Tuesday, October 16, 2016 How Ford Created a Huge Market by Lowering its Prices
Probably no one in business today can remember the earthquake caused by Henry Ford, and even in business schools, his case is rarely taught. But Ford’s story has priceless lessons for any ambitious entrepreneur or executive today. When he was 45, and a moderately successful industrialist, Ford took a brave stand that shook the world. The decision not only created his fortune but made him a leading architect of the twentieth century and one of the most celebrated and influential people on the planet. Ford recalled the turning-point in his autobiography: “What I am trying to emphasize is that the ordinary way of doing business is not the best way. I am coming to the point of my entire departure from the ordinary methods. From this point, dates the extraordinary success of the company. We had been fairly following the custom of the trade. Our automobile was less complex than any other. We had no outside money in the concern. But aside from these two points, we did not differ materially from the other automobile companies.” When Ford had his light-bulb moment, several hundred rival entrepreneurs were making cars. They were much the same in background and activity: all engineers; nearly all product designers; all auto enthusiasts, entering cars in motor races and taking a keen interest in who won; and all making no more than a few cars a day. They sold them to the same type of customer, too — the only market at that time for cars — rich and leisured gentlemen, usually motor “nuts,” skilled in driving and maintaining their beautiful beasts. Ford, though not the market leader, was one of the biggest manufacturers, making around five vehicles a day. But however conventional he appeared in 1908, there was always something odd about Henry Ford and his opinions. Though his whole industry was in the business of providing “pleasure cars” for the rich, Ford conceived a vision of something completely different. To their horror, he told his salespeople: “I will build a motor car for the great multitude. It will be large enough for the family but small enough for the individual to run and care for. It will be constructed of the best materials, by the best men to be hired, after the simplest designs that modern engineering can devise. But it will be so low in price that no man making a good salary would be unable to own one — and enjoy with his family the blessing of hours of pleasure in God’s great open spaces.” The idea of democratizing the automobile inspired Ford. His great insight was that the key was price. If he could make a car cheap enough, it would, he believed, sell in vast quantities. While it’s all very well to realize that price might be the key to expanding sales, how did Ford manage to keep his prices sufficiently low to create a new mass market? His first idea was to redesign the product and make just one standardized, simple model: “In 1909 I announced … without any previous warning, that in future we were going to build only one model, that the model was going to be the ‘Model T,’ and that the chassis would be exactly the same for all cars ... I thought it was up to me as the designer to make the car so completely simple that no one could fail to understand it. That works both ways and applies to everything. The less complex an article, the easier it is to make, the cheaper it may be sold and therefore the greater number may be sold.” So, by making a single product — for more than a decade, with few variations and options permitted — Ford could reduce his costs considerably. He also paid great attention to the materials that went into his cars. For example, he pioneered the use of vanadium steel, a French invention that was both very light and very strong — ideal to create usefulness for the customer. The vanadium steel disposed of most of the weight in Ford’s car — decreasing fuel consumption — yet actually cost less than the traditional alternative. The other plank of Ford’s low-price car was a new production system, geared to make vehicles at high scale and low cost. He built the world’s biggest factory — not just the biggest car factory — on a massive sixty-acre site at Highland Park, near Detroit. It opened on New Year’s Day, 1910, and the gain in productivity was marked: The average number of employees rose from 1,908 to 4,110, and the cars built from a little over 6,000 to nearly 35,000. The real breakthrough came in 1913 with a proprietary innovation, designed by his production managers: the move from batch production to a continuously moving assembly line. The effect of simplification and scale was to move the price of a Model T down to $550 by 1914, when 248,307 of them were sold. By 1917, the price had fallen even further, to $360, with the result that sales soared to 785,432. In 1920, Ford sold 1.25 million Model T’s. Compared to 1909, a price reduction of 63 percent — to almost a third of the original price of the Model T, which was itself a good fifth cheaper than comparable cars — had resulted in a sixty-sevenfold increase in the number of cars Ford sold. Simplifying made the company’s cars both easier and cheaper to make. And the price reduction was enormously effective in boosting the whole market as well as Ford’s share of it. By 1920, his share had soared to 56 percent, three times larger than that of his nearest rival, General Motors, which was an agglomeration of five different car brands. Ford was by far the most profitable car company in the world, both absolutely — relative to sales — and relative to capital employed. Even Henry Ford himself was surprised by how much demand responded to the lower price. A price reduction to 35-40 percent of the original price boosted sales by more than 700 times. The fact is, the relationship between price reduction and demand expansion is asymmetrical. If you cut price by half or more, demand rises exponentially — by tens or hundreds or thousands of times. Henry Ford’s example perfectly illustrates how cost and price reduction isn’t a one-off affair, but a gradual, continual process, fueled by a few big innovations — in Ford’s case a simplified car model, standardizing on one model and the moving assembly line — and a mass of smaller ones. Prices don’t have to be slashed in half immediately. Instead, a virtuous circle can be created, where the first cost reductions create a larger market and greater market share, with the benefits of greater scale subsequently lowering costs and prices and raising demand further. What’s essential, however, is a dogged commitment to achieve the lowest possible cost and price. Key pointsOne way to create a huge new market — with a different type of customer, only able or willing to pay a much lower price — is to simplify your product so that it is much easier and cheaper to make, and hence sell. But in order to price-simplify, you need to reduce the price by at least 50 percent. This doesn’t need to happen all at once, but you need to continue cutting costs and prices each year — by about 10 percent a year. Take a lesson from Ford:
If you’re a price-simplifier, cutting your prices is the primary objective. But, like Ford, you should also increase your product’s quality, utility and ease of use if this can be done without incurring extra costs. Richard Koch is an entrepreneur who has made over $300 million from starting businesses and investing in early stage venture capital. His businesses have included Filofax, Plymouth Gin, Belgo Restaurants, Betfair, FanDuel, and Auto1. Formerly he was a consultant with the Boston Consulting Group and a partner of Bain & Company before cofounding LEK consulting. He is author of many books on business and ideas, including The 80/20 Principle, which has sold over a million copies and been translated into 35 languages, and his newest title Simplify: How the Best Businesses in the World Succeed. Richard wrote the foreword to the Entrepreneur Press bestseller, 80/20 Sales and Marketing by Perry Marshall. Back To Leeconomics.com |
The following excerpt is from Richard Koch and Greg Lockwood’s book