Defining a commodity
A ‘commodity’ is an agricultural or industrial produce that is exchanged for another commodity through the medium of money. The price of a commodity is determined through the interplay of the supply of and the demand for that commodity in a market setting. There is also a risk attached to the production of a commodity. For instance, a farmer is never able to the cost of his production and risks the cost incurred to produce that good; thus, he or she is led to bring his or her produce to the market, where all other farmers also bring their produces due to the same reason, and then, their price is determined through economic interactions (Armstrong et al., 2015). For example, two farmers growing the same crop come to the market to minimize the risk that they had taken while producing. A commodity is also defined as a good or a service that varies little or not at all across its different producers. In business terminology, any good or service produced become a commodity if there is minimal difference in quality or utility provided by it (Lewis & Zalan, 2014). Therefore, goods and services produced and sold in a perfectly competitive market setting is a commodity: perfectly competitive market is known as a market that functions on zero-profit condition as opposed to a monopoly market where goods or services enjoy profit due to a certain unique character it embodies. As any good or service start to enjoy any competitive advantage and consequently, high profit, that good or service is “uncommoditized.” In our following analysis, we will explore different aspects of a commodity and how business strategies are also shaped along those characteristics of a commodity. A commodity is also characterized by certain financial or other sorts of services it provides.
Memory(4%), Battery (6%), other parts (23%), Hard/CD drive (12%), display modules (16%) are most commoditized. These parts do not enjoy any brand value, and the competitive advantage attached to brands. The prevalent markets for these components are perfectly competitive with very low margin of profit operating (Chen & Schwartz, 2013).
Dell, Intel microprocessor, and Microsoft Operating System earn relatively higher profit. These components are uncommoditized. These components are produced by the corporations which have high brand value. Therefore, willingness to pay for these products are also high.
- i) Components described as “other parts” are most commoditized as these commodities are sold in the respective markets at perfectly competitive prices (Chen & Jermias, 2014).
- ii) Components such as memory, hard/CD drive, battery are “commoditized” since competition is very high, and thus, profit margin is low in these industries.
iii) Display modules earn relatively higher profit due to possibility of differentiating the quality of display. Profits earned in this market for display module is spent on Research & Development team which increases the technologies used in these modules.
- iv) Dell is earning very low operating profit, and going on a loss (- 6.5%). However, gross profit for Dell is around 24.5% according to the statistics until 2017 financial year. As can be seen, around 6-7% of one unit revenue is going to Dell.
- v) Microsoft’s operating profit margin is 19.4%, and Microsoft earn a net margin 13% of the profit. 11% of $1 revenue for PC goes to Microsoft. Microsoft earns a higher profit than Dell.
- vi) Intel earns most profit. 26% of $1 revenue of PC sold goes to Intel. Of the whole revenue, 22% is retained as operating profit (Kempf et al., 2013).
List of profit-earning components in PC ecosystems
- i) Components categorized under “other parts” can be any of search, experience or credence goods. That is to say, their quality can be ascertained by seeing, or after using, or cannot be ascertained at all, respectively.
- ii) Memory is a credence good because the quality cannot be verified by looking at it or by using it.
iii) Battery and Hard/CD drive are experience goods since it is impossible to tell if these are of good quality without using them for sometime.
- iv) Display modules are search good, since the display, if can be bought after checking the specifications as well as any display unit, the quality can be known. On many circumstances, it can also be an experience good.
- v) The PC ecosystem manufacturing brand, in this case Dell is a credence good since it is impossible to assess the overall performance without purchasing it and it is also difficult to ascertain quality even after using for some time.
- vi) Microsoft OS is an experience good since one can totally tell how the operating system performs after using it for some days.
vii) Intel is credence good since a microprocessor is a complicated technological component and it is almost impossible to assume one can know everything to search for the quality of a microprocessor or can ascertain its quality after usage of a period of time.
- i) Competitive advantage: If one producer has competitive advantage over another in producing a particular commodity, it means that the cost incurred may be the same but willingness to pay for that the good produced by the former producer is higher, or willingness to pay being the same, latter incurs a higher cost to produce that good (Becerra, Santaló, & Silva, 2013). Low level of competitive advantage leads to the product being commoditized.
- ii) If the market is too competitive, that is, if there are too many producers in a market producing the same good, pricing is done at the marginal cost. No profit is ripped in such cases. This leads to commoditization of the product.
iii) If the products are homogeneous in nature, that is, there is no scope for differentiation, and the goods are characteristically Equal to one another, and the level of uniqueness of one product produced by one producer is very low, this leads to commoditization (Casadesus?Masanell & Zhu, 2013).
- iv) If there is no recent technological advancement in any industry, and the industry is stagnant, since the industry runs on zero profit condition, there is no scope for further investment that can improve the quality of the good or lead to any differentiation. Then also the goods are commoditized.
- v) If there is high degree of information or high mobility of labor and capital, not requiring any skilled labor in the process of production, the products are commoditized easily (Zucman, 2014).
- vi) If the buyers have perfect information about the price of the market, and also the quality are not differentiated, this leads to the commoditization of a product.
WTP stands for “willingness to pay” of a consumer for a particular commodity. C is the cost incurred to produce that commodity. It has been observed that the more this difference between WTP and Cost, the more there is possibility to uncommoditize that segment (Hoejmose, Brammer, & Millington, 2013). WTP varies chiefly on the basis of the differentiation of the product on the basis of quality. This wedge determined from the difference between WTP and C also ensures the level of profits earned by the product. It is clearly discernible that this said wedge is positive, as in, WTP has to be higher than the cost incurred to produce in order for profit to be positive. Higher wedge leads to more competitive advantage of the producer in that segment among all the producers. This wedge determines the level of uniqueness of the concerned product. The product can be differentiated in two ways leading to variations in the wedge (Shin et al., 2015). Horizontal differentiation occurs when there are some consumers who are willing to pay more but there are also some who are not willing to pay more, but those other consumers are willing to pay more for another product in the same industry. In car industry, some people are willing to pay more for SUV’s whereas some are willing to pay more for Sedans. Vertical differentiation is said to occur for a product which has some unique character and that is unanimously agreed by all the customers, making it an unique product and thus, ensuring a higher WTP (Liu & Zhang, 2013). If everything else is held constant, higher quality of some segment leads to higher WTP. For example, all else held equal, if Intel provides a better microprocessor, customers are willing to pay for the better performance it promises to provide. Innovation towards a cost-effective production leads to lowering of production cost. Increase in WTP and decrease in cost leads to a higher wedge and consequently the product is said to have a higher degree of uniqueness and thus, earn a certain brand value, the product earns more profit. If each of the segment in the production process attracts higher willingness to pay, the willingness to pay is summed up to a much higher willingness to pay (Liu & Zhang, 2013). In case of the products that are commoditized, wedge is very low or zero, whereas, for the products which are uncommoditized, wedge is high. Factors that increase the scope for differentiation of any product, and hence, chances of higher WTP is the features and performances provided by the product (Gabszewicz, & Wauthy, 2014). At certain cases, complementary service that the product provides along with its main function also enables it to attract higher WTP. Intensified marketing and promotional strategies also lead to differentiation. Intensive technology used in design or product also lead to differentiation. In case of certain service oriented product, capabilities and effort that goes into its functioning, such as quality control and sales visits can increase the WTP of its customers (Oliveira et al., 2016). Improvement made in terms of customer care also lead to more satisfaction for the consumers and hence, more WTP. As the products become more differentiated, profitability increases as willingness to pay increases, everything else remaining the same. With the increase of brand value, the product is uncommoditized, and consumers do not buy it looking at its prices, but they buy it for the quality of the product itself, for its uniqueness.
References:
Armstrong, G., Kotler, P., Harker, M., & Brennan, R. (2015). Marketing: an introduction. Pearson Education.
Becerra, M., Santaló, J., & Silva, R. (2013). Being better vs. being different: Differentiation, competition, and pricing strategies in the Spanish hotel industry. Tourism Management, 34, 71-79.
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Oliveira, T., Thomas, M., Baptista, G., & Campos, F. (2016). Mobile payment: Understanding the determinants of customer adoption and intention to recommend the technology. Computers in Human Behavior, 61, 404-414.
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