How to Turbocharge Your Strategic Account Management

My father used to tell the story of an elderly couple living in a small New England town.

The husband had worked his entire career polishing the cannon on the town green every day. One day, as he neared retirement, he came home and announced to his wife, “For twenty years, I’ve worked for the town, and now I’m going into business for myself.”

“I bought a cannon.”

Stop polishing the cannon

Strategic account management in the most forward-thinking companies is undergoing a transformation that is increasing sales effectiveness and company profitability by 33% or more.

The most effective strategic account managers are shifting their focus from maximizing sales and gross margins, to going directly after major net profit increases in key accounts – without the false assumption that more sales equals more profits. In fact, nowhere is this false assumption a bigger mistake than in major account management.

Strategic accounts certainly have the scale and scope to provide critical revenues and gross margins. They are very important to revenue growth. However, major accounts also have massive power to reduce prices and to extract costly service packages. For most companies, and certainly for most strategic account managers, this pressure is very hard to resist.

This major account power leads to the extremely difficult situation in many companies, in which major account revenues increase while net profits actually decline. All too many strategic account managers find themselves in essence polishing the cannon.

What can a strategic account manager do?

Sell profits, not revenues

The most important factor in strategic account management is the vast difference between selling revenues and selling net profits. Most selling systems simply assume that these are equivalent, but nothing could be further from the truth.

In years of work on maximizing profitability, and in the billions of dollars of annual client revenues that run through Profit Isle’s, my company’s, analytical systems (see www.profitisle.com ), I have found that a surprisingly small portion of a company’s business provides all the reported earnings, and even subsidizes the losses on the remainder of the business

For example, one very successful, industry-leading company earned over 150% of its profits from about 15% of its business, and an amazingly large portion of these profits were simply eroded away by the majority of the business.

Importantly, a number of the strategic accounts were providing most of the profits, but a shockingly large number of major accounts were key profit drains. And, it was not at all clear at the onset which accounts were “good accounts,” and which were not. This is very typical.

Good accounts, bad accounts

The key to sorting your good accounts from your bad accounts – and your good products from your bad products – is profit mapping. I have explained profit mapping in my Harvard Business School Working Knowledge columns, in my blog posts, and in my award-winning book, Islands of Profit in a Sea of Red Ink.

In essence, you can build a profit map by doing an all-in P&L on every invoice line. This yields a very detailed picture of the company’s profit landscape by account, product, vendor, service, cost factor, and numerous other dimensions. Profit Isle has very powerful software to do this, and to create game plans for profit improvement.

The reason it is critical to do a full P&L by invoice line is that accounting systems aggregate revenues and costs in separate buckets. This makes it impossible to match each of your revenue sources to the cost of generating it.

Think about this: Are all your products priced the same in every account? Is the cost to serve all accounts equivalent? If not, you need to understand how to match specific costs to specific revenue streams on a very granular basis, and this is especially critical for major accounts with substantial bargaining power.

Islands of Profit – profit levers

If, as with nearly all companies, 15% of your accounts are providing 150% of your profits, your most important objective is to secure and grow these Island of Profit accounts. Yet if they are providing only 30% of your revenues, in most companies they will be getting only 30%, or less, of your “love.”

These high-profit key customers are your most important asset. In fact, they probably are not even getting as much attention as your large accounts that are unprofitable, because your big, low-profit customers are always pushing and complaining.

As a strategic account manager, you have three very important “profit levers” to turbocharge the profitability of your Islands of Profit strategic accounts: (1) profiling and account selection; (2) pricing and product portfolio; and (3) supply chain integration.

Profiling and account selection

Think about this: How does your company select new products or new marketing approaches?

Odds are that you do a survey and let all customers have a vote. Alternatively, perhaps you give your big accounts more votes than small accounts. But do you give your Islands of Profit customers, which are giving you all your profits and more, enough votes?

In building profit improvement game plans for our clients, we very often specifically and carefully survey their Islands of Profit accounts. The results are astonishing.

In most situations, the Islands of Profit customers have remarkably similar profiles, needs and views – and these are very different from the overall customer base, and even from the other major accounts. By aligning your company’s products, services, and positioning with your most profitable customer segment, you can directly drive strong profitable growth from the start.

Just as important, when you have a clear profile of your Islands of Profit customers, you can identify their critical characteristics and buying triggers. This enables you to increase profitable sales to existing Islands of Profit customers, and to rifle shot your sales and marketing efforts to identify and land new accounts that have the highest potential for strong, fast, high-profit growth.

In this way, you can shift resources from low-payoff business to high-payoff business. No more polishing cannons.

Pricing and product portfolio

Once you have identified your Islands of Profit customers, you can look at your own business’s best practice in pricing and constructing a product portfolio for these customers.

Here, you can do a comparative analysis of what you are selling to the different market segments of your most profitable customers. Every sales rep is different, and every customer interaction is different. Yet very clear best practices emerge, and nearly always raise a revealing “aha moment.”

For example, many sales reps are afraid to price high, especially for a major product in a major account. One top client manager likened this to a fear of getting a “speeding ticket.” Yet, in practice, the sales rep is much more likely to get a “ticket” in a price sensitive, unprofitable major account than in an Island of Profit account. By understanding the difference in best practice pricing in the accounts in the respective categories, reps are much more likely to price their Islands of Profit customers at market.

The result: very fast revenue growth that is all profit.

Product portfolio – the question of what to sell to an account – has a very similar solution to the pricing dilemma. By identifying the Islands of Profit customers and analyzing best practice set of products bought, you can construct very powerful guidance for the sales reps. Here, again, you are analytically removing the sales to large, unprofitable customers (which we call Coral Reefs) that muddy your understanding of your most profitable (real net profits) strategic accounts.

This creates a clear best practice pathway to fast sales growth in key highly-profitable accounts.

Moreover, we have found that the real super-sweet spot for high profit growth is selling Islands of Profit products in Islands of Profit accounts. By really digging in and understanding these two critical categories, you will be able to laser-focus your selling efforts on where they will pay off fastest and strongest.

Supply chain integration

For strategic accounts, supply chain integration is a prime sales and profitability weapon. I have explained this in my writings (for example, see Profit from Customer Operating Partnerships).

Supply chain integration gives you three critical benefits.

First, you reduce your key customer’s cost of operations, often by 40% or more. These savings stem from reduced inventories, duplication of services, and other factors.

Second, your own sales grow, often by 35% or more in your highest-penetrated accounts. This very fast, massive sales growth is driven by the huge customer cost savings, and by the operating level relationships that develop between your grass-roots operations staff working in the customer, and the customer’s counterpart operations managers.

Third, your own cost of operations drops, often by 30% or more. These savings occur because you now can control and stabilize your key customers’ order patterns, enabling you to reduce inventory, shipment frequency, and expedited movements. Importantly, this major saving enables you to keep your prices stable, and still strongly grow your profits.

This leads to a crucial question: Why not do this with all your key accounts?

The problem is that supply chain integration takes time and resources to develop. And, if your customer is a transactional buyer with a weak capability to partner, your costs will blow up and your profits will plunge. This leads many companies to be very hesitant to enter into these relationships at all.

Which customers should you approach for supply chain integration? The answer is clear: your long-term Islands of Profit customers.

Yet, if you can’t identify your Islands of Profit customers, you should rightly fear simply responding positively to any large customer request for supply chain integration – especially since your Coral Reef customers (large and unprofitable) are most often the ones that are most aggressive in pushing for these advanced services with no intention of adequately paying for them.

And if you devote your precious resources to supply chain integration with your Coral Reef customers, you are not only buying a cannon – you are walking into quicksand.

Strategic account management’s ultimate prize

Strategic account managers are vital to a company’s success. When you identify and deftly manage your Islands of Profit accounts, you create fast, powerful growth in both revenues and profits – strategic account management’s ultimate prize.

This is the essence of turbocharged strategic account management.

The critical question for all strategic account managers is: Can you identify, secure, and grow your Islands of Profit Accounts, and laser-target new accounts that belong in this group?

If so, you have an opportunity of a lifetime to build really fast, strong profitable growth.

 

Profit-based Segmentation, Omnichannel Retailing, and Same-day Deliveries

Recently a friend, who is editor of a leading business publication, sent me this note:

Another question for you. How valuable do you think segmentation is for omnichannel retailers?

Should every retailer do this type of analysis before deciding whether it should engage in same-day fulfillment and delivery?

Appreciate your thoughts.

I wrote back the following:

Thanks for the note. Great question.

Profit-based segmentation is absolutely critical for retailers, both for traditional business, and for omnichannel and possibly same-day deliveries.

In virtually all companies, the majority of transactions and customers are largely unprofitable, while the minority are highly profitable. Most of the cost and inefficiency comes from the unprofitable portion (which I call the Minnows and Coral Reefs). Why give unprofitable customers enhanced services that make them much more unprofitable - and remove resources that should be spent on making the Islands of Profit customers even better served?

Major changes are sweeping through retailing and distribution, upsetting traditional ways of operating. These changes bring huge new risks and enormous new opportunities. If managed well, a company can leapfrog its competitors, carving out a leading position for years to come. But if not managed thoughtfully, they can cause costs to explode, service to drag, and market position to falter in a surprisingly short period.

What are the key elements of success?

Profit-based segmentation

Over the past several months, I have worked with a major retailer that is a leader in its segment. This highly-successful company increased its already-strong profits by nearly 300% using profit-based segmentation in combination with a range of powerful enhanced services including omnichannel retailing and same-day deliveries.

The core to understanding how to craft a powerful, multi-dimensional, enhanced service strategy is profit-based segmentation, which is rooted in profit mapping. I’ve written about profit mapping in my book, Islands of Profit in a Sea of Red Ink, and in many of my blog posts. The underlying methodology is to create a full P&L on every transaction, or invoice line. You can aggregate these in a database, and unravel a company’s complex profitability picture along any dimension – customers, products, vendors, segments, sales reps, and others.

For example, we have developed a very powerful, sophisticated system that does big data profit analytics, including profit mapping; for more, please see: www.profitisle.com.

Profit maps are critical to developing and deploying new enhanced services like omnichannel retailing and same-day deliveries. They tell you where you are making money, and therefore where you can and should invest in enhancing customer service because you will get much more in return. They also tell you where you are losing money, and thus what parts of your business will become even more unprofitable if you continue to layer on more and more enhanced services.

Consider the following example, a disguised version of a very-successful company: 

 

This is a very typical picture of a successful company’s profit landscape.

Islands of Profit. Only 9% of the customers are Islands of Profit – the company’s high-revenue, high-profit sweet spot – yet they bring in 47% of the revenues and a whopping 142% of the reported profits.

Your prime business objective is to secure and grow this segment of your business by building loyalty and providing terrific value, while attracting more customers who fit the profile. You should provide a full range of enhanced services to this segment because the payoff is very high, because it builds very strong competitive advantage, and because these services will enhance this key group’s loyalty.

Coral Reefs. On the other hand, Coral Reef customers – high-revenues but low-profit – represent 26% of the customers and 30% of the revenues – but only 6% of the reported profits.

These customers are large, but marginal or unprofitable. They don’t warrant provision of enhanced services unless you have a very well-managed program to convert them to Islands of Profit.

Note that most marketing analyses would treat both the Islands of Profit customers and the Coral Reef customers as the same because they focus on revenues, not profits. In fact, nearly all marketing analysts do not have the sophisticated analytics necessary to sort this out. In fact, because there are over three times as many Coral Reef customers as Islands of Profit customers, most services aimed at this combined group will be dissipated on unprofitable and marginal customers.

Minnows. These customers – low revenues and low profits – account for the majority of the company’s customer base, and 20% of the revenues – yet they actually eat away 50% of the profits made from other, primarily Islands of Profit, customers.

Minnow customers are small and unprofitable, yet in most companies they account for a majority of the business activity and a disproportionate amount of the costs. Simply offering enhanced services to all customers will mostly benefit the Minnow customers, with little return and wasted resources. Offering enhanced services only on larger purchases is similarly flawed because the purchase may well be unprofitable, and because an Island of Profit customer with an occasional small purchase surely warrants enhanced service in light of the overall relationship.

Your objective for this group is to minimize your cost exposure, unless you can convert them to Islands of Profit customers. For the most part, providing Minnow customers with enhanced services merely throws a lot of good money after bad.

It might be argued that some Coral Reef and Minnow customers might be enticed to become Islands of Profit, and thus should receive enhanced services like same-day deliveries. Often, this becomes a strong marketing argument. The right way to handle this situation is to offer the service on a trial basis, and to monitor carefully whether the customer’s purchase pattern changes and the customer actually becomes an Island of Profit.

Palm Trees. This company has only a few Palm Tree customers – low revenue but high-profit – with 3% of the customers generating 3% of the revenues and 3% of the profits. This is a small group, but important to the company’s prospects for future profitable growth.

In this way, profit-based segmentation enables a company to offer a powerful range of enhanced services, gathering huge benefits from its high-profit customers, while keeping its costs under control.

Powerful new services

What does this mean for the development and deployment of new enhanced customer services like omnichannel retailing and same-day deliveries?

It makes all the difference between success and failure.

Most companies simply assume that these enhanced services are new capabilities that they should offer to all their customers. This is a huge mistake, and it is rooted in a fundamental misunderstanding of customer service.

Customer service is correctly measured by how often you keep your promise to your customers. But you do not have to make the same promise to all customers. Here’s the dilemma: if you try to give the same fast or enhanced services to all your customers, your costs will explode – or your service will degrade across the board, unless you pour inordinate amounts of resources into customer service.

Better to define different levels of order cycle time or enhanced services for different groups of customers, with your Islands of Profit customers receiving the highest level of service, but with all customers consistently getting what they were promised. This way, you will be able to keep your service promises to all customers at a reasonable cost. For more on this, see my blog post on service differentiation, The Dilemma of Customer Service.

Service differentiation

Thus, service differentiation is the key to linking profit-based segmentation to provision of enhanced services like omnichannel retailing and same-day deliveries. For example, think about omnichannel retailing, which many companies are considering in response to moves by Amazon and others.

Omnichannel retailing is a very powerful marketing approach that is now emerging. Many companies see this as necessary to stay competitive. Yet, it can be enormously expensive and unproductive if not constructed in a thoughtful way.

Profit-based segmentation is the key to getting it right.

Let’s return to the profit map. The omnichannel issue is analogous to the same-day deliveries issue, in a very fundamental sense. The question is whether a company simply assumes that its omnichannel resources (and same-day deliveries) should be spread across all customers and potential customers, or whether they should be concentrated where they provide the highest returns – the Islands of Profit customers.

Certainly, all-purpose websites are open to all potential and actual customers. However, really effective omnichannel retailing entails much more than that – enhanced services ranging from recognizing who is coming onto the website, to offering select customers custom views and online chat, to following up by email and phone, to enabling the customer to receive expedited shipping or priority on local store inventory.

The decision of how much to invest in enhanced services like omnichannel retailing and same-day deliveries should and must be determined by profit-based segmentation: it is not a question of whether to offer these services, but rather to whom to offer them. And, if the answer is effectively everyone, your best customers will wind up getting very thin gruel indeed.

As we saw before, Islands of Profit customers warrant the enhanced services that characterize really effective omnichannel retailing because they will generate ample profits that defray the cost and provide a strong return. If an Island of Profit customer occasionally consumes services but only has a small purchase, the overall value of the relationship still warrants great service.

On the other hand, in the absence of profit-based segmentation, companies most often fall back on simple segmentation based on overall customer revenues or order size. Both of these segmentation measures are fundamentally flawed, and will create major profit drains that result in the inability to build great services aimed at those who really count.

Offering full omnichannel service, and similarly offering same-day deliveries service, to all customers simply dissipates resources faster, and leads to even less for the Islands of Profit customers who generate the company’s core profitability.

The worst case

The worst case scenario is that a company offers omnichannel services, same-day deliveries, and other costly enhanced services to all customers, quickly runs short of resources, and winds up with a meager, uncompetitive offering.

The biggest danger here is that if a smarter competitor develops a service differentiation strategy rooted in profit-based segmentation, and offers really state-of-the-art services to its Islands of Profit customers – with satisfactory services to its other customers – the competitor will pick off the best Islands of Profit customers from the other firms in the business. This will leave the other firms with only the marginal and losing portions of their businesses.

The smarter company that rooted its strategy in profit-based segmentation will leapfrog into a leading position, while the less thoughtful companies will see their key sources of profitability dwindle away.

The lesson? The key to success in this new competitive world is to shape and focus your strategy using profit-based segmentation. You will sprint to an early competitive lead, and harvest the enormous first-mover advantages for years to come.

How to Double Your Market Share While Countering a Price War

Several weeks ago, I wrote a blog, “How to Win a Price War.”  A number of readers sent me notes, including my former Harvard/MIT executive student, Tenglum Low. Tenglum was a top executive of both a major Malaysian steel company and a major brewery, and he related his experience doubling his market share in the face of a price war by focusing on turbocharging his company’s value proposition.

Here is his story (slightly edited):

Dear Jonathan,

Your article on “How to win a Price War” is great reading, and a reminder to corporate leaders on how to enhance profitability and market share through value creation and value capturing.

Sun Tzu had often reminded generals and sovereigns that the objective of war is not simply killing the enemy, but instead it is ultimately a means to gain power and kingdoms. The best generals know that the real victory is to win a war without the need to fight any battles.

The most effective generals seek to win a kingdom without destroying its resources, so as to fund their next battle. Hence, in the world of competition, we should destroy the enemies without destroying the industry profitability. When we become the market leader, we can command a substantial portion of the industry profit pool.

I remember fighting the Malaysian steel war in the 1990s as a young Head of Commercial of Southern Steel. Within three years, we grew from 30% market share to 60% market share in domestic wire rod. Many strategic moves were played in the near duopoly market.

Today, I would like to narrate our moves in response to steep price discounts by the market leader at that time.

The steel products were near homogeneous in quality. But despite this, the slight differences of the products of the steel mills –  if synchronized well with the production equipment of the customers –  can make great differences in customer productivity. Hence, if any steel mill became the dominant supplier to the users, it could “re-synchronize” its products with the customers’ equipment, and thereby significantly enhance the customer’s productivity. Then, if the customer used the same drawing process with another supplier’s wire rod, the customer’s productivity would drop significantly – and these losses would be much greater than any price discount offered. This essentially locked in a relationship with very high switching costs.

With this knowledge in mind, we evaluated the customers through a new paradigm. We looked at the concept of “supply chain versus supply chain”, and how we could focus on growing carefully targeted customers in order to grow our sales.

The customers, at that time, could be segregated into six areas of downstream products. We decided that we could not be a supplier to all the customers in each segment because each of them wanted to become the leader in its respective downstream segment. Customer competition was extremely intense. We decided instead to pick a few leading players in each downstream segment and nurture them into market leaders. These customers needed to buy more than 70% of their steel requirement from us in order for us to “re-synchronize” our products with their production equipment, thus giving them the great benefits of higher productivity, and, once this transition was made, the 30% supplied by our competitors would have an inferior value proposition.

To enhance this mutually beneficial relationship and generate more sales, we supplied them with very competitive prices for their export requirement, which filled up their surplus capacity.

Meanwhile, our competitors offered price discounts to their customers in the nail segment to disrupt our dominance.

At that time, nail customers used 0.12 carbon killed steel as their raw material, priced at RM1200/metric ton. (Killed steel is a lower grade of steel, which has a lower drawability than rimmed steel.)

Our competitors offered our customers 0.08 carbon rimmed steel at RM1250/metric ton instead of the usual RM1300/metric ton, which was a big discount.

However, we understood the following issues:

a.         At RM1250/metric ton on wire rod produced from imported raw material, the competitors barely made profit (Malaysian steel mills could only produce killed steel, while rimmed steel is imported);

b.         The 0.08 carbon rimmed steel is good for drawability, but being much softer steel, it is not suitable for the whole range of nails.

Instead of responding by simply following this value-destroying price war, we shifted the basis for the competition by creating a new product of 0.10 carbon killed steel, and sold it to our customers at a price of RM1230/metric ton. This better met our customers’ needs at a lower cost, and our competitors could not follow us.

We made more profit from these products, and the customers also saved more cost!

Eventually, through our “supply chain versus supply chain”, most customers bought more than 90% of their raw material requirements from us.

Best regards,

Tenglum Low

The moral of the story: The best way to win a price war is not to have one – by turning it into a value war; you will take the best part of the market, while your price-oriented competitors will not know what happened to them.

Many thanks to Tenglum Low, a very thoughtful executive and a great friend - JB

How to Win a Price War

Price war! How can you win without destroying your own profitability? Fire a bigger weapon? Outlast your competitors?

Any way you look at it, a price war is the ultimate in self-destructive, lose-lose behavior – but it is one of the most common of all management problems and concerns.

Paradoxically, not only is a price war devastating for you and your competitors, but it is very bad for your customers as well. When a customer forces its suppliers to focus on price competition, it loses the opportunity to work with its suppliers to increase its real long-term profits in two crucial ways: (1) by reducing the joint costs of doing business together, and (2) by helping the suppliers to find creative ways to turbocharge their customer value proposition.

In short, the real win strategy – for both customers and suppliers – is to turn the price war into a value war.

Powerful tactics

When confronted with aggressive competitor pricing, the instinct is to respond with a price cut.

After all, why lose the business? Even worse, if you lose those customers by failing to respond, you could be in danger of losing them permanently, sacrificing the lifetime value of the relationship. This concern pushes managers to respond even more aggressively, and before long the pricing discipline of the competing businesses collapses, and with it goes the company’s profitability.

What can a manager do?

The best tactical answer is to attack the hidden assumptions that frame the price war.

For example, if a competitor quotes an uneconomically low price, why not suggest to the customer that it demand a five-year contract. After all, the price certainly will rise back to former levels once the incumbent is out of the picture. This demand will force the attacker to back down because the losses would be too great over a multi-year period.

Another effective tactic is to rein in the instinct to respond where the attack takes place. In most price wars, the attacker aims at your most lucrative accounts and products – your Islands of Profit. By responding where you are attacked, you effectively do the most damage to yourself – and often the least damage to the attacker.

In fact, in most price wars, the attacker is funding the price war by maintaining a very lucrative, protected portion of its business – its Islands of Profit – as its core source of cash flow and profitability.

The answer? Strike back at the competitor’s source of cash flow.

A classic example comes from the airlines a few decades ago. Some carriers, like United and American had very lucrative east-west routes (e.g. NY-LA), while others, like Delta, had very lucrative north-south routes (e.g. NY-Miami).

When an east-west carrier tried to enter a north-south route with low prices, the incumbent’s most common response was to match the price reduction, thereby losing a huge amount of money in its lucrative north-south routes – routes in which the attacker had little to lose but much to gain.

Instead, the smart response was to strike back by entering the attacker’s prime east-west routes with low prices – attacking the source of cash flow that supported the price war. This very quickly ended the price war. (Remember that it is illegal in the US to actually conspire with a competitor to set prices.)

Preventing price wars

These tactics are effective in framing an effective response to a price war. But how do you actually prevent one?

I was asked this question a few weeks ago by a writer who was working on an article about distributor branch pricing.

She asked how much “wiggle room” branches have when it comes to differentiating themselves from the competition based on price, and whether there is an argument for price matching if a customer comes in demanding a cheaper price they may have received down the road.

The answer is that there is a progression of three increasingly effective ways to respond to a price war – match the price, lower the customer’s total cost, or increase your value footprint.

Price. The seemingly obvious, and instinctive, way to respond is to simply to match the competitor’s low price.

This is an invitation to lose your profitability for two reasons: (1) your competitor probably will up the ante with another price cut, setting off a vicious cycle, and (2) you are essentially training your customers  to hammer you on price at every turn. After all, you’re showing them that you will fold under pressure.

The more effective counter-tactics mentioned earlier – shift the time frame or shift the locus of attack – are much more effective than simple price matching. But it is even more effective to proactively act to prevent a price war. You can do this in two ways: reducing total cost and turbocharging your customer value proposition.

Total cost. The second – and much more effective – way to respond is to systematically find ways to reduce the cost of doing business with your most important customers. By reducing costs for both your customers and for your own company, you can create real new value that will endure in the long run. Smart customers will strongly gravitate toward this process.

You can take measures to reduce your customer’s direct cost. I outline and discuss these profit levers in my book and in many of my blog posts. They range from operations cost reductions (e.g. flow-through supply chains) to product/category management (e.g. product rationalization).

Conversely, customers can create surprisingly big cost reductions for the supplier. For example, by helping the customer smooth its order pattern, you can reduce your supply chain costs, often by 25% or more. Better forecasting offers similar gains, as does a limited but well-aimed product substitution policy. These profit levers benefit both the supplier and the customer – by much more than a simple, temporary price cut.

Smart suppliers pass a big portion of their savings back to their customers in price reductions. Here the customers know that the price reduction is fully warranted by real savings, and therefore can endure over time.

Customer value. The third, and most effective, way to “win” a price war is to prevent it by waging and winning a customer value war. Yet all too many managers think of this last, if they consider it at all.

Think about the example of Baxter’s Stockless business that I have often cited in my book and blog. For example, see: Profit from Customer Operating Partnerships.

Several years ago, Baxter was stuck in a price war, with its products like IV solutions, viewed as commodities mostly bought on price by low-level hospital purchasing staff. Baxter mapped the joint hospital-Baxter supply chain, and discovered that it could enormously reduce both businesses’ costs by sending a supervisor into a major hospital to count the needed product, then picking orders into ward-specific totes, and delivering and putting the product away on the patient floor or clinic.

This was the forerunner of vendor-managed inventory, which many companies offer today. Incidentally, Cardinal ultimately bought this business from Baxter, and Cardinal’s ValueLink offering is still an extremely effective business run in many of the best major hospitals.

Stepping back, Baxter developed a way to permanently “win” the price wars that raged in its business by converting them into a one-firm race to lower the total cost of the joint supply chain, passing this saving to the hospitals. And this saving was so large that it dwarfed the pennies at stake in the price wars.

However, Baxter packed even more into this business initiative. In the prior period, before the Stockless/ValueLink was developed, the hospitals were reluctant to operate a large network of off-site clinics and surgical centers. Many top hospital managers did not have confidence that their materials management staff could handle the complex scatter-site network of critical products.

The new partnership with Baxter enabled the hospital executives to gain confidence that the newly created supply chain, managed by a supply chain expert like Baxter (now Cardinal), could support the evolving network of facilities. In short, Baxter created a fundamentally new value proposition for the hospitals – enabling them to radically change the way they operated to bring huge new value to their customers – the patients.

The progression was incredibly powerful: from price matching, to total cost reduction that competitors couldn’t match, to partnering with the hospitals to create a fundamentally new and much more effective value proposition for the patients, which again the competitors could not match.

Baxter did not just win the price war – it eliminated it.

Baxter won the customer value war.

A Lesson from GE

GE is a very insightful, innovative firm. GE managers are trained not just to compete effectively, but to relentlessly search for fundamentally new and better ways to do things – winning by changing the competitive game.

A prime example of this is the decision of the GE aircraft engine group to change its product offering. In the past, the company offered traditional but effective product centered on aircraft engines and spare parts.

However, insightful executives stepped back and reflected on what GE’s airline customers really wanted: not just engines and parts, but rather, hours of engines effectively powering their aircraft. After all, they were in the business of flying passengers.

In response, GE developed a fundamentally new offering: “power by the hour”. GE wisely combined its prior offerings – engines, parts, and related services – into one offering that directly addressed its customers’ needs. Much as Baxter did for the hospitals.

Not only did this new “power by the hour” offering meet the customer needs much better that any competitive offering, but importantly, it combined a package of products and services that no competitor could match.

GE redefined its market so it had virtually no effective competitors.

Baxter did the same. So did Southwest Airlines.

The key imperative is very clear: Once you have a lead, step on the gas – and the most effective way to do this is by turbocharging your customer value proposition.

Islands of Profit

Winning the customer value war is most often surprisingly easy because your competitors rarely think about it. All too often they focus on tactics like price optimization, rather than accelerating their customer value proposition.

This is especially critical for securing your Islands of Profit – your high-revenue high-profit business. These customers are most susceptible to a competitor incursion, yet these also are the customers that are most receptive to innovations that fundamentally reduce your joint cost structure and transform your customer value proposition.

Your Coral Reefs – your high-revenue low-profit customers – on the other hand, are usually the most price-sensitive. Yet, many can be converted into Islands of Profit if you develop a compelling value proposition.

The same goes for your Minnow customers – low-revenue low-profit – especially those that are someone else’s big customers and are just using you to discipline the competitor’s prices.

The Essential Question

The essential question is: Are you so busy with tactical issues like  price wars that you “do not have the time or resources” to systematically and relentlessly build your customer value proposition? Especially for your Islands of Profit Customers?

Winning the customer value war is the only way to permanently prevent price wars and really secure your future.

Assessing Strategic Investments

Recently, I was involved in a discussion about a major strategic investment that a company was contemplating. This investment was a possible game-changer involving the development of an important new business capability. 

The key question on the table was: Will the prospective benefits exceed the costs, yielding returns greater than the cost of capital? What could be more obvious?

Two critical questions

In fact, assessing investments using the cost of capital, often called capital budgeting, is not obvious at all. It is a process that seems like second nature to virtually all managers, but one which only a few use correctly.

And it is critically important. If you get it wrong, it can lock your company in place, block your most important initiatives, and prevent you from getting in front of competitors.

Two key questions lie at the heart of sound investment assessment: (1) What is the cost of capital? and (2) How should I assess the value of investments?

Not so obvious

Let’s start with the first question: What is the cost of capital? Just look it up in a Finance textbook. It is the weighted average of the company’s cost of debt and cost of equity (with a few minor adjustments). Obvious, right?

In fact, the answer is not so obvious.

This seems like a technical question, but in reality it is a very important management issue because it tacitly determines a company’s asset productivity.

The cost of capital is actually a composite. It is the weighted average of the risk/return profile of the company’s portfolio of investments (ranging from buying new machines to developing new product lines) that together constitute the existing business. This portfolio is comprised of some investments that have a very low risk and low return, other investments that have a very high risk and high return, and many in between.

Contrast an investment in a well-tested new machine to improve the efficiency of an existing process, with another investment to develop a new product line. The former investment has a low risk profile, and thus is a sensible investment even if it generates returns that are lower than the company’s composite (overall) cost of capital. The latter has a high risk profile, and thus requires a higher return than the company’s composite.

Here’s the key point: it is wrong to evaluate each investment by the standard of the company’s composite cost of capital – instead the right measure is how its risk-adjusted return compares with relevant investments, those with similar risk/return characteristics, in the company’s portfolio.

As a practical matter, I think of three levels of risk/return: low, medium, and high. This makes the task of specifying a hurdle rate (the appropriate cost of capital) much easier.

Strategic vs. tactical investments

The second question – How should I assess the value of investments? – is vitally important to a company’s competitive success. The bottom line is that assessing strategic initiatives is fundamentally different from assessing tactical investments.

Tactical investments, which produce incremental improvements to the business, are the appropriate domain for traditional capital budgeting, featuring net present value (NPV) and return on investment (ROI) analysis setting well-understood costs against benefits over time. (Remember that even here, most companies’ capital budgeting processes fail to differentiate between low risk/return investments that warrant a lower hurdle rate, from the high risk/return investments that require a higher hurdle rate.)

In the world of major strategic investments, a completely different financial assessment process is needed: one that goes beyond simply adding up costs and benefits to also reflect strategic relevance, the prospective cost of capital, and the payback period.

Bad profits

Should you make all investments that pass the cost of capital recovery test? I wrote a very popular blog about this: What are Bad Profits?

The heart of the blog was this illustration:

 

 

 

 

 

 

 

 

 

 

 

 

The essential point is that in assessing investments, profitability alone is not enough – and this is especially true of major strategic investments. The other critical dimension is whether the investment is strategically relevant.

For example, investing in offering a service that is demanded by only a few customers, but not most customers, probably is not strategically relevant and, if so, you should avoid it even if the investment is profitable. On the other hand, investing in a showcase project to discover an important new customer need in your main line of business may well be very worthy in the long run, even if it does not offer immediate returns.

Yet, a simple business case would favor the former investment and discourage the latter. How can this be right?

Consider a profitable investment that is not strategically relevant, which would indeed pass the cost of capital test. What’s really happening is that this situation has two hidden costs that typically do not appear in the business case calculation.

First, an investment in a new service almost always exponentially increases the complexity of the business in unforeseen ways, and this increases the cost structure of the whole business. (In general, increasing the volume of existing business creates arithmetically increasing costs, but increasing the complexity of the business creates geometrically increasing costs.)

Second, an investment of this sort generates an inexorable future demand for more resources. Why? Because top managers generally do not really act for purely economic reasons – after all, how can you really estimate the costs and benefits of a service offering five years from now? Rather, at the executive level, they often act to ensure “fairness” – i.e. the executive in charge needs an opportunity to show what he or she can do with this new opportunity. And, it is much easier to start trying to grow an opportunity than to end it because the former is easy to measure, while the latter is difficult because turning it around is “just around the corner.”

These issues are central to growing profitability in a robust, lasting way.

Past or future cost of capital?

Let’s return to the question of the strategic investment at the opening of this blog. Here the investment was being judged by the current cost of capital, a measure that is backward-looking by definition since it reflects the current portfolio of investments made in prior periods. Yet the investment in question was being made to have a quantum effect on the company’s future.

For a strategic investment that will really change the business, the right measure really includes the prospective cost of capital, because it will change the basic shape of the company’s risk/return portfolio of investments into the future. It makes no sense to gauge it solely by a measure that doesn’t take into account what the strategic investment is designed to accomplish.

Consider a major strategic investment that promised to really change the company’s relationship with its key accounts – its islands of profit – accelerating major account profitability by increasing the value footprint, and growing high-potential underpenetrated accounts. In this situation the company would have a high likelihood of actually lowering its cost of capital, and a lower likelihood that the cost of capital would stay the same.

Viewed from this perspective, the proper cost of capital to use to evaluate the investment would be a blend of the current cost of capital with the prospective cost of capital – the cost after the strategic investment was made, and not solely the cost in the absence of the game-changing investment. After all, if the strategic investment has the effect of reducing the cost of future investments, shouldn’t this be counted as a major benefit?

This consideration is especially relevant for major strategic investments in public companies, where investment bank analysts’ views of a company’s prospects can have a major impact on the company’s stock price and multiple.

The practical-minded retort is that it is prohibitively difficult to estimate the prospective cost of capital for every possible investment. This is true and compelling. But, it certainly is possible, and indeed feasible, to estimate it for the occasional critical strategic investments that will really change the business.

Managing big risks

So, how do top managers actually assess major strategic investments? An important study conducted a number of years ago found that one of the most important measures actually used by top executives was the discredited measure, payback period.

Payback period is simply the number of years needed to recoup an investment. It is discredited relative to NPV and ROI because it fails to account for the time value of money: two investments may have the same payback period, while the first generates most of the benefits right away and the second generates most benefits at the end of the interval. Clearly, the first investment is superior, even though they both look the same by the payback measure.

So why do top managers pay so much attention to payback period in evaluating major strategic investments? Because a major strategic investment by definition changes the paradigm of the business, creating new value and often provoking competitive response. Therefore it is extremely difficult, if not impossible, to gauge the costs and benefits. It also may well absorb the company’s ability to undertake major change for some time. In this situation, a key top management question is: When will we able to make another major strategic move? Payback period provides an important insight into this critical question.

Cost of confusion

I remember working with a major telephone company in the early days of deregulation. The company served a broad area that included a major metropolitan area with a number of global companies clustered in a few dense locations. These companies were a prime target for new emerging competitors.

As the competitors entered the city and gobbled up the telephone company’s islands of profit customers by deploying fiber and offering new services, the incumbent was hobbled and couldn’t respond. It lost block after block of its most important business.

Why? Because its traditional business case process required an explicit estimate of costs and benefits for each investment (a holdover from the days of regulation). And, preventing a competitor from taking existing business – preventing the erosion of critical customers – was deemed by the finance group as not counting toward investment benefits because it was too “hard” to quantify.

Here, the erroneous use of a tactical investment evaluation process for evaluating strategic investments nearly cost the company its most lucrative business.

Profit maps into action

Thoughtful assessment of investments is the key to maximizing both asset productivity and strategic success.

For tactical investments, the key is developing a hurdle rate that reflects the right cost of capital for the risk/return profiles of the respective investments. As a practical matter, try bundling the candidate investments into three groups: high risk/return, medium risk/return, and low risk/return. Each group requires a different hurdle rate reflecting its different cost of capital. In this context, the traditional assessment measures, NPV and ROI, are very useful.

Strategic investments, however, are fundamentally different from tactical projects. They require a very different assessment process – one that goes beyond traditional cost/benefit analysis to reflect the strategic relevance, the prospective cost of capital, and the payback period.

The strategic relevance incorporates the important hidden costs of complexity and future opportunity costs, the prospective cost of capital embraces the possibility of game-changing gains that fundamentally alter the company’s risk/return profile, and the payback period speaks to the chess-like issue of when the company will be in a position to make its next major strategic move.

In the critical process of converting a profit map into results, wisely assessing investment opportunities is critical. And getting strategic investment assessments right makes all the difference between long-run success and failure.

Great Books for Winter Reading

In my prior blog post (Logistics Clusters - a terrific new book by Yossi Sheffi), I reviewed Yossi Sheffi’s terrific new book – Logistics Clusters – which explains how supply chain dynamics are transforming both company competitive advantage, and regional economies. This book is a must-read for all business managers, supply chain service providers, and government officials. It is fascinating, fast-paced, and packed with compelling factual examples.

Three other great books

For additional great reading, I suggest three other books: Reckless Endangerment, Turn Right at Machu Pichu, and The Seven Daughters of Eve.

Reckless Endangerment, by Gretchen Morgenson and Joshua Rosner is subtitled: “How Outsized Ambition, Greed, and Corruption Created the Worst Financial Crisis of our Time” – and the book certainly lives up to this description.

It is a gripping narration of the forces that led to the near-collapse of the US economy, complete with a blow-by-blow history and names. The really chilling issue is that most of these individuals are still in power, and history appears to be repeating itself in the current fiscal cliff and budgetary crisis.

Turn Right at Machu Pichu, by Mark Adams is a delightful tale. Adams interweaves the history of Pizzarro’s conquest of the Inca Empire, with the story of Hiram Bingham’s fascinating discovery of the ruins of Machu Pichu, with Adams’ own treks in the area tracing the respective histories and stories. The result is a wonderful amalgam by a great writer. By the way, Hiram Bingham is the Yale professor whose story reputedly formed the basis for the character, Indiana Jones.

The Seven Daughters of Eve, by Bryan Sykes, is an incredibly compelling scientific detective story. In this book, Sykes, a professor of molecular genetics at Oxford, describes his ground-breaking genetic investigations into human origins in a very understandable, compelling style that is hard to put down.

His investigations solve long-standing mysteries ranging from the origin of the polynesians, to the story of global human origins. He traces the development of his pioneering genetic techniques that enabled him to trace the lineage of all contemporary humans back through the shrouds of time to just seven women, whom he calls the “seven daughters of Eve.”

Logistics Clusters - a terrific new book by Yossi Sheffi

Logistics Clusters – Yossi Sheffi’s terrific new book – explains how supply chain dynamics are transforming both company competitive advantage, and regional economies.

Why did Singapore rise to international prominence? Why did Memphis outshine its regional neighbors? Why do competitors win by locating near each other and even sharing facilities? How will the transformed Panama Canal affect commerce on entire continents?

Sheffi answers these questions and more in his insightful and fast-paced book. The book’s focal point is an explanation, with multiple examples, of the power of clusters of supply-chain related businesses. These logistics clusters offer compelling advantages for carriers, for customers, and for regional economies.

The book is a must-read for all business managers involved in operations, supply chain management, and strategy – it systematically shows the decisive gains from locating in a logistics cluster.

The book is a must-read for all supply chain service providers – it details the powerful advantages from participating in a logistics cluster, and conversely the problems that result from failing to take advantage of this essential configuration.

And, the book is a must-read for government officials seeking to turbo-charge their economies and upgrade their labor force in a recession-proof, outsourcing-proof, sustainable manner.

This book is written in a fast-paced style that draws the reader through the fascinating story of why logistics clusters are so important to so many top managers and government officials, what benefits they create for all participants, and how to participate to harvest the value.

This is a very important book that reads like a novel. After all, who else but Yossi Sheffi could tell this fascinating story that starts with Roman-era supply chains, continues with the rise of Singapore and the demise of the Erie Canal, and encompasses the founding of Federal Express, the just-in-time distribution of spinal surgical kits, and the economic transformation of the Spanish Province of Aragon?

Three Cornerstones of Profitable Growth

What essential elements does a company’s top management team need to put in place to create years of strong, profitable growth?

Here’s my old family recipe: information, process, and value footprint.

These cornerstones formed the basis for a two-month series of workshops that I recently conducted with my colleague, Lisa Dolin, for the top 150 managers of an extremely effective global company.

All three elements are important and essential; without any of the three, the company will not reach its potential.

Information

A company’s core profitability information is contained in a profit map. I describe profit mapping in my award-winning book, Islands of Profit in a Sea of Red Ink. In essence, a profit map is built by developing a full P&L (including overheads) for every invoice line. Once this is accomplished, the profit map answers the critical question: What is the actual profitability of every product in every account?

It also answers a multitude of other critical questions about product and supplier profitability, as well as highly focused questions like: Are my low-volume unprofitable products largely consumed by my low-volume unprofitable customers (guess the answer…)?

Here are some important tips in developing and using profit maps:

Invoice-line information. Developing fully-costed information on every invoice line is absolutely essential. All too often, managers starting on the road to understanding and managing profitability focus on customers, with a rough invoice-level (as opposed to an invoice-line level) costing usually based on sales volume. These efforts give an inaccurate and incomplete picture. Even in your biggest, most obviously profitable customers, over 20-30% of the products are unprofitable by any measure – and without invoice line costing, this is completely hidden. Also, critically-important opportunities to work with suppliers are undiscovered.

Strategy first. One of the biggest surprises in profit mapping is how obvious the strategic opportunities and problems are. Many managers start the process with the assumption that they will focus on tactical issues like pricing and whether to take certain business. As soon as they see a profit map, they are struck by the fact that big portions of similar business are either very profitable, or very unprofitable. Immediately, they see what the company needs to do for really big improvements that put really big new profits on the table. Only later do they turn to the more tactical opportunities that need systematic grassroots mining.

Big opportunities early. Here’s what almost always happens when you give a profit map to a sales rep without guidance or training: He or she goes after small changes in small accounts (e.g. getting the customer to order three rather than five times per week), declares victory, and goes back to business as usual. 

Instead, it is most productive to focus first on the big profitable customers, where you have the best relationships, the highest volume, and most often where you have a 20-30% fast profit upside.

To repeat: focus first on your big, profitable customers – your islands of profit – both because they offer the largest, fastest profit gains, and because securing these critical accounts is the absolute most important way to protect your business from fatal profit erosion.

After that, look at the large, low profit customers. These are more difficult to change because they often are unprofitable due to unfavorable pricing or contractual obligations. These take time to change. The lesson: if you really understand your profit map, your true net profit landscape, you can ensure that your customer relationships are profitable from the start.

Don’t forget your products and suppliers. Most companies have as much, or more, upside opportunities on the product and supplier sides of their business, yet most instinctively focus on their customers. With profit mapping, you can see which customers are buying which products, and it is not at all unusual for over 50% of a company’s products to be unprofitable (and often purchased by unprofitable small accounts).

Keep it simple. Ultimately, your profit information will be used by lower level sales reps, supplier managers, and others. These individuals almost always do best with relatively simple formats and standard ways of analyzing and acting on the information. The lesson: don’t design the information for a highly quantitative analyst who loves to explore data. Instead, design the right tool for the job.

Process

The second cornerstone is process. Without effective processes, even the best profit mapping information will not be converted to action. Here are some process tips.

Regularity and discipline. It is imperative that a company create a set of processes that are regular and disciplined, with clear accountability for results. These processes span strategy, market planning, account planning, product management, and supplier management. In my experience, the best combination is monthly planning and results tracking at the local level (e.g. account planning), and quarterly planning and results tracking at high levels (e.g. strategy, supplier management).

If possible, tie these processes into the company’s natural cadence of planning and control (e.g. profit mapping becomes the core of the planning and budgeting cycle).

Wade in. All too often, companies spend inordinate amounts of time developing information, very little time developing core processes to convert the information into results, and almost no time on training and organizational development. This is a big mistake.

Again, in my experience, the training and implementation process works best in four steps.

First, create custom workshops for the top managers. The objective is to expose them to the information and to help them create the processes to convert the information into results. Here, we have found that the best results come from a combination of teaching cases, custom cases that we write on the company’s own business units, and planning sessions. The custom cases are crucial, as they give teams of the company’s top managers actual hands-on experience in working with profit maps and planning processes.

Second, develop pilot processes. Here, try a few alternative ways to work with the profit maps in formal processes. I suggest using a few great managers and effective sales reps to try things in separate efforts; the same holds with other functional areas like supplier management. It is important to have a few independent initiatives going, so you can see what works, and ultimately develop a combination of the best practices.

Third, create a way to scale the process. Even the best process needs to be changed in order to operate at scale, especially when less capable individuals are involved. Do this over several months in a purposeful way.

Fourth, work the processes into the company’s DNA and muscle memory. It takes time to perfect the implementation and to make the processes a way of life. Without this, the company will fall back on comfortable old practices, even if much less effective.

My old family recipe for wading in is: 6/6/1 – six months for steps one and two, six months for step three, and one year for step 4.

Compensation. If you continue to compensate your sales reps on revenues and gross margin, and they “work their pay plan”, it is obvious that you won’t maximize your profitable growth. Your sales reps need to be carefully trained, and the compensation has to be modified as they develop the new understanding and skills. Compensation is a very sensitive and complex topic, but I suggest that a bonus overlay works well in the first year.

In parallel, we focus strongly on training the trainers (especially the sales managers and their counterparts). Here the relevant metaphor is to school excellence: it the principal of a school is great, the school will be great; but if the principal is mediocre, the school will underperform almost regardless of how talented the teachers are.

Value Footprint

Your value footprint, or value proposition, is critical. The value that you create for your customers and suppliers determines the value that you can harvest. Several chapters in Islands of Profit in a Sea of Red Ink explain how to create a powerful value footprint – for example, check out Chapter 17, “Profit from Customer Operating Partnerships.” Several of my blog posts also focus on how to be effective in creating a value footprint – and importantly, how to match a set of value footprints to sets of customers (necessary for creating big value without having your costs blow up).

Here are a few important aspects of creating a strong value footprint.

Islands of Profit. The absolute most important priority is to secure and grow your islands of profit – your high-volume, high-profit customers – both to gain large, fast profit growth and to protect your core profit source. This is where pushing the envelope on your value footprint is most important and productive. And, in the process you will lower your operating costs by 20% or more, and increase your share of wallet by over 35%, even in your most highly penetrated accounts.

Not just customers. You certainly have an opportunity to develop a decisive value footprint for your customers – indeed, this is where everyone focuses. But, you have an equally strong opportunity to create value for your suppliers. The latter is almost always overlooked.

Showcases. I have written at length in my book and in my blog posts about the importance of showcase projects. A showcase is a small exploratory project, often with a relatively small well-run customer or supplier, in which you can jointly embark on a journey of discovery to find inventive new ways to do business together.

Vendor-managed inventory, cross-docking, category management, and many other widespread innovations grew out of showcase projects.

Here, the key is to keep a completely open mind and to learn by doing.

Resist the strong temptation to work with a major customer or supplier, and instead work with a smaller partner who is well-run and innovative. Work where the conditions for success are highest, and the risks of failure are lowest. Great companies have a constant portfolio of showcase projects. That’s how they stay in the lead.

And, as with any process, creating and improving a value footprint must be a regular, disciplined process with responsibility, regular cadence, results tracking and clear accountability – not just an occasional one-off project.

Huge gains

All companies have an opportunity for huge, fast gains and sustained profitable growth. I have been personally involved in projects involving nine-figure profit gains.

The secret of success is to cement in place the three cornerstones of profitable growth – information, process, and value footprint. With these in place, the company will naturally accelerate its profitability, growth, and competitive advantage.

Changing Organization Silos

What do you do when you have a great idea, and it hits the wall of “silo indifference?”

Silo indifference – my term – is the difficulty of engaging your company’s functional or regional groups in new business initiatives that offer the prospect of significant gain but disrupt their traditional operations. Here’s an illustration.

Several years ago, my group at MIT held a workshop on customer service for executives of our affiliated companies – companies that support our activities and host thesis research. About thirty top managers gathered in Cambridge for a full-day session.

We shared our latest research findings, and invited top managers from Ritz Carlton Hotels, Disney, and a few other customer service leaders to share their insights. At the end of the day, I led a session in which the executives discussed their thoughts and experiences in turbocharging customer service.

Turbocharging customer service

I started the session by asking “What is customer service?” My straightforward question drew a variety of more-or-less expected responses: line fill, case fill, answering the phone in 30 seconds, no telephone tag, fast order cycles, and others. The thread that linked these responses was that they all were operating measures.

More importantly, they all were internal operating measures. After all, what good does it do to have high fill rates if the customer has too much of the wrong inventory? Or if the customer is ordering twice as often as is economical? Or if the customer has a quickly answered phone call about a very disruptive service problem that should not have arisen?

The customer service measures that really count are those that reflect what the customer is actually experiencing, not what you are experiencing in your operations. It is a very common false assumption to simply equate the two. Not only that, but what counts even more is the customer’s perception of service, which again managers often simply, but falsely, assume reflects actual service.

In fact, customers’ perceptions of service are strongly determined by their worst experiences. Even if a customer’s really bad experiences are very rare, those will be the most memorable. Just think about the one time you had a really bad meal at a restaurant – did you go back? (For more on this see my blogs, Stumbling on Customer Service, and Demand Management Disney Style.)

Your worst nightmare

After the MIT workshop executives had developed a long list of internal operational measures, I asked a very different question: “What could your competitor do that would be your worst nightmare?”

At first the group was silent. After a few minutes, the discussion gathered steam and moved in a very different direction. The answers varied in form and content, but they all had the same underlying message: “If my competitor could coordinate internally to really improve my customers’ profitability, business processes, and strategic positioning, I would be in deep trouble. If my competitor really could do this, my customers would abandon our relationship and run to the competition without looking back.”

This was the customer service prospect that really concerned and worried everyone in the group.

So I asked the logical next question, “If this is the ultimate win strategy, and we now know the secret to competitive success, why don’t we do it first? It seems we have a golden opportunity to secure our best customers and take away our competitors’ prime business.”

The answer to this query still echoes in my mind. In essence, everyone in the group said in so many words, “We can’t. We just can’t.”

Why not? “Because,” the conversation continued in essence, “we can’t get our functional departments to coordinate around really innovative customer initiatives. They are too focused on their own departmental objectives and metrics [like the internal operational measures the group focused on initially].” Certainly, managers can get limited cooperation, but all too often this is overshadowed by the momentum of the mainstream business.

Here we had a textbook definition of “silo indifference.” Not a malicious lack of cooperation – just counterpart managers in other departments naturally focusing on their traditional “mainstream” activities and measures.

And, in most cases, these counterpart managers in other silos are appropriately focusing on the objectives they were given by top management. They are responding to the measures top management has told them are most important, and for which they are being held responsible.

What’s at stake? Massive competitive success.

The Apple problem

I thought about this customer service workshop when I had an opportunity to work with a group of top marketing executives of major financial institutions a few months ago.

I led a session on market innovation, in which I showed how a number of very innovative companies, ranging from Southwest Airlines to Apple, had entered tradition-bound industries, and revolutionized them with powerful new value propositions and compelling new go-to-market strategies. In their wake, numerous strong incumbents wound up reeling and a surprising number simply went bankrupt.

As I discussed the innovators, and explained how the industry incumbents had failed to respond effectively, I heard a familiar frustration. The marketing executives saw the need for fundamentally new, innovative approaches to take advantage of the massive changes beginning to sweep through the financial services industry, but they felt an almost insurmountable roadblock in engaging their counterpart managers, who were too busy operating and improving their “traditional” business activities.

These managers hit the wall of silo indifference. Just like the MIT workshop executives.

But the financial services managers faced a problem much more pressing and troubling: the impending presence of world-class innovators like Apple, Google, and others – all with massive resources, far-reaching creativity, and powerful go-to-market machines – and all taking aim directly at the sweet spots in their industry.

If the incumbents failed to act quickly and decisively, they would be in severe danger of failing to use their natural first mover advantage to secure the most profitable portions of their market – their islands of profit – and being left with the unprofitable portions. Just like the incumbent firms in industry after industry that failed to act.

Yet, there was an almost irresistible temptation for some participants to shift the conversation to comfortable topics like how to tune up the on-premise customer experience.

Nevertheless, a number of participants continued to drill into the core question of how to be an effective innovator, how to overcome the roadblock of silo indifference. And this led to a very productive discussion.

Accelerating change

All companies face the problem of accelerating change, overcoming silo indifference. Most fail to act decisively and effectively, putting themselves in danger of being overtaken by more capable, focused competitors.

How do the most successful innovators do it?

Consider this recent New York Times article (July 26, 2012).

News Summary: Google’s Fast Internet for $70/mo.

FAST SERVICE: Google says it will charge $70 a month for its long-awaited, ultra-fast Internet service in Kansas City.

THE SIGNIFICANCE: The service is intended as a showcase for what’s technically possible and as a testbed for the development of new ways to use the Internet. Bypassing the local cable and phone companies, Google has spent months pulling its own optical fiber through the two-state Kansas City region.

OPTIONS: For another $50 per month, Google will provide cable-TV-like service, too. There’s also a free, slower option, though households have to pay a $300 installation fee.

What is Google doing?

Two things.

First, Google is learning by doing.

The project is framed specifically as a “showcase” and as a “testbed for the development of new ways to use the Internet.” Since this involves changes in consumer behavior, Google couldn’t just survey the public. The cardinal rule in market research is that you can’t do market research for a product that doesn’t exist because the customers have no experience of it. The services driving Internet usage today weren’t even conceived in the early days of the internet. The only way to find out what will happen when Google offers service speeds that are 100 times faster than today’s service at comparable prices is to prime the pump and learn by doing.

Second, and very importantly, Google is wisely laying the foundation for a frontal attack on silo indifference. The best way to overcome this pervasive roadblock is to develop a showcase project that demonstrates clear, compelling value. With a clear, practical pathway to clearly superior new value, the counterpart managers throughout the company will migrate to the new value proposition. The wonderful thing about a successful showcase is that the managers throughout the company can actually come see it. They can “kick the tires,” and actually talk to the customers.

This is the fastest and surest way to accelerate change, to overcome silo indifference.

Why the phone company failed

Contrast this with the case of a regional Bell phone company about twenty years ago. This very strong, successful company was a regional powerhouse with ample resources. It was deciding whether to deploy broadband/video capabilities, and if so, how to deploy them.

The obvious path was to conduct a study, which naturally showed that the customers were generally interested, but not enough to pay a compensatory price.

At the same time, however, an alternative proposal was offered to conduct a limited showcase project by wiring a small upscale community of about 30,000 with video, and linking the community’s “communities of interest” (i.e. schools, sports, clubs, etc.) through the network. This would give the customers an opportunity to forge new communications pathways and to develop first-hand a sense of the potential value.

In essence, this could have been a forerunner for many of the Internet-based services we now take for granted, and would have catapulted this company far in front of its competitors.

The company had ample resources. But the innovators in the company failed to gather support from their counterpart managers. In the end, the Finance Department killed the project, noting that it could not convince them that it offered returns comparable to those that flowed from the existing operational program of replacing old switches. Silo indifference in action.

What happened to the company, at the time a very well-respected industry giant? It languished and ultimately disappeared, merged into another regional Bell, then both into another.

Effective Showcases

How can an innovative management team create effective showcase projects that overcome silo indifference? Here is an old family recipe that really works.

• Just do it. The cost will be very low, often trivial – frequently involving a few well-selected customers or suppliers – and the results can be transformative. There is no downside.

• Do it all the time. Set up showcase projects in all areas of your company, especially those that are involved in customer and supplier relationships. What do you have to lose? A minute fraction of your revenues and resources are involved, and the upside is enormous.

• Keep doing it. Very often the most important findings only emerge after the showcase evolves over time (perhaps a year or so). The second- and third-order changes are the most powerful. Remember that very few successful business ventures wind up pursuing their original business plans, but rather the key to success is to learn from experience and to evolve rapidly. The most successful venture investors understand this well.

• Select the most favorable conditions for innovation. Many companies select important customers or suppliers for showcases. Big mistake. There is too much at stake and the innovations necessarily will be incremental and tactical. Instead, look for a relatively small customer or supplier that is very innovative, where the CEO has “fire in the belly” to do new things, the company knows how to partner, and the operational match is great.

• Involve your counterparts early. Get your functional counterparts from the other silos involved from the beginning. Let them help shape the project, and in the process they will become champions. The project will almost certainly benefit from their perspective and capability, and the outcome will have the highest likelihood of being adopted.

Compelling results

Showcase projects offer the shortest distance between you and effective change. They are limited in scope, so you often don’t even have to ask permission, but the results are compelling. They are the ultimate change accelerators.

Why not try it?

The Strategic CIO

The role of the CIO is evolving at an accelerating pace. The most effective CIOs are shifting their focus from inward-looking operational issues to an emerging set of outward-focused strategic opportunities that are central to their companies’ financial and competitive success.

I call these new opportunities “customer-integrated systems,” a new class of critical systems that link a company to its customers. The most effective customer-integrated systems embody a service-differentiated design, with the CIO insightfully tailoring systems linkages to evolving account relationships.

Three CIO eras

Over the past decades, the CIO role has moved through three eras.

First, CIOs developed horizontal systems that automated and linked their companies’ core functions, like accounting, human resources, and inventory control. I think of this as the era of the Operational CIO.

Second, CIOs helped deploy a range of vertical systems that essentially tuned up these core functions in a variety of ways. I think of this as the era of the Tactical CIO.

While many of these vertical applications were important, they tended to be minimally-integrated with the overall business. All too often they amounted to a series of localized, uncoordinated improvements, each of which required significant organizational change.

This caused a big problem because the gating factor in IT systems effectiveness is a company’s ability to absorb change. Even if each application nominally offered a positive ROI, all too many of these systems failed to achieve their promise – not because they were technically deficient, but rather because the organization was not able to make the changes needed to reap the benefits. CRM systems provide a well-documented example.

The Strategic CIO

Today, CIOs are facing an immensely important opportunity to develop systems that link their companies with their most important customers. These emerging systems are ushering in the era of the Strategic CIO.

These customer-integrated systems form the essential infrastructure for the company to secure and grow its islands of profit, and to convert the accounts in its sea of red ink from marginal performance to solid profit contribution. Strategic CIOs are becoming key players in creating and driving their company’s most important business relationships, making them critical to their company’s profitability and strategic future.

New business era

The source of this emerging CIO opportunity is rooted in a major change that occurred over the past 30 years in the way we do business. We have moved from one era of business into another without realizing it.

The Age of Mass Markets spanned most of the 20th century. In this era, the win strategy was clear: maximize production volume to gain economies of scale and lowest costs. This meant distributing product as widely as possible through mass distribution fueled by mass marketing.

Companies simply dropped their product at their customers’ receiving docks, so distribution processes and costs were relatively uniform. Pricing was relatively uniform as well, so it was reasonable to manage both sales and operating activities separately from each other.

In this era, companies had little need for systems that comprehensively integrated them with their customers. It was entirely appropriate for CIOs to focus on horizontal systems, which automated their companies’ core internal processes, and on vertical systems, which essentially tuned up these core processes in a variety of ways.

Customer-integrated systems

Today, all this is changing. In the current Age of Precision Markets, companies form very different relationships with different customers – some arm’s length, some highly-integrated, and some between. These relationships have very different operational processes and cost structures, and at the same time, pricing varies widely from customer to customer.

This means that CIOs have to shift their focus toward developing a new set of customer-integrated systems that appropriately link their companies with their customers. Importantly, the nature of these links varies greatly from business segment to business segment, depending on the account relationship. And, in many cases, the nature and quality of the inter-company IT links will actually drive the profitability and share of wallet of the customer relationship.

The problem is that CIOs traditionally focus IT on internal processes and linkages. In all too many companies, these new externally-focused customer-integrated systems are largely off the radar screen.

Certainly, most companies today have elementary links such as web-based ordering and portals that display order status, but the true promise of customer-integrated systems is much more sweeping.

For the most important customers, customer-integrated systems will provide actual integration of selected functions between customer and supplier, creating very strong mutual benefits. For other customers, they will enable the flexible “showcase” projects that provide powerful new business initiatives. When well conceived, they will both reflect and accelerate a company’s critical business relationships, improve profitability, and provide enormous competitive advantage.

These new customer-integrated systems create huge opportunities for both revenue growth and cost reduction for both partners. But they also present important challenges for CIOs in three areas: (1) tailoring the customer-integrated systems to the evolving relationships; (2) developing the actual intercompany systems, often in coordination with channel partners; and (3) managing both internal change and change within channel partners.

For CIOs, this is exciting new territory that opens vast opportunities to produce huge, new, sustainable value.

Differentiated customer-integrated systems

One of the most important factors in designing and managing customer-integrated systems is the need to differentiate and tailor them for different business segments. In most companies, defining and building these differentiated customer-integrated systems is one of the biggest strategic imperatives.

Yet most companies today are implicitly viewing their customer systems through a one-size-fits-all lens. Instead, customer-integrated systems must be thoughtfully designed to differentially reflect the needs of different classes of account relationships.

Think about this service-differentiated account classification: (1) strategic accounts are major accounts with a willingness and ability to form integrated supply chain partnerships; (2) integrated accounts are large accounts, important but often somewhat smaller than strategic accounts, with less willingness to join in supply chain innovations; (3) emerging accounts are smaller accounts that are very innovative and generally fast-growing; and (4) stable accounts are smaller accounts that are generally reluctant to innovate significantly. Each account cluster requires a very different set of account relationships, supply chain structures, and customer-integrated systems.

Strategic accounts. These major accounts require a high degree of supply chain and planning integration, customization, and innovation. This creates the important need for a critical set of custom-tailored customer-integrated systems.

First, the supplier and the strategic account should develop an aligned, long-term business strategy. This typically involves a three- to five-year year shared strategic plan for the relationship, and joint long-range planning. The relationship should be innovative and involve shared risk. For example, one strategic account wanted to develop a process for picking up product at a major supplier's factories, rather than having it shipped from the distribution centers. As another example, several major suppliers are working with their strategic accounts to develop RFID systems to track products as they move along the joint supply chain.

Second, the companies' supply chains should be fully integrated. This should involve both supply chain processes and systems. Replenishment should be continuous, often involving vendor-managed inventory, rather than discrete orders. Some suppliers are pioneering efforts to develop new vendor management processes and systems that extend all the way to the retailer's shelf, rather than to the distribution center. For strategic accounts, the supplier should dedicate cross-functional account teams and significant resources to understand the account's structure and business. 

It is essential for the Strategic CIO, in parallel, to devote significant resources to working with strategic accounts to design and develop coordinated, integrated customer-integrated systems with enough flexibility to accommodate rapid strategic innovation. Importantly, the Strategic CIO and the team on-site have to be capable of coordinated change management, not only with their customer IT counterparts, but also with operating managers both within their own company and within the customer. This is very complex because the Strategic CIO has to be adept at working with key channel partners who have their own IT priorities and agendas.

Integrated accounts. These important accounts warrant significant care and resources, but not extensive customization. This can be seen in two areas.

First, a major supplier and integrated account should develop in advance an aligned business plan and scorecard. The joint business plan will not be as customized as in the case of a strategic account. The plan should have a shorter time horizon, perhaps one year, and the relationship should be collaborative and trustworthy.

Second, the companies' supply chains should be aligned and coordinated, but not necessarily fully integrated. The supplier should use existing internal processes to respond to orders from integrated accounts. Vendor-managed inventory systems may be appropriate for these accounts, as they are a cost-saving measure.

Here, the Strategic CIO faces a far more manageable set of challenges. While more traditional approaches like web-based ordering and order tracking may suffice for core activities, more complex systems support is needed for intercompany systems like vendor-managed inventory.

Importantly, integrated accounts have the potential to grow into strategic accounts, so it is important for the Strategic CIO to develop a strong set of relationships with his or her counterparts both in the customer IT group and among customer operating managers so they can be ramped up later. In many cases, strong coordinated customer-integrated systems can nudge an integrated account into becoming a strategic account, with the Strategic CIO directly driving major increases in revenue and profitability.

Because there is a long lead time in developing and installing coordinated systems, it is imperative for the Strategic CIO to map the IT terrain for integrated accounts as well as for strategic accounts.

Emerging accounts. These smaller accounts are very innovative and fast growing. They warrant significant supplier attention both because of their growth, and because they provide a low-risk opportunity for the supplier to develop new systems and processes. Yet, because they are small, there needs to be a limit to the investment.

The supplier should provide service that is both functionally excellent and flexible. The service must be efficient and largely standardized, or costs will quickly go out of control. However, the supplier often can justify meeting some unique needs, especially if the innovation can be scaled to the larger account base. These accounts are important because they force the supplier to push the innovation envelope.

These emerging accounts present yet another challenge for Strategic CIOs developing their customer-integrated systems. The core coordinative systems can be relatively standardized, like those of integrated accounts. But these accounts need a very flexible overlay of systems that enable coordinated innovation and continuous limited “showcase” experiments. These supporting systems can be ad hoc in nature, but they require thoughtful planning to understand how to scale quickly if the innovations are spread rapidly into the strategic accounts.

Stable accounts. These accounts typically cause a disproportionate amount of costs because many are unsophisticated and have idiosyncratic processes. For example, a stable account may order by fax rather than EDI, and may have unusual shipping specifications.

The key to supplying this group profitably is to offer a menu of service offerings, along with clear rules of engagement, such as minimum order sizes for various lead times, weekly ordering, and shipments to distribution centers only. In this way, the supplier can provide very reliable, consistent, cost-efficient service. This will ensure transactional efficiency for both the supplier and customer.

The customer-integrated systems objective for these accounts is to drive down costs by providing efficient means of transacting business. This is the area of customer-integrated systems that most companies have been focusing on recently because the pathway is clear, and the payback is compelling.

The danger, however, is to view these minimal cost-oriented customer-integrated systems as a one-size-fits-all solution sufficient for the whole account base. The most important accounts – strategic accounts, integrated accounts, and emerging accounts – require completely different types of customer-integrated systems. At stake are the company’s major revenue and profit streams.

One Strategic CIO’s experience

Here’s how the CIO of a major service provider has made the transition to Strategic CIO. He found that his strategic accounts are demanding exactly the types of integration described above, and this was pulling him to be extremely customer-focused. 

This CIO now spends 30-50% of his time either in business development or working with existing customers. Customer-integrated systems implementation investments (software and personnel) have already become equal to or greater than the investment in internal company systems.

The problem he encountered is that the customer-integrated systems were so critical and fast-growing, the company’s horizontal and vertical systems couldn’t support them. Consequently, the CIO has been investing in parallel in strengthening the company’s ERP system, and pulling some formerly-independent vertical applications into the ERP system, putting them under direct IT control.

The key success factors: a solid internal data model, efficient core processes, and excellent mid-level IT managers who can take projects to completion while seeing the strategic big picture.

The three-dimensional CIO

Today, CIOs have an enormous new opportunity to shape their companies’ future.

Horizontal systems were essential to ensure that a company’s core activities were efficient, and vertical systems were important to tune up and enhance a wide range of company activities. I think of these as forming two important dimensions of the CIO role.

But the third dimension, customer-integrated systems, enables a company to construct its essential links to its accounts. Today, the Strategic CIO directly drives revenues, profits, and competitive advantage.

If the Strategic CIO is effective, the company’s performance and market positioning will accelerate. But if the CIO neglects this critical opportunity, the company will be left further and further behind. This is the most important challenge facing CIOs today.

The successful Strategic CIOs develop a new set of skills and capabilities in four critical areas:

• Coordinating with counterpart managers within the company to develop and populate the service differentiation categories; 

• Tailoring the company’s customer-integrated systems to the account relationships;

• Working with counterpart IT managers in accounts to conceptualize and develop the joint systems; and

• Managing change, both internal and in channel partners.

We are entering the era of the Strategic CIO. Today, the Strategic CIO faces an historic opportunity to directly drive the company’s financial success, and to shape its strategic future.

In this era of the Strategic CIO, the company’s success depends on it.