Commoditization

Commoditization is the dilution of a market sector's internal differentiation and competitive nuances in favor of a mass market where price alone determines consumer behavior. The industry's mode of competition thus moves away from innovation of the underlying, commoditized product and toward alternative methods of building value.

As industries mature, barriers to market entry gradually erode, competition intensifies, and the market becomes saturated, forcing prices downward. In the eye of the consumer, there is increasing parity among a market sector's products and services, and building customer loyalty becomes all the more challenging. As the proliferation of products within a market sector reaches the commoditization point, the perceived distinction between brands and varieties vanishes altogether, and customers base their purchasing decisions solely on price. This in turn leads to a pricing war that wreaks havoc on profit margins. To combat commoditization, firms generally seek out new operating models, bundle services to add value, or diversify or specialize their product to capture a niche market within a broader market. If all else fails, firms may simply cut realized or potential losses by exiting the market.

The Internet's relationship to commoditization is something of a paradox. On one hand, the Internet provided a vehicle in which firms could escape commoditization of their products and services by opening new areas of competition. Firms shifted their business plans, often very rapidly, to quickly capitalize on the possibilities afforded by the Internet in fear of losing market share to rivals that were quicker to adapt. The avalanche that ensued, however, created another form of commoditization. Many firms simply established their online presence with too little attention to how to successfully integrate the Web into their existing operations, or how to distinguish their online storefronts from those of others. This process was greatly accelerated by the emergence of the World Wide Web as a medium of commerce, making transactions, comparison shopping, and bidding quick and effortless.

In the sort of mass merchandising that regularly takes place as industries mature and begin to consolidate through mergers and acquisitions, products and services grow more removed from the level of the customer, particularly in services, where the personal touch provided by local companies is replaced by larger national or multinational outfits. Meanwhile, personal dealings with customers are streamlined and mechanized in order to boost customer rolls and margins. This brings about a different sort of commoditization that requires careful remediation. Once again, the Web is a double-edged sword in this case. On one hand, it furthers this process since customer service is thoroughly mechanized and removed from the face-to-face medium. This dramatically decreases the firm's transaction costs and offers convenience to the customer. For those reasons, the Web has been vigorously embraced by firms across many industries. However, it also tends to erode any sense of personal connection to the firm.

A thoroughly commoditized market within the Internet spectrum was telecommunications bandwidth for high-speed Internet access. In this sector, commoditization was not so much fought as it was incorporated. The telecommunications industry established the Bandwidth Trading Organization to coordinate the trading of bandwidth in a manner similar to energy commodities. Such trading would facilitate the implementation of sophisticated financial tools that could manage market risk and generate stronger returns, much as is done in other financial markets.

There is no formula for combatting commoditization; how it is dealt with largely depends on the nature of the industry and the mode of competition therein. Commoditization is less likely to infect markets that require more capital investment to enter, such as heavy manufacturing. But even those industries are affected by burgeoning online business-to-business marketplaces. The capital investment required to enter into the modern information technology and computer software industries, meanwhile, is relatively small. As technology develops, it gets smaller all the time. Companies can distinguish themselves and stay a step ahead of industry commoditization by augmenting their brick-and-mortar operations with their online operations, rather than allowing online storefronts to eat into existing sales channels. The latter often was the case in the 1990s and early 2000s. One way or another, commoditization was a fact of life in the Internet economy, and how firms adjust will largely determine whether they have a place in it.