5

CREATE A WINNING CUSTOMER VALUE FOOTPRINT

Several years ago, SKF had a problem.* For years, the company had been a major producer in the world bearing market, with manufacturing facilities, dealers, distributors, and direct sales. With the rise of competition from Asian suppliers, along with automobile companies and digital competitors selling into the aftermarkets, sales and profits had become flat.

The company had three primary market segments: vehicle original equipment manufacturers (OEMs), machinery OEMs, and the vehicle and industrial aftermarkets. The OEM segments composed about 60 percent of the company’s revenues, with relatively low profitability, while the aftermarket segments contributed about 40 percent of SKF’s revenues, with higher profitability.

The top management team felt that the aftermarket customers had high potential but were underserved because the factories, which had dominated the company throughout its Age of Mass Markets history, favored the large OEM customers. In response, management split off the aftermarket business into a separate division, reasoning that it had a lot of unrealized potential and it was very different from the relatively monolithic, stable, high-volume, low-profit OEM business.

When the new aftermarket management team analyzed its markets, it saw that the aftermarket had two very different sets of customers. The indus- trial aftermarket, such as machine shops, constituted about two-thirds of this business; its customers’ most important need was to minimize machine downtime. The vehicle aftermarket, including auto repairers, on the other hand, contributed about one-third of the revenues; its customers’ most important need was to identify, locate, and install the right part.

This realization led the new team to develop two very different programs with different value footprints for these two very different customer sets.

DIFFERENTIATING BEARINGS

The industrial aftermarket customers were primarily concerned with keeping their equipment running and minimizing costly downtime. This meant that it was very important to maximize the lifetime of the bearing, which depended on bearing product quality, installation quality, protection from environmental contamination, and maintenance quality. Note that the latter three factors were controlled by the customers.

The team decided to focus on ensuring that the industrial aftermarket customers’ complete set of needs were met, which meant that the company either had to perform all of these services itself or train the customers to perform the services expertly on their own.

Based on this understanding, they developed a set of planned maintenance programs to minimize downtime. The program consisted of providing a comprehensive range of specialty bearings, specialized lubricants, automatic lubricating devices, cleanliness programs and products, sealing products, shaft aligning systems, monitoring systems, and installation services, products, and tools to speed the repair process.

The vehicle aftermarket customers had a very different set of issues: (1) to identify and locate the correct bearing for the vehicle, application, and year; (2) to understand how to mount and install it; and (3) to obtain the necessary accessories.

In order to address this customer need, the team developed literally hundreds of kits to sell to customers, each of which contained the right bearing, the right accessories, and the right installation instructions. They even included competitor bearings if SKF did not make the correct part. In order to support this program, the company developed a number of product support centers to provide technical support.

The results were stunning: the aftermarket profits rose by double digits relative to the OEM sector of the company, and the company’s stock price rose by double digits as well.

Breakthrough Understanding

SKF’s breakthrough was rooted in its relentless focus on its customers. This customer focus was a sharp break from the product focus that characterized most companies in the Age of Mass Markets. The company understood that the aftermarket business was diverse and that the cost of the bearing was only a very small portion of the total cost of the customer’s processes in which the bearings were an essential part.

The company succeeded by focusing on the customers that were receptive to a broader value proposition and building a set of extended products that resonated with the respective needs of the customers in its two aftermarket profit rivers. SKF left the price shoppers to its low-priced competitors.

In this formulation, the “product” that SKF was selling was not bearings, per se. Rather it was “trouble-free operations.” This was a very subtle but critical difference. When SKF shifted its focus and changed its offer, the company made it hard for customers to comparison shop because the company’s “product” became a unique package of products and services.

SKF developed an intimate knowledge of its customers. The company understood that its new value proposition fit many customers, but not others. It had to be very thoughtful about choosing where to invest the resources to develop its extended products, and it had to be very careful in identifying its new target customers.

This is critical: building a winning customer value footprint is just as much about choosing the right customers as it is about developing a compelling extended product. This underscores the importance of choosing your customers, aligning your functions to obtain these customers and creating the extended products appropriate for your different sets of customers, and managing your organization to produce your product-service packages at scale.

The first critical step in the transformation process was to “walk in the customers’ shoes,” with SKF’s product managers and sales reps actually spending significant time inside selected customers (not just interviewing them). This led them to understand their customers’ real problems. It also enabled them to identify the customers in each aftermarket segment who were receptive to a more comprehensive solution and, importantly, to identify the customers who simply wanted a low-priced bearing from low-cost providers.

SKF modified its product offering by building a more comprehensive extended product, which in essence, enabled it to “draw a bigger box around the business” and extend its customer value footprint.

The second critical step was to recognize that its customer segments were very different from each other, which in turn, required it to build very different extended products for its two aftermarket profit rivers. This is really important. While the physical bearings remained the same, the extended products in which they were embedded differed greatly from segment to segment.

This produced a sort of “theme and variations” effect, in which a physical product, like a particular bearing, was like a “theme,” while the various packages of services, like bearing maintenance, were like “variations” aimed at the different needs of the company’s diverse customers.

This situation makes product management, which includes product redefinition and extension, particularly complex and extremely productive. It is a core management process that is strategically critical and growing rapidly in today’s Age of Diverse Markets—and it is immensely important in positioning against the digital giants and other aggressive competitors, who often have only a limited ability to build extended products.

SKF’s experience illustrates the principle that today a “product” is defined by the customer’s use, not just by the physical product itself. By creating its portfolio of extended products, SKF was essentially creating a suite of “products” for each physical product. In the Age of Mass Markets, product management and customer management were very separate functions. In the Age of Diverse Markets, however, both customer knowledge and customer targeting are integral parts of product management.

Extended products almost always involve profoundly comingled sets of products and services. Deep customer understanding and transaction-based profit information are needed to productively analyze the cost to serve of these products (which usually varies from segment to segment and customer to customer). This understanding is essential for deciding which products to develop, determining where to deploy them, and managing their growth and extensions. It also is essential for pricing these extended products correctly.

Extended products are frequently a key cornerstone in a company’s larger strategy. For example, when Baxter developed its stockless system, which we described in Chapter 1, it essentially created a pipeline directly into every patient care area and clinic of a hospital. This channel was so efficient and convenient that it propelled sales by over 35 percent, even in the most highly penetrated accounts in the country.

Once Baxter developed its stockless system, it bought American Hospital Supply, which had a broad portfolio of products that complemented Baxter’s and which were used by the patient care areas and clinics that were serviced by Baxter’s vendor-managed inventory system. This gave Baxter a dominant position with the hospitals and transformed the industry.

When a company’s extended products, like those that made up Baxter’s stockless system, are deeply embedded in its customers, and especially when they need a degree of customization, managers need to be especially thoughtful about choosing their customers. The prime candidates for deep extended products are Profit Peak customers, who generally are vendor loyal and relatively price insensitive and who like service innovations that bring them new value. In contrast, spending a lot of time trying to sell these products to Profit Drain customers (because they are large), who generally are price shoppers, is unproductive and dangerous because they usually will not be willing to pay for the new service.

The SKF initiative builds on the same principle as Baxter’s stockless innovation: that extended products create enormous new customer value that digital giants and other narrow competitors generally cannot follow. However, the SKF case adds the important proviso that different customer segments often want and need very different extended products to fit their particular situations. Therefore, a company has to be very thoughtful about choosing its target sets of customers, aligning its functions around its respective customer segment needs, and managing its organization to produce its customer value. The company’s managers need the courage to say no to those customers who want a different value proposition.

VIRTUOUS CYCLE OF MUTUAL VALUE CREATION

Company after company in today’s economy is reducing its supplier base by 30 to 60 percent. The decision on who wins big versus who gets pushed out is almost always determined by a supplier’s ability to produce more essential customer value through an innovative customer value footprint: creating enhanced profits and strategic advantage for the customers.

In addition to the plentiful customer value gains that flow from building an innovative customer value footprint, the supplier harvests significant value as well. For example, the stockless system that Baxter created for its hospital customers generated very important gains in every key component of Baxter’s profitable growth:

•   Revenues: Provided 30 to 40 percent revenue increases, even in highly penetrated accounts; eliminated price sensitivity; refocused sales reps on selling products, not solving service problems

•   Costs: Enabled cost reductions of 25 to 40 percent in both sales and marketing, and in supply chain management

•   Profitability: Identified targeted profit improvement initiatives, often with gains of 25 percent or more

•   Cash flow: Created immediate cash flow increases, as inventory was lowered and excess costs were reduced, with no investment needed

•   Asset productivity: Rapidly eliminated nonearning assets; put assets to more profitable and more productive uses

•   Risk management: Built enormous switching costs in key accounts; dropped unneeded assets and expenses

This broad set of value points was created in parallel for the hospitals as well, leading to a virtuous cycle of mutual value creation and ever-deepening business relationships.

In fact, several years ago, at the height of the last financial crisis, we were invited to participate on an innovation panel, along with top executives of three Fortune 100 companies. After our presentation on the process of innovation, the three executives discussed their innovation processes.

All three companies had the same strategy and process: they were building closer operating ties with their Profit Peak customers to increase the customers’ profitability. In the process, they were reducing their own costs and raising their profits. At the same time, they were investing a portion of the new profits to extend their value footprint and deepen their key customer ties, producing even more profits for the customers. This led the customers to give them an increasing share of wallet.

Even at the depth of the prior recession, their Profit Peak customer revenues and profits were growing at strong double-digit rates.

WIN THE CUSTOMER VALUE WAR

Building a compelling customer value footprint is a critical strategic imperative that is most starkly illustrated by a situation every company faces from time to time and every manager fears most: a price war. This is an especially troubling and increasingly serious problem as the digital giants and other aggressive competitors with streamlined costs and Big Data advantages move into incumbents’ traditional markets.

This raises an important question: how can a company win a price war without destroying its own profitability?

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

Paradoxically, not only is a price war devastating for a company and its competitors, but it is very bad for 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 footprint.

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

Winning the Price War

When confronted with aggressive competitor pricing, the instinct is to respond with a price cut. After all, why lose the business? Even worse, if a company loses those customers by failing to respond, it 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 companies collapses, and with it goes the companies’ 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 multiyear 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 the incumbent’s most lucrative accounts and products—its high-profit customers. By responding where it is attacked, the company effectively does the most damage to itself—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 Profit Peak customers—as its core source of cash flow and profitability. The answer, therefore, is to strike back at the competitor’s source of cash flow—the competitor’s Profit Peak customers.

A classic example comes from the airlines a few decades ago. Some carriers, like United and American, had very lucrative east-west routes (for example, between NY and LA), while others, like Delta, had very lucrative north-south routes (for example, between NY and 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 United States to 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 can a company prevent one? We were asked this question a while 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 customers come 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 the company’s value footprint.

Match the Price

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

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

The more effective countertactics mentioned earlier—shift the time frame or shift the locus of attack—produce much better results than simple price matching. But it is even more effective to proactively act to prevent a price war. A company can do this in two ways: reducing the customer’s total cost and turbocharging its customer value footprint.

Lower the Customer’s Total Cost

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

A company can take measures to reduce its customers’ direct costs. They range from supply chain cost reductions (for example, flow-through supply chains) to product and category management (for example, product rationalization). Subsequent chapters of this book discuss these measures.

Conversely, customers can create surprisingly big cost reductions for the supplier. For example, by helping the customer smooth its order pattern, a company can reduce its own supply chain costs, often by 25 percent or more, even while reducing the customer’s ordering and handling costs. Better forecasting offers similar gains, as does a limited but well-aimed product substitution policy. These profit measures 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 it can endure over time.

Increase Your Customer Value Footprint

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.

The example of Baxter’s stockless business illustrates the enormous potential value in increasing a company’s customer value footprint.

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 value into this business initiative. In the prior period, before stockless was developed, the hospitals were reluctant to operate large networks 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, could support the evolving network of facilities. In short, Baxter created a fundamentally new value footprint for the hospitals to offer to their customers—enabling them to radically change the way they operated to bring huge new value to their patients.

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

Baxter did not just win the price war. It eliminated it. Baxter turned the price war into a customer value war in which Baxter was the only viable competitor.

Several highly successful companies, like Southwest Airlines, have developed extended products that transformed their respective markets so they had few effective competitors. Southwest, for example, redefined its business from competing with other airlines to competing with buses for the business of travelers with modest incomes. It did this with a cluster of extremely innovative cost-minimizing measures that included standardizing its fleet, rejecting assigned seats, and serving secondary airports in smaller cities that were underserved by air carriers. As another example, consider how Apple virtually eliminated the music CD and low-priced camera businesses by developing the iPhone, which is a convenient, multipurpose device anchored by a portable telephone, which everyone wants and needs.

The most effective competitors will not be those who win by doing better what incumbent firms have always done. Rather, they will win by doing things that have never been done before in an industry—creating a fundamentally new and much more effective customer value footprint for their Profit Peak customers. Of course, every manager has a golden opportunity to seize these all-important first-mover advantages by being the innovator.

The key imperative is very clear: once a manager has a lead, step on the gas—and the most effective way to do this is by turbocharging the com- pany’s customer value footprint.

Winning the customer value war is most often surprisingly easy because the competitors rarely think about it. All too often they focus on tactics like so-called price optimization (in essence, selective price raising), rather than accelerating their customer value proposition and lowering the customers’ total costs.

This is especially critical for securing a company’s Profit Peak customers. These customers are less susceptible to a competitor incursion, yet they also are the customers that are most receptive to innovations that fundamentally transform the company’s customer value footprint and reduce its joint cost structure. Managers risk losing these critical customers if they reduce their efforts to push the frontier of customer value creation. In this sense, choosing your customers implies the need to push the envelope on the customer value footprint that those customers seek and embrace.

A company’s Profit Drain customers, on the other hand, are usually the most price sensitive, and very often they are the ones driving the price war.

The essential question is whether a company’s managers are so busy with tactical issues like price wars that they “do not have the time or resources” to systematically and relentlessly build their customer value footprints— especially for their Profit Peak customers.

Winning the customer value war is the only way to permanently prevent price wars and secure a company’s future.

TWO LANDMARK INNOVATORS

The cases of General Electric and Zara further illustrate the process of developing and managing integrated packages of products and services to build winning customer value footprints, capture the strategic high ground, and create years of profitable growth.

General Electric’s Power by the Hour

Several years ago, General Electric undertook a sweeping transformation to enhance its high-service customer value footprint. This program brought it a major increase in strategic advantage, profits, and market share. It innovated by creating a set of powerful extended products that provided unique combinations of physical products plus outstanding customer service and comprehensive technical support.

For example, General Electric’s aircraft engine business decided to combine its products with enhanced service offerings to create a hard-to-follow strategic advantage. The business always had a variety of offerings, including engines, spare parts, and a variety of related services. It had innovated by improving and proliferating each of these offerings.

At that time, the company took a close look at its customers, figuratively “walking in the customers’ shoes,” and it determined that what most of the customers really wanted was working aircraft engines, and not an array of individual products and services that enabled that to happen.

Based on this insight, General Electric developed a breakthrough offering called Power by the Hour, in which it offered its customers an all-in price that reflected the customers’ engine usage. In this way, it created a customer value footprint that strongly aligned with the customers’ real need. This not only produced powerful sales and marketing advantages, but importantly, most of their competitors, many of whom were niche players with limited capabilities, could not follow.

In essence, General Electric redefined its industry by “drawing a bigger box around its business”—from selling products, to selling products plus services, to selling all-in results—to create a strategic positioning that implicitly defined most of its competitors out of the industry. General Electric chose customers who wanted an all-in service, aligned its functions to provide this package of products and services, and managed to coordinate in producing this unique extended product at scale.

Zara’s Innovation

Zara is a Spanish retailer with an innovative strategy. The company focuses on customers who want the latest fashions. It developed a merchandising policy of stocking a limited amount of each product in each store. Because it had chosen its customers for their desire to be at the cutting edge of fashion, these customers rushed to the Zara stores to get the fashion merchandise before it ran out.

This policy was tremendously effective. The company developed very strong sales at the beginning of each season, and it restocked the stores with new fashion lines as the season progressed. The customers rushed to obtain garments while they were available, eliminating the need to mark down products toward the end of the season.

Zara developed a very effective supplier management policy to match its merchandising strategy. It conceptualized demand as “waves on the ocean,” and sourced the “ocean” portion of demand in Eastern Europe where suppliers were low priced but inflexible, while it sourced the “waves” locally, where suppliers were higher priced but very flexible to changes in volume. Because the merchandise was fashion oriented and Zara’s customers were not bargain hunters, they were willing to pay full price. Besides, if Zara ran out of a product, it had another desirable new product to replace it.

Zara was successful because it chose its customers carefully, aligned its business to serve these customers, and managed the company’s operations to make the system work.

STRATEGIC CATEGORY MANAGEMENT

Strategic category management—positioning a company’s product set (both physical products and extended products) to be essential to its target customers as its industry transforms and grows—is the management process that is at the heart of virtually every highly successful company. This is where strategy, sales, supply chain management, and channel management—choosing customers, aligning functions, and managing the organization—come together in a complex set of processes that largely determine your company’s success or failure.

The history of how Microsoft became one of the world’s most successful companies in an amazingly short period of time illustrates both the power and subtle success factors of this critical business capability.

Microsoft’s story starts in 1975, when Bill Gates was a sophomore at Harvard. His high school friend, Paul Allen, showed him the January 1975 issue of Popular Electronics featuring a story about how the Micro Instrumentation & Telemetry Systems (MITS) company developed the Altair 8800 microcomputer. Gates and Allen focused on the microcomputer customers’ emerging needs, determined that there would be a personal computer industry, and saw a need for programming languages. This spurred them to develop the programing languages that would position them at the heart of the new, emerging industry.

In his Harvard Commencement 2007 address, Bill Gates told of how he went to his dorm room and called the responsible executive at MITS, offering to provide software for the new PC. He worried that the executive would realize that he was just a student calling from a dorm room, but the executive told him to come see him in a month, which was fortunate because Gates and Allen hadn’t written the software yet.

When Gates received the nod, he dropped out of Harvard, Allen left his programming job, and they moved to New Mexico to finish the software. That was how Microsoft began.

An observer at the time noted that Gates and Allen started Microsoft with the stated mission of putting a computer running Microsoft software on every desk and in every home. That is how they chose their customer. Before long, Microsoft was the dominant provider of software to the early PC business.

Unlike many other PC and software pioneers, however, Bill Gates was first and foremost a businessman. He clearly saw the need to get an inside track on the industry’s revolutionary growth by using his products to create a dominant strategy. This became the basis for aligning his company and managing its early organization.

The second major cornerstone of Microsoft’s early success came about five years later. IBM had developed its PC, and Gates had agreed to provide BASIC for the new computer. He also offered to provide an operating system.

At that time, Microsoft was the dominant provider of PC software, but Digital Research’s CP/M was the dominant PC operating system. IBM sent a team of managers to Digital Research and Microsoft to find out more about the companies.

First, they went to Digital Research. Unfortunately for Digital Research, and fortunately for Microsoft, Digital Research’s Gary Kindall decided to skip the meeting.

Needless to say, when the IBM team arrived at Microsoft, they were greeted by Bill Gates. Gates proposed providing an operating system, and IBM was interested. The only problem was that Gates didn’t have an appropriate system.

When he heard that IBM was interested, Gates contacted Seattle Computer Products, a small local company that had an early operating system called QDOS (“quick and dirty operating system”—later to become a more respectable-sounding MS-DOS). Microsoft bought the system for $50,000 even though it didn’t work well. The company rewrote it and entered into its historic agreement with IBM in which MS-DOS would be provided on every IBM PC, while Microsoft was free to sell MS-DOS to every other PC maker as well.

That is how Microsoft became Microsoft. The rest is history. Bill Gates was 25 years old at the time.

This story is remarkable. What’s even more amazing is that at every point, someone else had a better product. But Microsoft always had a much better strategy: choosing the right customers, aligning the company’s activities to meet these customers’ needs, and managing to produce the needed products and services.

In checkers, there’s an old rule of thumb: if you’re not sure what to do, move toward the middle. Bill Gates relentlessly moved toward the middle of his target market and won by constantly positioning Microsoft at the center of the entire evolving PC industry.

The moral of the story is that a great strategy always beats a great product. Or, as they say in sailboat racing: a good sailor in a bad boat will always beat a bad sailor in a good boat.

The danger is that day-to-day operational category management issues like pricing, promotion, and packaging are so pervasive and pressing that they often crowd out the opportunity to focus on strategic category management, which is much more important to a company’s success.

Product Positioning Excellence

What made Bill Gates so successful was his intuitive sense of strategic category management, linked of course, with a terrific ability to manage. He was intuitively able to visualize the development of a historical new industry almost like a chessboard on which he could position his budding company.

The actual products that Gates offered were in a sense derived from his need to meet opportunities that were emerging in his customers’ businesses. By moving fast to fulfill these developing customer needs, he was able to lock up market opportunities that would rapidly become huge and enormously lucrative.

Microsoft’s key success factor in its early days was not product excellence, per se. It was product-positioning excellence. Once the company locked in its customer positioning, even with a marginal product, it could then work hard to improve the quality and performance of its product.

This is the power of strategic category management. The most effective category managers operate at two levels: strategic and operational. Strategic category management—an integral part of broad-gauge category management—concerns how to create strategic dominance and sustained profitable growth by positioning a company through its product offerings to be a central factor in its target customers’ business.

Category managers need to devote a significant amount of their time teaming with their sales and supply chain management colleagues to target the right customers and stay deeply involved in constantly improving their company’s extended products that move the company into new realms of customer value creation. The key to accomplishing this objective is to initiate a constant series of profit-showcase projects, in which company managers have an opportunity to learn by doing. They “walk in the customers’ shoes,” through which they join with selected customers to identify and develop new customer value footprint opportunities that even the customers themselves did not initially see.

Profit-showcase projects, described in the next section, are a primary way to create new breakthroughs in customer value. Market research—both surveys and focus groups—cannot do this because while most consumers are able to differentiate among attributes of products that they know, like determining whether they probably would like mint-flavored coffee or soap in dispensers, most consumers cannot judge products that are outside their range of experience, such as flying cars today, or using Google to surf the web in the early days of personal computing.

Steve Jobs was famous for not using market research. Instead, he trusted his own vision and creativity to develop the iPod, iPhone, and iPad, along with a few less successful products. Thomas Edison was another visionary who developed the electric light, movies, record players, and a host of other world-changing inventions without market research.

Key Success Factors

Many managers of companies that make or distribute physical products lose valuable strategic and profit opportunities because they don’t capitalize on the benefits of building extended products through strategic category management.

This is natural. They are very focused on managing their physical products. Consequently, they often view designing and managing related services, such as information support, vendor-managed inventory, and joint category management, as almost an afterthought, a nuisance cost to be recouped if possible. This is a big mistake.

Benefits of Extended Products

Extended products are central to strategic category management.

Today, managers have a unique historical opportunity to create decisive first-mover advantages as the Age of Diverse Markets disrupts old, established industry orders. But these will be available for only a limited time—until industries settle into new orders and the players are locked into new, permanent roles.

Selling more products can give a vendor additional presence in customers, but selling extended products can give a vendor a new strategic positioning and a host of top-level contacts deep in their target customers’ organizations. This can be immensely important in reversing a vendor’s slide toward commoditization and price competition.

Paradoxically, in most extended product sales, especially those that involve deeply embedded extended products, the larger the change, the easier it is to sell the new relationship. This occurs because larger, more comprehensive value footprints almost always produce new value in multiple areas of the customer’s organization. The purchase decision naturally gets elevated in the customer’s organization to an officer who has broad responsibility and a long-term strategic perspective, rather than a lower-level, price-oriented buyer.

Building your extended product can offer the opportunity to create compelling value in unexpected ways. For example, Nalco, a company that provides chemicals to water treatment systems, installed sensors that could be read remotely in the chemical tanks on the customers’ premises. This enabled Nalco to be much more efficient at replenishment and production. But the company didn’t stop there.

Nalco’s managers developed a deep understanding of the customers in their target market. They had many conversations and on-site visits with their counterparts in customer organizations, which enabled them to “walk in their customers’ shoes.” Through this process, they realized that their innovation allowed Nalco to monitor the actual rate of chemical drawdown and compare it to the expected rate if the customer’s water treatment system were operating at peak efficiency. When the Nalco engineers saw a variance, they would call the water system’s managers and alert them to adjust the system. This routinely led to customer savings many times the cost of the chemicals. In a city like Chicago, for example, the cost of a poorly performing system was tens of millions of dollars, compared to the cost of hundreds of thousands of dollars of Nalco’s chemicals.

This innovation created unique differentiation that even digital competitors with big data and AI could not follow because once Nalco modified a customer’s chemical tank and established its information links with the customer’s engineers, it had an inside track into the account. This gave Nalco compelling first-mover advantages and competitive advantage.

In the process, it made Nalco indispensable, transforming the company’s positioning from commodity supplier to essential strategic partner with strong information-based barriers to entry. Nalco drew a bigger box around its business, expanding its customer value footprint—and internet- based competitors could not follow. The moral of the story is that you always have an opportunity to increase your customer value footprint, and real value always wins.

Most deeply embedded extended products enable a company’s account managers and operations personnel to develop close relationships and trust with their counterparts throughout the customer’s organization. Many of these managers in the customer’s organization are important members of the customer’s buying center who otherwise would have been inaccessible. These new relationships throughout the customer’s organization are essential to identifying, creating, and selling new generations of ever more effective extended products.

Extended Product Issues

Extended products provide many valuable advantages—far beyond new fees and the ability to raise prices. However, these products, especially the deeply embedded extended products, involve some very important issues.

It is critical to choose your customers carefully and align your functions with the needs of your respective profit rivers. Many customers are not good candidates for extended products, especially for deeply embedded extended products, because of their profit potential, buyer behavior, capability to partner, or operating characteristics.

For example, Baxter soon learned that its stockless system was best suited for sophisticated large hospitals clustered in a medical area because the hospital cluster provided logistical economies, had large profit potential, and preferred longer-term contracts with demonstrated savings. This means that category managers must develop a thoughtful, practical set of account qualification criteria, as well as one or more fallback extended products in the company’s relationship hierarchy.

Unfortunately, many companies’ sales compensation systems reward all revenue increases. They have no choice but to do this unless they utilize the transaction-based profit analytics needed to understand actual customer net profit.

Very often, extended product costs are not incremental, and they are difficult to quantify. They usually involve facilities that are jointly used by different processes in a company. Also, well-designed extended products, like Baxter’s stockless system, actually lower a supplier’s costs, even while they increase its sales. Transaction-based profit analytics enable managers to define, price, and manage these complex products.

Profit-Showcase Projects

A profit-showcase project is a critically important component of strategic product management, both for exploring customer potential when you are choosing your customer and for understanding how to enhance your value footprint in your target customers. It provides a very valuable opportunity to “learn by doing” by spending time physically in a customer to understand how your company’s products are selected and used in the broader context of the customer’s business processes in which they are embedded. In order to successfully develop innovative extended products, it is very important to have several profit-showcase projects running at all times.

For example, Baxter developed its stockless system in a profit-showcase project in which a small team from Baxter spent a few weeks in a hospital systematically observing and measuring its supply chain processes, without an initial hypothesis on how to make them more efficient.

Several years ago, we were involved in a showcase project in which a company’s CEO approached the CEO of a very innovative customer. He asked if he could place a team in the customer for a month or two. They would observe the customer and perhaps generate some measures of the customer’s activities. In essence, they would be “walking in the customer’s shoes.”

The CEO explained the profit showcase to his customer’s CEO by saying, “I have an empty bag today. After two months, my team will tell me what to put into the bag, and I’ll see if you want to buy it.” Of course, the customer’s managers were instrumental in helping to identify what would be in the bag—codefining the customer’s evolving real needs and codesigning the new extended-product offering. Needless to say, the customer’s CEO bought the innovation that was “in the bag.”

Only by spending time and working on-site in the customer can a supplier’s team and their customer counterparts evolve a really deep understanding of the customer’s needs and embody it in an innovative, compelling extended product. In the process, of course, they develop very strong relationships with each other, which are important in both selling the innovation and in implementing the new processes.

A profit-showcase project is very different from a pilot project. A pilot project is usually a proof-of-concept demonstration for a process that has already been analyzed and tentatively approved, while a profit showcase project is a “voyage of discovery” without a predetermined result.

The best locations for showcase projects are those where the conditions for innovation are most favorable. These are typically smaller, highly innovative customers.

It is important to bear in mind that the most effective profit-showcase projects develop completely new ways to structure and conduct a business (for example, Baxter’s stockless vendor-managed inventory system). Thus, market acceptance is a moving target; it will rapidly increase once the early adopters have shown stellar results.

The most productive way to develop and manage profit-showcase projects is to create a formal, ongoing process that is the responsibility of a committee of upper management (directors and VPs), and not an occasional ad hoc event. In fact, this is an essential responsibility of a company’s MPG Committee, which we describe in Chapter 8.

Selling Extended Products

In selling deep extended products, especially those that require some customization, it is very effective to form a team jointly with each customer. The team’s objective is to “rediscover” the extended-product opportunity and to quantify the benefits. Because innovative extended products involve completely new ways to do business, it is critical for a group of customer managers to move through the process of specifying the innovation and verifying the benefits—even though the supplier already has this knowledge. The customer managers on the team will become core supporters, which is essential to selling the innovation (at least until it is accepted widely by the market).

When building a company’s value footprint in its Profit Peak customers, it is important to shift from transactional to relationship selling. (We will explain this process more thoroughly in the next chapter.)

In transactional selling, the sales rep typically takes the lead until the customer relationship is well established. At that point, the supply chain manager makes contact to ensure smooth operational interactions.

Relationship selling, especially with high-profit customers and prospects, is very different. It is a joint multicapability selling process with the sales reps, supply chain managers, and other involved departments teaming closely to engage the account.

Because high-profit customers almost always should have a degree of supply chain integration inherent in their relationship, a very different dynamic naturally occurs. Supply chain managers are essential—especially in the early stages of high-profit customer engagement—because they will naturally bond with their customer counterparts to start solving joint problems and creating joint operating efficiencies. This process will drive the relationship deeper and accelerate both revenues and profits—as we saw in the Baxter case with the relationship that developed between the Baxter materials management coordinators and their counterparts, the head nurses.

It is important to put every element of a company’s relationship with its high-profit customers under the microscope by “walking in your customers’ shoes.” For example, at Edison Furniture, which we described in Chapter 1, the delivery manager noted that about a third of the drivers had great customer service skills, while the rest simply drove trucks. In the existing system, each driver loaded his or her truck and drove through traffic to the customer who happened to be next on the list.

Instead, the delivery manager suggested that they station the “master” drivers, those with strong customer service skills, near the Profit Peak customers in the field. When an order was being delivered to a Profit Peak customer, the regular drivers would shuttle the products to the master driver located in the field; then they would change trucks so the master drivers always were the ones who interacted with the premier customers. The master drivers were trained in selling, as well as delivering, and, in time, they generated so many sales that they were given commissions.

This example underscores the importance of moving past the old functional view of a company, where sales owned the customer. Today, everyone can—and must—add value to the customers’ experience and increase profitability, even those in what were traditionally considered cost centers.

Expanding the Customer Value Frontier

Successful strategic category managers create a stream of innovative extended products that meet the rapidly evolving customer needs of their target sets of customers. This is a moving target. Once a company has success and momentum in creating an innovative extended product that really expands its customer value footprint for its target customers, it is easier to build on its experience and relationships to keep expanding its customer value footprint.

Unfortunately, all too many managers see this as a one-time task and fail to keep innovating—essentially losing the opportunity to make their customer value innovations a permanent strategic category management capability.

The moral of the story is that once your company has the lead, step on the gas. Never give customers even the slightest reason to look around for an alternative. A company’s customer value footprint tells the story of its success or decline.

MANAGING TO STAY ON TOP

The following four essential steps frame the most productive processes for systematically building a company’s value footprint.

Walk in Your Customer’s Shoes

Spending significant time physically in a set of customers is a great way to judge the potential of a set of prospective customers and, once chosen, to build a powerful customer value footprint. The objective is to observe the entire purchase-to-use cycle for your products. This includes everything from selecting the products, to procuring them economically, to understanding how the customer is using them.

Here, a manager is looking for opportunities to build the broadest, most powerful customer value footprint. The early development of innovations like vendor-managed inventory and category management provide examples. So do the contemporary early initiatives to create strategies based on the industrial internet, also called the internet of things (IoT).

Importantly, building a company’s extended-product portfolio can offer the opportunity to create compelling value in unexpected ways, as illustrated by the cases of Baxter, SKF, Nalco, and Zara.

Here is our take on the ultimate truth in business: managers always have an opportunity to increase their companies’ value footprint, and real value always wins.

Move Toward the Middle

A classic rookie move in chess is to go for checkmate on an early move, instead of laying out the board position. The equivalent of the board position in a supplier-customer relationship is real value and customer trust. Once a manager has worked to understand and develop a truly winning value footprint with a very creative extended product, the next essential task is to systematically align the company by putting the core pieces in place. And often, the core pieces are subtle.

For example, suppose a supplier wants to develop a highly integrated supply chain with a major customer, and the customer is not interested in this type of relationship. The core building blocks, as always, are real value and customer trust. These grow naturally out of the broader multicapability customer engagement teams that go far beyond the traditional sales rep and buyer relationship.

Even with an arm’s-length relationship, the supplier can arrange for its supply chain managers to meet periodically with their counterparts in the customer in order to discuss ways to enhance customer service. Over time, the supplier’s supply chain managers will develop a trusting relationship with their customer counterparts. Note that this process does not focus on selling products or solving problems; it focuses only on building trust, although some long-festering misunderstandings may have to be cleared up early in the process.

Later, once the trusting relationships have developed, the supply chain managers can bring these customer counterparts to meet operations managers in other customers that already have productive, highly integrated relationships with the vendor. These meetings will naturally gravitate toward identifying and confirming the value produced.

Through this process, the supplier can align its functions and build the essential core of real value and customer trust that will lead to a highly productive, highly differentiated relationship with the target account.

Touch the Dream

Every top manager in every company has a dream—a vision of what real success looks like. This nearly always centers on turbocharging business growth, inventing creative new business initiatives, and building a dominant strategic position.

When a company’s customer value proposition enables its customers to move toward their dreams, the company will become an essential strategic partner to its customers.

This can happen in unexpected ways. For example, we’re deeply familiar with the operations of a number of vendor-managed inventory systems and other integrated supplier-customer innovations. These certainly create important benefits, including customer cost reductions. But surprisingly often, the most powerful, but unexpected, benefit is that the partnership enables the customer to enter new markets or offer new services because it can draw on the supplier partner’s deep, specialized capabilities—as Baxter did when its stockless system enabled hospitals to create networks of remote clinics and care centers.

By enabling the customer to grow its business in powerful new ways that the customer alone could not have done, the supplier becomes an essential part of the customer’s success. The supplier wins the value war by touching the customer’s dream.

Have the Discipline to Remain Focused

It is so tempting to operate close to the surface of a customer relationship, focusing primarily on the day-to-day sale of a company’s products and services, searching out tactical gains. And if a manager does achieve tactical gains, it is overwhelmingly tempting to focus on celebrating these “victories.”

However, the top managers who succeed in the long run have the discipline to remain focused on understanding their target customers, developing the most powerful customer value footprint, and systematically building the alignment in their company to be able to deliver results at scale. When they have created this understanding, they redouble their efforts to push the value creation envelope even further and continue to search relentlessly for new ways to create real value and customer trust.

RELENTLESS FOCUS

We’re reminded of a wonderful exhibit on American ingenuity mounted several years ago by the Smithsonian Institution: If We’re So Good, Why Aren’t We Better?

The best managers in the best companies are always relentlessly focused on this question, and they are almost frantic to find an ever-better answer. This is how they got to be market leaders, and it is why they stay in front—choosing their customers, aligning their functions, and managing to build their winning positions as their industries undergo revolutionary change.

THINGS TO THINK ABOUT

* Sandra Vandermerwe and Marika Taishoff, SKF Bearings: Market Orientation Through Services (Lausanne, Switzerland: IMD, 1990).