Value Navigation: Create, Capture and Convert

Transcription

1 Value Navigation: Create, and Convert Companies work hard to create customer value they spend most of their available resources on products or services that will have customers beating a path to their doors. Fewer spend time on capturing some of that value determining appropriate volumes for production and effectively setting prices. And fewer still pay much attention to converting the value captured into profits and investor returns. Run a Google search on the phrase, create value for customers or create customer value and you will receive more than 20,000 hits on the first and another 26,000 on the second. Now search the phrase capture value from customers only 590 or so hits. Finally, search convert customer value less than 200 hits. So, what s the difference between creating customer value and capturing and converting that value? Only the difference between running a charity and running a business. Successful navigation of the value landscape requires attention to all three aspects of value. Of course, only those businesses that succeed in Create for Customers for Company Convert to Profit & Returns creating customer value in the first place will have the opportunity to venture further. And so we start with the simplest advice begin at the beginning. Value Creation is in the Mind of the Beholder Your customer s definition of value is the only one that matters. Ah yes, your engineers are high-fiving all over the lab and your marketing people are positively joyful about your new product, but it won t matter much if customers don t agree. Your customer s definition of value emerges from three sources, and two of them are beyond your control: what you offer his internal realities the influence of competing alternatives Buyers express their value perceptions in many ways through what they purchase and what they don t, through what they say is important in the buying process and the steps they actually take to buy. And, of course, buyers express their value perceptions in the prices they attach to each of these choices. While you may think differently, that price is not exclusively an expression of your product s merits but your product s merits within 2005 Business Navigation Group Page 1

2 both the larger competitive landscape and the customer s internal context. How much of the created value you get to actually capture depends on all three factors. Did we say that two of the three factors your customer s internal realities and your competitive landscape were beyond your control? Indeed, they are, but they don t always have to be. Getting Outside the In of Innovation Leading firms in today s market have become ferociously interested in innovation. Look at P&G, 3M, GE and hundreds of others. This focus on innovation makes sense coming after a tough global economic downturn and aggressive attention to productivity and process improvement. As those endeavors run their course, it s natural to look toward innovation to drive growth. But innovation that lacks outside perspectives can become just technology looking for a place to happen. Outside-Innovation can help you establish some albeit limited control over those two other factors in customer expressions of value. Value perception may start in the mind of the buyer, but you don t have to let it get stuck there. Relentless attention to your customer s perspective during the innovation process, even collaborative innovation with your customers and suppliers, can give you insights into how you can capture more of the value you create. The same can be said for serious attention to your competition s positioning. Key elements of your product s differentiation its competitive value proposition can only emerge from a leadership position in competitive research and analysis. That s right; that obscure craft you have regulated to a dark corner in your marketing department. But take heart; if you are like most companies, you can double your investment in competitive research and analysis by adding just one person. Collaborative customer innovation and significant attention to the competitive landscape for the results will help ensure your ability to capture more of the value you create. Capturing Value What s in Your Wallet? Creating value for your customers even with your customers is no guarantee that you will get your fair share. Especially if you don t know what your fair share could be. The fundamentals of the US automotive and appliances industries from the 1970s through the 1990s were essentially the same. Both converted metal, glass, plastics, paint and design expertise into products that consumers used daily. The price consumers paid for cars during that period grew substantially in actual and constant dollars. For major appliances, constant dollar prices shrunk. Consumers 2005 Business Navigation Group Page 2

3 bought $20,000 automobiles with a life expectancy of 3 5 years. They bought $800 refrigerators and expected them to last 15 years or more. Was the automotive industry creating more value than the appliance industry, or did the automotive industry simply capture a greater share of the value it created? While the answer is complex, it seems that the latter is closer to the truth. We can say this because of more recent appliance manufacturer efforts to develop high-end models with premium pricing and much more detailed market segmentation. Their bundles of metal, glass, paint and design expertise are now capturing the kind of customer value the automotive industry once earned. Appliance manufacturers have successfully moved their consumer s first question from price to value by changing the products attributes from function to lifestyle. Care must be taken that fair share is backed up by value-based pricing. An excellent example of this was the Electronic Data Interchange (EDI) market of the 1980s. Several large vendors, including IBM, GE and Sterling Commerce provided the software and data exchange services that enabled paperless transactions among buyers, sellers, financial institutions and other intermediaries. The productivity impact of this was enormous. One of the vendors, GE Information Services provided EDI services that supported about $1 trillion in goods and services transactions annually. Even if we were to estimate the productivity value at a measly 3%, that would amount to $30 billion in customer value generated. But, GE Information Services was able to capture only $350 million in revenue from this creation. About 1.5% of the value it created for customers. So why did GE and its competitors leave so much money on the table? First, vendors used scorekeeping units in their pricing structures that were unrelated to the value they delivered. The units were based on the technology the volume of data transmitted not the productivity value of processing business-to-business transactions globally and instantaneously. This caused customer confusion about what vendors actually sold. And in this case, the scorekeeping units used were for technology that was dramatically declining in price. Second, vendors used cost-based pricing. Several vendors entered this market from the rapidly commoditizing telephone industry. With them came pricing formulas based the cost-plus mechanics required by utilities commissions regulators whose mission was to leave the lion s share of the value with the consumer. Value Conversion the Tricky Business of Efficiency Value creation and capture will remain academic pursuits without the final step conversion. Here we mean the conversion to profit for the business and then returns to shareholders. It is certainly no mystery that revenues have to exceed costs to produce 2005 Business Navigation Group Page 3

4 profit. And most companies work hard to keep costs down by looking for more efficient methods of manufacturing, distributing, selling, and managing inventory and supply. But most companies do not pay attention to their pricing methodologies in this critical step of value conversion although they should. Companies usually offer a variety of products and some return better profits than others. Smart pricing methodologies can help create incentives for customers to purchase the optimal mix for profit realization. And this can be done without increasing incentive spending. Take a look at what Ford has been doing lately. Well, okay in Ford used a variety of pricing techniques that added up to an additional 30% first quarter 2003 profit and an impressive half point of market share. All while spending $300 less per car on incentives than GM. Here s what the company did: Cash-back incentives based on model demand. For example, $1,000 back on the fast-selling Escape; $3,000 on the slower-selling Explorer Cash-back incentives based on profit. For example, the high-margin Expedition sold with a $3,000 incentive, while the lower profit, but popular Taurus got a small price hike. Bundles based on high margin segmentation. Ford created limited-edition, upscale versions of some models with a bundled set of features like a power running board and heated and cooled seats. Ford s moves were not rocket science. Yes, they did some sophisticated tracking of customer preferences in each dealership to understand which models should receives which incentives and which customer segments might opt for upscale bundling, but the overall pricing strategy was pretty straightforward. And powerfully efficient. The key to Ford s increased profit realization was neither volume nor cost cutting it was smart pricing. Not what we usually understand to be efficiency. But perhaps we should take another look at that concept. Efficiency is simply output divided by input. Process improvements, best practices adoption, cost management, and similar activities are what most often come to mind when we think about efficiency. But these improve efficiency by attacking the denominator the inside view of efficiency. Ford concentrated on the numerator and improved the yield from the outside from its customers. Smart Pricing isn t the Answer to Everything but Almost As you navigate from value creation, to capture and then conversion, keep your pricing strategy in mind think of it as your longest lever. Indeed, small changes in your pricing structure can have extraordinary effects on both the capture and conversion phases of your company s value navigation Business Navigation Group Page 4

5 Most companies traditionally worked hard at the left side of the diagram below. They took out cost, improved processes and allocated capital and resources with an eye toward improvements in efficiency. More recently, companies have turned to the right side and made significant investments in innovation. The more innovation offered to the market, the greater the chances for value creation and capture. Create Create Efficiency Innovation Value Convert Convert Strategic Pricing We strongly believe that it is now timely to tie these together with greater attention to strategic pricing. Smarter pricing is critical in capturing a greater share of what innovation creates and in optimizing customer contributions to efficiency so that more of what s captured is converted into profits and shareholder returns. For more information, please contact Dennis Crane at Business Navigation Group on or djcrane@biznavgroup.com 2005 Business Navigation Group Page 5