into shopping malls alongside Zara and Zara Home.

In 2012, Inditex opened new stores in 64 countries. In Q1 2013 alone it opened outlets in 30 countries and announced plans to make online sales available in Russia and China. Sadly, co-founder Rosalia Mera passed away in August 2013.

By contrast, Italian fashion brand Benetton issued a profit warning in fiscal 2012, and announced plans to delist itself from the Milan stock exchange. A number of its franchised stores closed worldwide in 2013. Benetton’s plight was not an isolated case, but was representative of the struggle that many mid-market retailers have experienced since the global financial crisis.

The second success story has been the rise of German luxury car maker Porsche, which announced a 173 per cent surge in 2013 operating profits to €2.6 billion from selling just 155,000 cars. That nearly matches the VW marque’s 2013 operating profit of €2.9 billion from selling 4.7 million cars. (Porsche is part of the Volkswagen Group – click here for separate analysis.)

Porsche’s ongoing success reveals two things: one, that the serial recessions of the 21st century have not blunted the spending power of some buyers; and two, that luxury brands are making the real money in an increasingly commoditised marketplace.

What’s the common ground?

Zara’s and Porsche’s core markets may be different (although the Strategist suggests that many a Porsche driver has worn a Zara jacket), so it may seem as if the two stories have little in common – beyond illustrating growth in two companies selling non-essential goods.

But in fact, these companies represent two signs of a structural change that is rippling across the business landscape, a tectonic shift that few western companies have identified or understood.

Mainstream markets for a range of goods and services are polarising: innovative, aspirational makers such as Porsche are flourishing, while those able to deliver desirable products frugally and fast, such as Zara, are flourishing too. This leaves the middle being pulled apart. But the primary cause is not customers’ incomes; if it were, then every company at either end of their markets would succeed.

The mid-priced mass market is bearing the brunt of developed economies’ pain. Examples of the failing middle are rife. In June 2013 alone, six major mid-market retailers in the UK with a combined turnover of £600 million went into receivership.

The pain of the lacklustre middle-market is not a blip but part of a change in the structure of developed economies. Those who talk about recession, which those economies pass through one-third of the time, are missing the point. To understand why a European clothes company and an upscale car maker are making hay in the rain while similar firms wilt around them, it is worth considering a paper written in 2002 by Seamus Smyth of UK thinktank NasLab.

Zara designs

Zara concept designs can be taken to market quick

In the 1990s, Smyth worked at Shell, where his job was to predict future technologies and market trends. He did this successfully for years, but as the millennium swept closer and the dotcom boom seemed about to turn the business world on its head, Smyth realised that the extreme changes brought about by globalisation and the internet rendered conventional trend-spotting unreliable. He set about finding new models.


One of the first concepts he came up with was what he called ‘substitution’. This arose from the observation that while traditional markets had long seen progressive evolution, companies, products and business models could be usurped en masse if a market’s foundations were disrupted. His thinking built on Clayton Christensen’s notion of ‘disruptive innovation’ and added new thinking, particularly around how incumbents should act.

Smyth’s writings were filed alongside those of MIT’s Nic Negroponte, who spent the end of the century saying that dozens of industries would shift from units to bits and become digital services. Negroponte was right, of course, but most people saw Smyth’s theories and proposals as yet more dotcom theorising.

Over the next few years the obvious truth of Smyth’s observation was revealed: Google ripped the guts out of the traditional advertising business model; Apple stopped rotting in its own walled garden and began tempting Adam and Steve with music and mobility; Twitter published news by the nanosecond by allowing human beings to subscribe to each other; and so on.

This much is common knowledge, and it all happened so quickly that Smyth’s starting point – accurate as it was – now seems obvious, as a new order emerged to change the way we shop and communicate with each other. As a result, his more detailed theory was overlooked just as quickly.

The people who saw only the sugar coating of Smyth’s observation missed the hard centre. His hypothesis wasn’t rooted in ‘futurology’, or in the risks of being a passive victim of competitive change; his concern was what organisations should do about it.

Smyth considered what the implications might be for both the substitutor and (more interestingly) for the substituted. His response wasn’t to be “more digital” (Negroponte’s mantra of the time), it was to examine the implications of change for any organisation’s core values.

‘Substitution’ was Smyth’s solution, and he said that to succeed, organisations need to do it within themselves. Zara is part of this wave of substitution. It understands that to survive on the high street in physical premises, its service needs to be more engaged with its customers, not less.

What it has done, along with a handful of other companies like the UK’s Topshop and Japan’s Uniqlo, is substitute the well-established seasonal cycle of the fashion industry with a customer-responsive one.

Haute couture ideas

For years, the fashion industry spun through its Spring and Autumn cycles, with haute couture houses showing their wares in New York, Milan, Paris, and London and directional styles then filtering down from catwalk to high street via diffusion lines and copycats.

In that world, collections were put together well in advance, buyers purchased stock in bulk, and the customer chose from the season’s offerings. But problems arose when lines didn’t sell or more popular fashions emerged from the street.

What companies like Zara and Topshop understood was that while fashion houses paid Kate Moss and others to walk their clothes down the runway, people were often more interested in what she wore when she was out clubbing or shopping.

Zara, Topshop and Uniqlo changed their design thinking while optimising their supply chains so that they could respond to sudden changes in taste. This meant that they could bring new garments to the high street almost overnight, which demanded a flexible, evolving inventory with limited editions and short-run stocks. That created additional peaks of demand within the once-predictable quarterly cycle, fuelled in part by social media.

So the reason Zara has been bucking the trend in Europe is because it is a substitutor. Its strategy was not to do what everyone else was doing faster, better or cheaper; its strategy was to do it differently, based on its core values and what it saw the market needed.

Strategist Substitute 2 Clipping

Fast Retailing (Uniqlo) chair Tadashi Yannai

When companies drift

Organisations often get caught up in the minutiae of what they do, rather than the bigger picture of why they are there. They make the classic mistake of those who are at risk of being substituted: they concentrate even harder on failing by pushing towards ever-lower levels of quality.

Meanwhile, they pour money into telling their customers about their latest ‘innovation’ – another marketing hook, ad campaign or logo. Many of these strategies miss the point, however, because the mindset of a substitutor seems counter-intuitive to people in mature businesses.

But where does a maker of expensive, high-performance vehicles fit into this? The answer lies in another counter-intuitive strategy: how some companies have managed to turn being substituted into a new competitive advantage.

To understand Porsche’s recent figures means going back to this second, more interesting part of Smyth’s model. As we’ve seen, the first was hardly radical – innovative ideas arise and disrupt/usurp the old – but the most useful part is what Smyth said would happen to those mass-market ideas that are substituted.

Ironically for a discussion about Porsche, Smyth used the example of what happened to the pony and trap when the internal combustion engine came along.

Overall, horse-powered transport went into steep decline with the arrival of the motor car, but not all of it did. It persisted for a while among people who couldn’t afford a car, but it also deepened its hold upmarket – state occasions; upscale weddings; equestrian events; and so on. Its new-found scarcity, and therefore its exclusivity, became attractive. It became something to aspire to rather than escape from.

It’s an extreme example, but in any industry where substitution is taking place, the mass-market products or services that are substituted become perceived for a while as second rate, but eventually their lack of mass appeal expands their cachet among high-value niche audiences. Vinyl records – sales of which are up by 70 per cent year on year – are an example of this. And so is Porsche.

Driving towards change

Toyota Lean Production

Toyota: Lean production

The substituting innovation in the car industry was the introduction of Global Platform Development, with the shift away from national or regional centres. The sharing of design and engineering resources, economies of scale, and just-in-time supply chains meant that companies could develop and bring to market well-made cars at competitive prices.

It was Global Platform Development that enabled Toyota to become the bestselling car company in the world as locally made mid-market cars became redundant.

So, as Smyth predicted, the incumbent brands have gone in one of two ways: they have either become devalued and/or gone out of business (Saab, for example), or they have moved up into higher-value niches, which is what Porsche has done.

This era could be called ‘the Great Substitution’, as globalisation, new technology and changing demographics conspire to force many mid-market incumbents to change. In the Great Substitution, two polarised customer types have emerged, and understanding which ‘pole’ your organisation really serves is vital, because your business lies in fulfilling their needs.

The first is what’s traditionally known as ‘the consumer’ – not a demographic group in this argument; simply a description of an activity. Each may have more or less money to spend than other consumers, but consumption is their bottom line. The things that are generically important to them are: ease of access; ease of use; comfort; and price. As a result, they have become fickle and demanding, and share good and bad experiences via social media.

Although some consumers may say they prefer specific mainstream brands to others – banks, high-street clothes shops, chain cafés, and so on – what really interests them is what these products or services can do for them. They may exhibit loyalty to one or another for a time, but it is highly conditional and often based on familiarity and habit rather than any deeper bond.

Many organisations imagine that a bond is there and waste huge sums of money spinning a fake mystique around it when they should really be investing in making their products and services better.

Clicking to disloyalty

For the purpose of this argument, the Strategist says that ‘consumers’ are not always distinct from many business-to-business (B2B) customers. Clicking from website to website in search of industry news is a form of consumer activity. When such business services are poorly differentiated from each other, users are only loyal to them out of habit, if at all.

In short, ‘consumers’ don’t care deeply about most such products or services beyond what each one can do for them. And if there is one trend that all consumers have exhibited over the last decade it is to become less tolerant. That isn’t going to change, and yet some companies persist in treating their customers with contempt; a strategy that tends to be rooted in internal drives towards cost savings.

The second customer type is the aficionado. Aficionados behave differently to consumers when it comes to their passion. They are immersed in each subject that interests them. They have a deep love and attachment to it, to a maker, or to a type of product; they enjoy being part of a select group and are prepared to pay for the privilege. Authenticity, heritage, exclusivity, quality, depth, slowness, craft and nuance are all important to them.

In other areas of their lives they will be consumers, but it is aficionados who buy Porsches and, higher up the scale, Bugattis and Ferraris. Such makers foster aspiring aficionados as well, to whom they can sell a vision of being part of the group.

In the UK’s automotive sector, niche players like Morgan, Caterham and McLaren thrive. These are the types of makers that car aficionados love, because they are not designed, rendered or engineered to seem authentic; they are authentic. Triumph motorcycles are another example: customers are loyal, order books are full for years, and their products are premium priced.

But that is just the car and bike industry. What about everyone else? Once you look for aficionados in markets where substitution has taken place, you can see them everywhere.


The rise of the aficionado.

Rise of the aficionado

It is aficionados who buy handmade mechanical Swiss watches, a niche born out of quartz substituting mechanical movements as a mass-market product. It is aficionados who wait for 15 minutes to be served in an owner-run cafe rather than go to Starbucks; it is aficionados who buy medium-format Rolleiflex cameras; and it is aficionados who are buying vinyl records and turntables in ever-increasing numbers – so much so that new, specialist companies are springing up to serve their needs. Some of these passions carry heavy price tags, but not all of them do.

An aficionado-based business does not always demand that its customers are wealthy, necessarily, but rather focused and with high standards: people who are after something specific and high quality. These customers will swiftly detect a fake or an interloper.

As with our redefinition of consumers above, aficionados can include B2B service users, if they are a well-defined group and they genuinely care about the exclusivity and quality – and sometimes heritage – of the product or service they use. An aficionado-focused strategy, then, does not just mean selling to wealthy minorities.

This is not to say that aficionado-focused businesses never fail. Some companies go to the wall because they begin applying consumer thinking to a customer base that is, essentially, aficionado.

Other companies suffer the inverse problem: they fail to identify that it is disloyal consumers who keep them in business, and not aficionados. As a result, they waste millions of pounds on creating an aura of ersatz exclusivity, while cutting back on the service quality that makes consumers stay. Most banks fall into this category. Failing brands should stop advertising their way out of crises and set about improving people’s lives.

As the balance of economic power shifts to the East, smart organisations should consider securing higher-value niches for themselves, as Porsche has done. Alternatively, they should explore substituting long-established practices, as Inditex has.

If you are in the mid-market and either don’t have the stomach or resources to be a substitutor, then the only alternative is to specialise. In short, if you can’t be a mass-market contender in the new environment, then be a specialised, higher-value one. To do any of this demands rigour; it is not about spin or clever messaging. After all, German cars appeal to aficionados because German car executives, designers and engineers love cars. It’s really that simple.

To thrive in the current environment you have to be an aficionado yourself. TS

The Strategist says

Decide if you run an ‘aficionado’ or a ‘consumer’ business (craft, or convenience?). Be honest about the answer – don’t pretend to be the former when you are the latter. Don’t focus on failing faster or cheaper. Focus on being different. Specialise in high-value niches, or innovate in a mass market. Stand for something that people can identify from your products/services.
Neil Gibb is a writer, adventurer and director of performance management consultancy SLP. Originally from the UK, in recent years he has spent a lot of his time working in the emerging economies of East Asia.
Additional content: Chris Middleton.



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