Granular Metrics, Feedback and Experimentation. Arnoldo Hax Alfred P. Sloan Professor of Management

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1 Granular Metrics, Feedback and Experimentation Arnoldo Hax Alfred P. Sloan Professor of Management

2 Contributions of the Delta Model The Triangle Opening the mindset to new strategic position The Best Product does not always win Three Strategic Options: Best Product Total Customer Solutions System Lock-in Adaptive Processes Aggregate Metrics Granular Metrics and Feedback Linking Strategy with Execution Measuring success Discovering performance drivers Execution is not the problem, linking to strategy is Good financials do not always lead to good results Managing by averages leads to below average performance Execution is captured through Three Adaptive Processes: Operational Effectiveness Customer Targeting Innovation whose roles need to change to achieve different Strategic Positions Aggregate performance metrics need to reflect each of the Adaptive Processes and their role based upon the strategic position Product performance Customer performance Complementor performance Business is non-linear. Performance, particularly bonding, is concentrated. Granular metrics allow us to focus on underlying performance drivers, to detect variability, to explain, to learn, and to act.

3 The Delta Model and Granular Metrics Select Performance Indicators Act from Variability Define program Define structured tests Rollout Detect Variability Drill down to detailed segmentation Isolate variability Learn from Variability Hypothesize cause and effect Evaluation Explain Variability Identify performance drivers Correlate drivers with variability

4 Drivers of variability for selected performance indicators Performance indicators Product cost and quality Customer profit Complementor contribution Business segment economic value Drivers of variability Scale Density-e.g. e.g. concentration of service Location Labor productivity- practices and training Equipment productivity- design Process design And so on Customer size Customer revenue Tenure Acquisition cost Channel mix Customer care support Customer investments in relationships And so on Size of relevant complementor products Complementor investment in business Relative size in customer value chain Complementor contribution to customer economics Exclusivity of relationship And so on ROI (return on investment) profitability Risk- volatility and covariance Option value Investment base Cashflows

5 Experimentation as the basis for effective change Large Size of Change Small The middle road: lower returns, or unacceptable when first mover advantage is high Ineffective: lower returns, or unacceptable when first mover advantage is high Unacceptable risk, as a starting point. Highly desirable as endpoint Testing: the relevant area for experiments leading to large change Slow Speed of Change Fast

6 Cost De-Averaging: Using Granular Metrics To Drive Performance

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8 The drivers of the cost of order-fulfillment Cost of order fulfillment Location of work centers Activities of order fulfillment Manpower productivity Equipment

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11 The behavior of cost by type of defects Client Defect-free % of % of % of % of orders orders orders orders 71% $100 5 Days 18% Business Data Service Orders Business Data Service Orders 24.0% $ Days 60% Focus of program development Business Data Service Orders 5.0% $1, Days 22% Average 1 $ Days

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15 Profit De-Averaging: Using Granular Metrics To Drive Performance

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17 The drivers of customer profitability in the credit card business s Profit by customer Revenue per customer Number of customers Balance level per month Months of tenure

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21 Customers targeting behaviors Behaviors Offer Test/year Service tier Key metric Targets Solicitations/year Segmentation frequency Risk orientation Data sources Staff analysts Typical competitors 75 products 30 4 ROE, Delinquency High response likelihood 50 million Biannual Risk averse Capital One 5,000 products 15, NPV High NPV potential 400 million Ongoing Price for risk 50,

22 Capital One- achieving a Total Customer Solutions through Customer Targeting Variation 2 Variation 1 Select Offers Further improvement Offer Creation Core offer Interest rates Fees Promotions Mass marketing Screen for profitability Full life cycle customer profitability Variation 2 Variation 1 Test cells Collect customer response

23 Success metrics Customer NPV Acquisition cost Activation Percent with revolving balances Fee income per account Charge-off per account Tenure Typical competitor $62 $77 58% 25% $55 $71 4 years Capital One $427 $67 79% 40% $73 $54 6 years

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