The Art of Embracing Commoditization

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The Art of Embracing Commoditization

By Eric BoudierAnders Porsborg-Smith, and Martin Reeves

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Contact the Authors

  • Senior Partner & Managing Director, Global Leader, Industrial Goods Practice
  • Senior Partner & Managing Director, Global Leader, Industrial Goods Practice

China’s economic slowdown has led to overcapacity in many sectors and a significant fall in the prices of many commodities. Although many businesses will regard this as a short-term, cyclical challenge—one they can weather through capacity adjustments—it may prove for others to be something entirely different. It may mark the onset of commoditization, a secular and more severe challenge for which businesses may be wholly unprepared.

Commoditization is not necessarily a death sentence. (See “Escaping the Doghouse: Winning in Commoditized Markets,” BCG Perspectives, April 2015.) But surviving it, or even benefiting from it, can entail drastic measures, such as rethinking strategy, repositioning the company in the industry’s value chain, and overhauling its operating model. Many businesses facing commoditization fail to respond with anywhere near the required boldness or speed, however. Indeed, some may not even recognize or acknowledge the challenge, let alone succeed at crafting an effective plan to address it.

Understanding Advantage in Commoditizing Markets

Eventually, all products become commoditized. (See “BCG Classics Revisited: The Growth Share Matrix,” BCG Perspectives, June 2014, and “Adaptability: The New Competitive Advantage,” BCG article, August 2011.) A company’s optimal strategic response will depend not only on the industry’s current state but also on its likely evolution. In attempting to gauge the latter, a company must try to determine whether it can establish a sustainable position on the basis of any one of three factors: its cost position; whether, and to what extent, there are imperfections in the market that it can exploit; and its ability to redifferentiate its product. (See Exhibit 1.)

Choosing the Right Business Model

Arbitrageurs do not necessarily own production assets—and, if they do own them, it is typically as a means of acquiring information about imperfections and exploiting pricing inefficiencies rather than earning a producer’s intrinsic margin. Makers of generic pharmaceuticals, for instance, do not necessarily produce all the molecules of the drugs they package and market. (In some cases, though, they might consider doing so if it enabled them to be more reactive to market opportunities, such as sudden outbreaks of disease, or if it allowed them to take fuller advantage of short-term pricing spikes.)

In fact, what makes an arbitrageur’s business model unique is not its production footprint but rather its operating model. The key characteristics of that model are the following:

  • Agility. Market imperfections are short-lived; arbitrageurs must be agile in order to exploit them. If a producer can reoptimize its value chain on a quarterly basis, an arbitrageur must be able to make decisions in hours, or even minutes and seconds, if it wants to take advantage of observed pricing inconsistencies.
  • An Emphasis on Delegation and Empowerment. To be agile and able to make decisions with sufficient speed, operators (including suppliers, sellers, logistics and value chain optimizers, and production schedulers) must have the freedom to make decisions without approval from upper management.
  • A Simple Performance Metric: P&L. To ensure that actions taken by operators increase value for the company, the main KPI used is the global profit generated by all activities, as measured by the profit-and-loss statement.5 Notes: 5 Sometimes these companies might use a risk-weighted P&L. One oil company, for example, created P&Ls for individual teams, preempting political discussions among the teams about the logic of emphasizing particular functional KPIs, such as operating cost or production losses.
  • Tight Control over Operations and Strong Risk Management Capabilities. Delegation and empowerment have a price. Companies need to ensure that operators do not misuse the freedom they have been given. An independent control function, complemented by strong risk management capabilities, must be in place to ensure that operators stay inside the parameters they have been assigned.
  • A Superior Understanding of the Market. The ability to detect genuine market imperfections and gauge their potential evolution is crucial for arbitrageurs. Gaining this ability requires access to timely market information from the company’s production and marketing functions. It can also be fostered by robust information-gathering and fundamental-analysis processes. The goal is to know the market better and to seize opportunities more quickly than competitors.
  • A Strong Market Footprint. To detect and take advantage of market imperfections, arbitrageurs need a large, diverse footprint in the product market in the form of production assets or contractual commitments that give them access to products. Arbitrageurs also must be able to move and store products economically and have logistics positions that allow them to access end consumers cheaply. The more diverse the network of positions, the easier it will be to arbitrage the market. Acquiring or building such a network can be costly, however, so arbitrageurs usually choose to create a virtual portfolio of assets through long-term contracts.6 Notes: 6 An arbitrageur may opt to acquire assets if it becomes difficult to control them without ownership. In that case, the arbitrageur will be looking to acquire assets whose costs are in the third or fourth quartile in order to avoid paying a large premium for the assets’ intrinsic value: the main purpose of the acquisition is gaining access to the assets’ extrinsic value. This arrangement often allows an asset’s intrinsic value to remain with the asset’s owner while the arbitrageur gets access to the extrinsic value.

The current environment offers arbitrageurs an interesting opportunity to improve their position. Many producers find themselves challenged in their core business because their margins have fallen substantially. In response, they have opted to refocus their efforts on first- or second-quartile cost assets and sell marginal or logistics assets, such as storage facilities or subscale refineries—many of which have the potential to deliver considerable value to arbitrageurs. We have seen large oil producers, for example, selling refining and logistics assets to oil merchant-traders that are focused on extrinsic value.7 Notes: 7 Vitol, Trafigura, and Gunvor acquired refining, logistics, and distribution assets from some of the largest oil players between 2010 and 2013, a period when intrinsic refinery margins were low.

A subset of the arbitrageur model is what we call “platform” business models. Companies like Amazon and Sotheby’s are able to control the market platform itself, either digitally or physically. This allows them not just to extract extrinsic value from the market through superior market information but also to monetize value as monopoly platform holders. (Discussion of the necessary market dynamics and requirements for companies that would deploy such models is beyond the scope of this article.)

Producer-Arbitrageur. For companies in an industry with a steep cost curve and structural market imperfections—crude oil is an example—a producer-arbitrageur model should prove compelling. In most cases, however, producers do not opt to expand into arbitrageur-type models. Many of these businesses are unaware of the potential value at hand—an EBITDA margin of as much as 5%, depending on the sector and situation—which can be captured with minimal capital investment and limited risk. Many producers with good profitability are also reluctant to increase the complexity of their business model in an effort to gain access to their industry’s extrinsic value. They are typically hesitant to dedicate management attention to this pursuit and are afraid of derailing a business model that they understand well and that is extracting significant intrinsic value from the industry.

These concerns are legitimate. The operating models, cultures, and skill sets required of producers and arbitrageurs are quite different. Nevertheless, a number of businesses, including several oil companies, utilities, and pharmaceutical companies, have successfully blended the two models and are reaping substantial rewards.8 Notes: 8 Examples of oil companies include BP, Shell, and Total; examples of utilities include EDF, Engie, and Statkraft. Best practices of such companies include the following:

  • Physical Separation of the Entities Responsible for Production and Arbitrage Trading. The respective cultures and incentive systems are likely different; mixing them could create tension while diluting the capabilities needed to win in both areas.
  • A Clear Interface Between the Two Functions. Maintaining this interface will promote a high degree of responsiveness to market opportunities while ensuring clarity in the decision-making process. This is critical—there should be no question about who has the lead when different types of arbitrage opportunities emerge.
  • Responsibility for the Steering of Production in the Hands of the Commercial Function. This will enable the firm to manage assets optimally against a volatile market.
  • Transparency in Value Creation Along the Value Chain. Optimization decisions often affect both the commercial and production parts of the value chain. If different parts of the chain employ different metrics (for example, production efficiency versus margin), it will be difficult to evaluate tradeoffs at the speed required to leverage market imperfections.
  • Use of Ex-Post Results to Gauge the Performance of Teams and Individuals. The intrinsic and extrinsic value that can be extracted from assets and market positions can vary considerably depending on market movements. Sometimes achieving budget figures will be easy; other times, impossible. It is therefore important to measure performance against real-time market potential.


Commoditization is inevitable for most businesses and is happening with increasing speed. But it is ultimately survivable and potentially advantageous, provided a company recognizes and understands the challenge it faces and responds strategically, quickly, and with rigor.

Leaders facing commoditization pressures in their industry should ask themselves the following questions in order to become a beneficiary of commoditization rather than a victim:

  • How is commoditization changing the basis of competitive advantage in my industry?
  • Which of the strategies discussed above are the most viable for my company?
  • What changes do I need to make to my business model, and what capabilities do I need to develop, to ensure my company’s success?
The Art of Embracing Commoditization

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