The Need for Aggressively Driving Down Costs

In the Oct 2009 issue of Harvard Business Review there is an article co-authored by GE’s CEO Mr. Jeff Immelt and Tuck Business School professor Mr. Vijay Govindarajan. The article’s theme is “reverse innovation” – it talks about how GE (and some other global businesses) are introducing in US, innovations that were originally developed for lean markets. [tweetmeme source=”pricingright”] Countries like India and China have a vast population that has low willingness to pay mostly because of their extremely low wherewithal to pay. So instead of introducing stripped down versions of products that were primarily developed for US (wealthy customers) market GE is creating these products ground up for India and China. The authors provide as examples GE’s $1000 electrocardiogram device and a portable, PC-based ultrasound machine that sells for as little as $15,000.

Is this new or revolutionary? Since the innovation flow is reversed this is indeed new for most businesses but this in its essence represents a gap in business strategy – something all businesses should have been practicing whether or they are global, local or glocal. I am not referring to reverse innovation, I am referring to aggressively driving out costs from the system.

Henry Ford wrote in his book My Life  and Work,

Our policy is to reduce the price, extend the operations, and improve
the article. You will notice that the reduction of price comes first. We
have never considered any costs as fixed. Therefore we first reduce the
price to a point where we believe more sales will result. Then we go
ahead and try to make the price. We do not bother about the costs. The
new price forces the costs down.

Businesses like GE find it important to develop $1000 EKG for markets like India because that is what the customers are willing to pay. In the US markets there have been no real drivers for such innovations (until now) –  either the customers had higher willingness to pay or did not care because someone else was paying for it. In the specific case of medical equipments, the hospitals did not care about the high price tag because their customers did not care. Since the  hospitals could charge a high usage fee (that are mostly paid by insurers who then get it back in the form of high premiums from their customers) they did not actively force their suppliers to drive out costs from the system. So there was no incentive for any player in the value chain to focus on costs.

Had this been a different system where the patients pay out of pocket and/or have lower willingness to pay for use of such medical equipments then we would have seen each player actively squeezing out the costs to “make the price”. As Ford wrote, “the new lower price would have forced the costs down”. This is exactly what is happening now with down economy and high health care costs. So the low cost innovations that worked for markets with low price points are flowing back to markets that previously had high price points.

The lesson to takeaway from GE’s experience is not that we all should look for innovations in low willingness to pay markets to introduce them in high willingness to pay markets (although it is not a bad lesson) but know that a business should always be aggressively focused on  driving down costs be it through innovation or any other means.

In my article on Value Equation, I wrote the that a marketer has two levers to pull in maximizing their profits:

  1. Increase total value add to the customers
  2. Reduce the cost to create that value

Since pricing is a share of the net value added, improving anyone or both of the components will result in better profits even if the initial pricing were wrong.

Whatever new label you slap on this innovation flow – there is nothing new to the importance of driving down cost from the system.

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