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Pricing During Frantic Under-Supply | The Right Moves in the Cell Phone Business | You Have the Right - No - the Responsibility - to Raise Prices! | Breaking the Bank | Holden Live! Wrap-up | Everyone Believes Them Now | A Young Dog Learns an Old Trick: Online Customer-Specific Offers | Good Reading!
Pricing During Frantic Under-Supply
From “PlayStation 3 on Rescue Mission” by Martin Fackler, The New York Times, November 11, 2006
Commentary By Steve Haggett
We hope your kids aren’t expecting a Sony PlayStation 3 this Christmas.
As the hot holiday gift this year, the PS3 is chronically short of supply. Priced at about $600, or almost five times the price of the previous generation PS2, there are long lines to buy one whenever they show up in stores. But what is the free market rate Sony could charge?
Many of the PS3’s that are purchased are bought by toy scalpers who immediately place the product on e-Bay, where prices peaked at over $25,000 – more than 40 times the list price – after settling down to a more ‘reasonable’ equilibrium price of $1,000 on more recent auctions. Tens of thousands of wannabe consumers log onto YouTube simply to watch videos of lucky owners opening their PS3 carton!
Compare this phenomenon with the California energy crisis of 2000-2001. California regulated itself into a similar situation, discouraging construction of new supply and capping retail prices while de-regulating wholesale prices. In the winter of 1999-2000, wholesale power prices were stable at about $30 per MWh. Manipulation of supply by bright young traders and managers at Enron and Reliant led to average prices one year later of $300 per MWh, with peaks at $1900, which is over 60 times the previous average.
Consider the results. By generating the buzz that the long lines and amateur videos create, the PS3 creates a healthy waiting list of eager customers, resetting price expectations well above previous levels. If others pay over a thousand dollars to an online broker, the Sony’s $600 premium price must be a great deal. Enron and Reliant, pursuing not just a premium, but a skim pricing strategy, ended up under investigation. Enron agreed to pay a $1.52 billion penalty, and then went bankrupt under the weight of criminal convictions. Its major customer, Pacific Gas & Electric, was also driven to bankruptcy as a result of the high wholesale but capped retail prices.
That’s an important lesson when facing a situation of under-supply. A premium price strategy can support a new price equilibrium and build long-term demand. A short-term skim pricing strategy can sometimes lead to long-term payback. The Right Moves in the Cell Phone Business
From "Samsung Changes Its Strategy In Bid to Regain Market Share" by Yun-Hee Kim, The Wall Street Journal, December 6, 2006
Commentary by Dr. Reed Holden
Wow, business executives are getting smarter every day. Samsung has finally realized that their focus on high-end cell phones might be great for profits, but it's lousy for market share and theirs is slipping. What most executives would do is drop prices. That's almost always the wrong move. That's because the price drop loses the opportunity for profits in the high-end segments, and the product cost structure is usually too high to compete in the low-end segment anyway.
Lee Ki Tae, Samsung's cell phone President, has recognized that not having a low-priced product has virtually shut them out of the high-growth markets in China and India. In these markets, the largest segment of consumers may not have the resources to buy high-priced phones. Last year, Motorola introduced a sub-$50 phone for those markets. Finally, Samsung has recognized that they need to do the same thing if they want to be profitable and to grow. Finally!
Everyone repeat after me: price for profits, low-end products for share. Do I need to say it again? OK: price for profits, low-end products for share. That's the mantra of successful managers. You Have the Right - No - the Responsibility - to Raise Prices!
From “Profit In Mind, NASDAQ is Raising Fees – and Brows” by Aaron Lucchetti and Kara Scannell, The Wall Street Journal, December 8, 2006; Page C1
Commentary By Mark Burton
One of the major stock exchanges, the NASDAQ, is taking hits in the press because, horror of horrors, they are raising their prices. Last time we checked, that’s a pretty good way to make more money. Some would say the trading data that the NASDAQ generates is a public good as timely, accurate information is a key ingredient for well-functioning financial markets. Gee, that sounds nice, but let’s not forget that data are generated using NASDAQ assets, and that it is also a public company with profit and growth goals.
This problem isn’t unique to the stock exchanges. We find a similar pattern in a lot of businesses that create and sell high-value data. Customers depend on it and the really good stuff is usually only available from a few sources. As a result, they feel uncomfortable and raise a stink, because they don’t have alternative sources for a critical business input. Complaints about fairness make many executives very nervous about raising their prices. Our advice? Get over it and play hardball. What customer in their right mind is going to be happy about a price increase? Define what the increase is going to be and stick to it. The worst thing that a firm can do is announce an increase but have an internal goal that is actually much lower. Everyone knows that game and you just increase the perception that your prices are negotiable. If you have a high-value offering, customers may complain but they will pay you. Often the only real barrier to a price increase lies within the minds of the team trying to carry it out.
From “Funds Consider New Ways of Paying for Research” by Tom Lauricella, The Wall Street Journal Online, December 8, 2006
Commentary By Nelson Hyde
What should you do when customers start insisting that you break apart your carefully constructed, bundled offerings so that they can pick and choose—when those bundles are core to your business model?
That’s the problem Wall Street is facing. Investor funds often buy research and analyst advice from brokerage firms that also place trades for them. They usually pay for this, not in cash, but with “soft dollars” by allocating more trades and commissions to the brokerage firms, but now mutual fund giant Fidelity has negotiated contracts that separate research and trading payments.
Sounds simple, but it’s a huge problem for brokerage firms. Now funds can walk away from mediocre research or trading services they don’t want. Projections say research expenditures will drop by almost half and trading commissions by 15-30% over five years. Some brokerage firms will respond by slashing prices to protect share. Others will match. There go the margins.
As dire as the projections are, brokerage firms can improve their lot. There are two underlying sources of the problem, and brokerage firms can fix both of them: (a) the value of their offerings is not clear to buyers (b) they allow volatile market conditions—instead of real economic value—to dictate pricing. If they want to remedy these, brokerage firms must begin the hard work to:
Commentary By Dr. Reed Holden
Toyota recently announced that they are seeking 15% of the global market by 2010—that's an increase of four percentage points in four years. Here's the question—is there anyone who doubts that they will achieve that objective? Of course not. By the way, that objective will unseat the mighty (?) General Motors which has held the top spot for the past five decades. It's worth it to look at how Toyota did that.
First, they didn't do it with discounts. Oh, sure, they discount at the dealer level. In fact, discounting at the dealer level is something they encourage. After all, it hurts the dealers, not them. Unfortunately, it hurts Toyota's quality image as well. Their dealer ratings continue to be at the bottom of the barrel, but they haven't discounted the brands. Their brands are typically 5-15% higher than all competitors, even during downswings in the markets. When Ford and Honda were discounting their brains out in the 1990's to get the top brand sales spot, Ford won the battle for a while but ended up losing lots of dollars in the process. That's why they call it the winner's curse!
Toyota just kept their prices higher and let quality do it's work. They eventually took over the top spot for sedans and continue to hold it with high prices and quality products. Did it take patience? Sure. It also took an accommodating leadership team and investor community. It takes time to let products and quality do its job in the market, but if you are in there for the long haul, and most businesses should be, it's worth the wait. A Young Dog Learns an Old Trick: Online Customer-Specific Offers
From “Online Retailers Are Watching You,” The Wall Street Journal, November 26, 2006
Commentary By Steve Haggett
Each year, the holiday season reminds us just how creative online merchants can become as they tailor specific offers to individual customers. A recent article in The Wall Street Journal, “Online Retailers Are Watching You,” (November 26, 2006) describes how customized promotions are offered based on information tracking—where you originated, whether you have visited the site before, your geographic location, what search words you used, and dozens of other factors. Overstock.com uses over 40 customer attributes to select from among thousands of potential offers.
As scientific as this has become on the web, it is really no different than the age-old practice of customer-specific pricing. For decades, construction products companies have posted an annual price list and assigned a specific discount factor to each customer, depending upon previous volume, strategic importance, and other factors.
What any business wants to do is match the right offering and price to the right customer. A business manager needs two elements to perform this well: an understanding of customer demographics and clear pricing rules.
A basic understanding of customer demographics allows you to identify which of your products and services offers the most value to this unique customer. While this is a novelty for online retailers, who previously saw customers as simply an IP address and a credit card number, it’s basic block and tackling for business-to-business sales and marketing leaders.
Clear pricing rules allow you to ensure that similar customers receive similar prices. When two last-minute travelers with similar travel histories purchase seats across the aisle from one another, they should pay similar prices. When a large, strategic client and a new, growing customer make a purchase, they should receive different offers.
What we see as novel—and potentially ominous to some—with online data mining reminds us of the power and importance of those two business fundamentals.
By Steve Haggett
In a previous Holden newsletter, Reed asked if our readers would like the opportunity to participate in periodic informal discussions—interactive chats focused on value management and pricing. The response was immediate, and this past Tuesday, 45 of you participated in a Holden Live discussion focused on how to do a better job quantifying and selling your value proposition.
The discussion focused on the question of encouraging a cascade of value-driver questions: how to transform from an organization that aggressively sells to one that aggressively listens. The response from the participants was that quantified value models are usually strongly accepted. It’s the process of gaining the customer-specific data to populate them that creates the greater challenge. Often sales managers are trained to focus on the next sale, not to spend time building the understanding required for a value model, which is what most customers want. We discussed approaches different companies have used, such as taking sales engineers to marketing staff to the customer. These staff members are often quietly introduced as anyone from ‘corporate folks who I’m trying to help understand what goes on in the field, so they may have a few questions on fundamentals’ to ‘outside consultants.’
A survey of our newsletter distribution found that about 35% of our readership currently uses a quantified value model approach, and 65% aren’t there yet.
Companies have found that the secret to success lies in providing simple tools that enable the sales representative to understand the customer’s financial value drivers—an approach that can dramatically improve both customer trust and account profitability.
Reviews from Dr. Reed Holden
Who Do You Blame for High Costs? | If I Could Just Have a Minute to Explain | What Business Are You Really In? | Reed's Rapid Rejoinders | Good Reading!
Who Do You Blame for High Costs?
From "Still Built on the Homefront" by Timothy Aeppel, The Wall Street Journal, October 24, 2006
Commentary by Dr. Reed Holden
Do you worry about high costs? Sure, most managers do. The question is - what do you do about them? For many the solution is outsourcing – both for products and professional services. The solution makes sense, because the costs are often lower and the quality is better from offshore sources. Even little Holden Advisors has begun using resources in India to do basic research and to develop documents. In some cases, it's a good move. The first important factor is if the company doesn't incur a significant cost to moving work offshore. In the professional services business, where content moves electronically, that's a no-brainer.
But what if it means that it takes you four weeks to deliver parts to customers rather than four days? What if it means that your cost structure moves from high fixed to high variable? Each will inhibit your ability to compete in very different ways but with generally the same results – a death spiral.
If you are in a cost-cutting mode and are looking at outsourcing to a foreign shore, make sure you understand the implications. Don't outsource if there is not a clear logic for why the foreign costs are lower than yours. Many times we have seen the drive to outsourcing because higher costs are suspect, but the decision comes from information taken from really poor costing systems. Are you shocked? Good, because it often floors us, too. We also see times when it comes from bad management – just look at the automobile industry. When GM runs a plant, it costs lots more per vehicle than when Toyota runs one – even if it's the same plant. That's lousy management.
The fact is that there are a lot of US manufacturers who have found that with good systems and good management, they can produce a quality product at a competitive cost. This article talks about Bobcat, Intel, Goodyear tires, and a bunch more. They bucked the tide of outsourcing and came out ahead. Take a lesson from them. Don't outsource for outsourcing's sake – you're looking at the wrong person to blame – foreign competitors. If I Could Just Have a Minute to Explain…
From “Pet Peeves” by Sara Nassauer, The Wall Street Journal, October 30, 2006
Commentary by Mark Burton
If annoying customers is a bad idea, then why do so many companies do it? Ever wonder why… a) Car-rental companies charge so much for gas? b) Why you have to provide your account number 82 times to your credit card company? c) Why you get a four-hour window when having furniture delivered?
Believe it or not, there are often very reasonable explanations for actions that scare the customers too much. The problem is that the offending firms are amazingly inept at getting the word out. Here are the answers.
So let me see. What we actually have are: a concierge service for busy travelers, a behavioral fraud screening system, and a standard delivery service designed to keep costs down (and an opportunity to up-sell to time-definite delivery). Maybe I have on my rose-colored glasses today, but these points sound like the seeds of compelling value propositions – not annoyances. They are also examples of what happens when companies don’t look at all customer “touch points” as opportunities to communicate and deliver value. If you keep the logic behind your service and pricing decisions hidden, your customers have little reason to trust you – or to remain loyal. What Business Are You Really In?
From “Amazon’s Risky Bet,” BusinessWeek, November 13, 2006
Commentary By Mike Lawson
We all know the story of Amazon all too well: Invest in technology and distribution and the money will come. At least that was the thought by Jeff Bezos, Amazon’s Founder and CEO. The good news is that Amazon has evolved from a money pit to a viable business that actually makes money. To continue growth, Bezos is looking outside the box of being an ecommerce retailer to a business process outsourcing (BPO) and distribution company. That’s a pretty good bet if you ask me.
Many years ago, Ray Kroc made the comment that he was in the real estate business and not the restaurant business. Of course, we know how successful McDonalds is as a corporation, but the real wealth of McDonalds is in its real estate holdings – property in the busiest intersections across the world. Another example is FedEx. While many people think that FedEx may be in the shipping and distribution business, their real business is document security and peace of mind. One final example is a medical device company that sells high-value, high-price products. Through its loaner program, its real business is customization, convenience, and just-in-time inventory to surgeons and hospitals.
Bezos seems to have a similar vision with Amazon as it has mastered online retailing and distribution and has a huge network to support these two things. Why not innovate and serve customers who could use Amazon’s technology and distribution services? This positions Amazon to become an incredibly valuable BPO company with the ability to serve both end consumers as well as small- and medium-sized businesses.
Reviews from Dr. Reed Holden
Batten Down the Hatches, There's a Storm Brewin' | Caterpillar Turns Scraps into Gold | Dirty, Greasy, and Worth Its Weight In Gold | Reed's Rapid Rejoinders | Can We Talk? | Grow Revenue Without Losing Money | Good Reading!
Batten Down the Hatches, There's a Storm Brewin'
Commentary By Dr. Reed Holden
From "Investing: Is the Corporate Profit Machine About to Sputter?" by Norm Alster, The New York Times, October 1, 2006
Avast ye timbers matey. Argggh. OK, so maybe there's not a storm brewing, but at least some economists think there's a significant downturn coming in more than a few key industries. Is yours one of them? If it is, now is the time to pull back projects and constantly monitor signs of market slowdowns so you can slow down your own delivery systems and avoid the devastating use of price to stem the tide of steep declines.
Maybe your industry won't be hit, but that's not really my point. My fear is that companies didn't learn much during the downturn in the early 2000 years. You may have been trying to forget the pain, but you do remember those dramatic downturns in revenues and devastating downturns in profits. They were caused by two things. The first was the decline in markets–you can't really control that. The second was the panicked use of price to try to avoid the decline in sales–that's what causes the profits to disappear.
So, if you can't prevent the decline in sales, why not just decide to ride the storm out with at least some level of profits rather than losses? That means taking a hard look at your pricing strategy for each product and early warning systems and strong controls. Do you have them yet? Are you relaxing and enjoying the current uptick in sales, or are you looking on the horizon at the storm signs? If you are not watching the horizon, you are destined to repeat the mistakes of managers from the last downturn. It may come now or it may come in five years, but there is always a storm coming. Smart sailors know that and are ready. Caterpillar Turns Scraps into Gold
Commentary By Dr. Reed Holden
From "Everything Old is New Again" by Brian Hindo, BusinessWeek, September 25, 2006
Most of us remember Caterpillar from the 1980's. Bloated costs, labor problems, and Japanese competitor Komatsu breathing down its neck. What a difference two decades make. Caterpillar has transformed itself into a world-class competitor with high quality and low costs. They actually do whatever they can to extend the life of many of their components. Why? So they can later remanufacture the parts and sell them again. I love it!
Remanufacturing at Caterpillar is now an entirely separate division with over $1 billion in sales and it's the fastest growing division. Due to this operation, they're able to keep reselling parts and engines to customers at half the price with more profit than selling brand new components. Lots of good things come out of this effort. First, they have to develop a long-term relationship with customers–always a good thing. Also, customers are incented to develop a long-term relationship with Caterpillar so they have a way of converting old parts into renewed ones. Second, their pricing is very smart. While the renewed part might have a price of 50% of a brand new one, when the replacement part is ordered, it is billed at the full price to ensure that the returned part can be rebuilt. The customer gets a credit when the old part is received and inspected. Finally, this puts them ahead of the environmental efforts that are forcing many companies to take products back anyway. This way, Caterpillar not only meets the recycling requirements, but they make a ton of money doing it. Ya gotta love it! Editor's note: Below is a second story on remanufacturing, with different advice to consider, which is why we decided to run both.
Dirty, Greasy, and Worth Its Weight In Gold
Commentary By Mark Burton
From "Everything Old is New Again" by Brian Hindo, BusinessWeek, September 25, 2006
One of the key elements of the Value DisciplineSM is the use of low-priced flanking products. These products literally protect the flanks of higher-value offerings by giving sales a ready-made, fall-back option when customers ask for a lower price. By forcing customers to choose between the higher-value offering and a lower-price, it exposes poker players who are bluffing to get a lower price.
Leading manufacturing companies are now getting sophisticated at leveraging this opportunity. Their lead weapon is remanufactured components and products that are often priced 50% less than a new one. Since the cost of refurbishing components is also significantly lower, the sales of remanufactured components can also be quite profitable. This is why companies like Caterpillar design new components to be remanufactured and require product managers to consider remanufacturing as a part of their new product strategy.
Too often product managers get intoxicated by creating a big bang with new product launches. The really smart ones think through the whole product lifecycle and what they can do to help sales deal with poker players. How much time does your organization spend thinking about low-priced flanking products? How big is the missed opportunity?
Having just read The Cluetrain Manifesto (see this month's Good Reading), I'm wondering if now isn't the time for developing a dialogue with pricing, marketing, and sales professionals. The subject would be about the things that need to be done to develop better collaboration to achieve more effective pricing.
We get lots of good comments on this newsletter. The problem is that it is one-way. Yes, it is a way to see how we think. But, it doesn't give us a chance to see what is on your mind. And it doesn't give us a way to engage in a dialogue to provide ideas or perspective on issues you face.
Nope, this isn't another attempt at promotion, and no, we will not be using this for business development. We get plenty of opportunities to do that with our speeches and articles. This would be a no-holds-barred chance for professionals from different areas to talk about what is working for them, what isn't, and what to do about it. I'd host the chat room and would guarantee daily postings that respond to questions and comments.
I don't know if this will be a blog or a chat room. Also, I don't know how often we would run the chat–maybe we could start with a monthly one-hour chat. I will guarantee that we'll all get something of value out of this–knowledge and insights.
So, are you interested? Let me know and we'll get this going.
Reed Grow Revenue Without Losing Money
Commentary By Mike Lawson
From “A Reality Check for the Sales Staff,” The Wall Street Journal, October 6, 2006
Most salespeople want to do the right thing for their employer: sell as much of a product or service as they can at the highest possible price customers will pay. But often they don’t because of their compensation goals. Too many companies like Syngenta (before they made the changes below) reward their salespeople on volume alone without regard to earnings or profit. The result is that sales lives up to its end of the bargain, but the company continues to see losses or low profitability quarter after quarter. To help identify this problem, look for the following symptoms.
If you experience any of these symptoms, it may be time to overhaul sales compensation or perform a cost-to-serve analysis account by account. Let’s face it, the days of sales filling the role of order taker are long gone. Sales must be more responsive, must constantly communicate value to customers, and must be prepared to sell to smarter customers educated in the art of purchasing and negotiation. In addition to overhauling sales compensation, it may be necessary to perform a cost-to-serve analysis for each account. We all know that we spend 80% of our time on 20% of our problems. These could be problem customers that always have a change order at the last minute or tie up customer service resources. Performing a cost-to-serve analysis of each account will identify these problems.
If you have identified any of the symptoms above, it may be time to get professional help. Although there are some ready solutions, such as changing sales compensation or performing a cost-to-serve analysis, executing these solutions usually requires specialists. Invest in the right solutions so you can grow revenue without losing money.
Reviews from Dr. Reed Holden
Columbia University Pricing to Win: Strategy and Tactics | Kevin Rollins & Michael Dell: Pull Up, Pull Up | Hey Jeff, Forget the Shadow, Worry About Results | Location, Location, Location! – Part 2 | Taking Advantage of Your Customers | Reed's Rapid Rejoinders | Good Reading!
Columbia University Pricing to Win: Strategy and Tactics
Dr. Reed Holden has joined Columbia University as Adjunct Associate Professor to teach a four-day Pricing Executive Education course along with Prof. Noel Capon, former Marketing Division Chair and ex-McKinsey Consultant Prof. Hitendra Wadhwa. This program will be offered twice a year as part of the Executive Education Certificate of Business Excellence.
Key Benefits
Kevin Rollins & Michael Dell: Pull Up, Pull Up
Commentary by Dr. Reed Holden
From "Consumer Demand and Growth in Laptops Leave Dell Behind" by Christopher Lawton, The Wall Street Journal, August 30, 2006
Large airplanes have a special feature that warns pilots if they are too close to the ground. You might have heard the voice coming from the cockpit when the pilots are getting the aircraft ready for departure. It says: "Pull up, pull up." Pretty good advice when it's needed. We suggest that Mr. Rollins and Mr. Dell get similar devices that are triggered by declines in market share, profits, and stock price (down 60%).
What's the matter with these guys? There are two fundamental problems that they keep slipping on. The first is, of course, price. If you missed last month’s article on price elasticity, go back and read it. Go ahead, I'll wait… In a growth market, Dell was an engine of success. They calculated market elasticity and leveraged it very effectively with lower prices. The problem is that when markets mature, managers misinterpret cross-brand elasticity measures as demand elasticity – this is a serious error. According to Gartner, PC unit sales are projected to grow 10%, but revenue is going to decline 2.5%. Read that as mature/declining market. When you use lower prices expecting demand to follow, it doesn't work, because competitors match the price. Dell keeps using price as a competitive weapon, and it fails miserably. Under Mark Hurd, HP has gotten its cost house in order and can now compete head-on.
Also, HP has begun to win the feature battle. They have more appealing computers that are available in a broad range of consumer outlets. People can drop by a retail store and get their machines in 30 minutes, rather than 4 days. And, they get to play with them first. Dell is still stuck in the direct model that is not getting them close to retail consumers. This double whammy is going to cause continual decline until they start fixing the fundamental problems in their business – location and performance.
Dell's problems are reminiscent of Digital Equipment Corp, now part of Hewlett Packard. DEC was stuck in a distribution model through Value Added Resellers and was unable to evolve to a more open source model. When DEC crashed, it caused the loss of jobs and market value. Will the same thing happen to Dell? Hopefully not. Especially if they begin to listen to that voice: “Pull Up, Pull Up.” Hey Jeff, Forget the Shadow, Worry About Results
Commentary by Dr. Reed Holden
From "Five Years Into Immelt Era, GE Steps Out From Welch's Long Shadow” By Kathryn Kranhold, The Wall Street Journal, September 11, 2006. Jeff Immelt has been at the helm of GE for over five years. He has had to deal with the post-September 11th effects in the business and, yes, things are getting more competitive. Unfortunately, while revenue is up 50% under his tenure, the stock price is down 12%.
It took Jack Welch more than five years before the giant GE felt the impact of "Neutron Jack" in a dramatically increasing stock price. Maybe we have to give Mr. Immelt more time. But you have to wonder if he really has the magic formula to make GE perform like it did in the 1990's. Yes, "closer to the customer" and improved marketing are certainly great mantras, and we like to see them. The problem is that the devil is in the details, especially in a company like GE.
We agree to be patient, but you wonder if his playbook has the details he needs to be successful in this increasingly competitive global environment. Better collaboration and customer care are important things to talk about. The key is to leverage the effects of those investments with better pricing, and we have yet to see any sign that they know how to do that. We're adopting a "wait and see" approach. Yes, sales do seem to be increasing dramatically, but profit growth is lagging sales growth by a wide margin. The real trick, Mr. Immelt, is to grow both. Location, Location, Location! – Part 2
Commentary By Mark Burton
On the heels of our story last month about manufacturers giving customers the option to make price-value trade-offs depending on where their product is produced comes another great concept – give customers the option to make trade-offs based on how they consume or use the product.
With their new “Amazon Upgrade” feature, Amazon.com is doing just that. Here is how it works. When you order books included in the program, you get the option to purchase an “upgrade” to also view the complete book text on-line. The Amazon site states: “Using the Amazon Online Reader, you have permanent access to view and search the full text of your books. You can easily highlight and bookmark your books, as well as add notes and tags. The Amazon Online Reader will even let you print pages and copy text. Finally, you can access the Amazon Online Reader from any computer with an Internet connection. If you can access a computer, you can access your books.”
On a sample of my recent purchases, upgrade prices ran from $1.49 for low-priced paperbacks that cost $10 to $18.78 for a $90 text book. That’s an incremental 15% - 20% in revenues. At a marginal cost near zero that is pure profit. Many businesses would kill for margins like that – forget about them being incremental. This kind of tactic is much easier for data and information businesses, but the incremental revenue opportunities are too significant to ignore for physical goods as well as service businesses. What are the different contexts in which your customers could use your product? What are you doing to convert that insight into pricing leverage? Taking Advantage of Your Customers
Commentary by Rachel Jacobsen
From “Printing Firms Draw Complaints for Murky Billing” by Laurie P. Cohen, The Wall Street Journal, September 11, 2006.
It seems that financial printers have lost their minds, or at least their business sense. They have abandoned all standard billing practices and customer service in favor of a “clients need us, so we can take advantage of them” mentality. According to the article, financial printing companies are submitting bills to clients well in excess of initial estimates, and when asked for justification, they refuse to provide backup.
Service projects are often difficult to scope initially and they can change over time, so initial estimates are just that – estimates. However, the inability to defend a final price is inexcusable. Apparently, financial printers don’t think this common courtesy and standard business behavior applies to them. All companies should provide clients with a clear price metric (a unit of measure used to communicate the price) and commit to a concrete form of pricing. There are a number of potential price metrics – flat fee, per-user charge, time and materials, percent of revenue, etc. Companies can choose the best one after evaluating potential metrics against a number of criteria. Some key criteria that are the best price metrics:
Each criterion is not equally weighted and not all are relevant for every company. In the case of the financial printers, the ability to validate the metric may be the single most important criterion: customers regularly complained that the printers refused an audit.
Unfortunately, problems with pricing from financial printers seem to be industry-wide, so it is difficult for customers to seek recourse. As such, as shocking pricing behavior becomes more publicized and customers realize that others are being treated in a similarly unjust fashion, the financial printers industry should prepare itself for an onslaught of litigation – or competitors who make price transparent and predictable.
Will The Last One Out Please Turn Off the Lights? | 3 Words – Location! Location! Location! | Inelastic BTB Markets | Ignore the Critics: Cutting Costs is Only Part of the Picture | Stuck in Reverse | Destroying Customer Value: What Happens When Customers Talk | Good Reading!
Will The Last One Out Please Turn Off the Lights?
Commentary by Dr. Reed Holden
From "Evolve or Die" The Economist, July 29th, 2006, pp. 58 "AOL to lay off as many as 5,000 in Strategy Shift"
The big challenge in management today is parking lots. You can either be filling them up or emptying them out. Successful companies deal with evolving technologies and customer needs by innovating and evolving themselves. Those firms tend to be growing their businesses and hiring new people.
At the other end of the spectrum, AOL is joining the growing list of "technology dinosaurs" that are never able to adapt to the changing technology and needs of customers. They join 3Com, Novell, Silicon Graphics, Borland in the graveyard of companies that focused too much on cost cutting and their prior business model. In doing that, they lost the faith of their customers and employees. AOL failed to quickly adapt its business model from dial up to high-speed connection. In doing that, they took a major step back to fast competitors like Verizon and Comcast. Though coming from very different directions, both of the competitive firms focused on the flow of information rather than cutting costs. They continued to invest in new technologies and encouraged customers to adopt advancing technologies through pricing and promotion.
Maybe we should start a "day late and a dollar short" club in the newsletter for firms like AOL and those corporations whose managers were more comfortable circling the wagons while the world around them changed. The problem is that while the managers were a day late, it was the employees that ended up being a dollar short. All you need to do is look at the parking lots. 3 Words – Location! Location! Location!
Commentary by Mark Burton
From “Made In the USA? Now, Customers Get to Choose,” The Wall Street Journal, August 9, 2006
Globalization is often misunderstood as simply a means to lower costs and slow the loss of profits in painfully competitive markets. This article shows why companies that take that view are missing significant opportunities to give customers more choice and, in some cases, sell the same product at higher prices.
Giving customers a choice about where their work is done is common practice for outsourced services suppliers. The approach is now being applied to manufactured goods. The value proposition is compelling and simple. If customers want American quality and the ability to oversee production, they can have it. If they are willing to give some on delivery times and the ability to oversee product, they can get a lower price by having the product made overseas.
Most companies make this choice for customers behind the scenes. The problem is the customer may not find out until something goes wrong and their urgent order is stuck overseas. Smart companies realize that control over the trade-offs that can be made in production are useful pricing levers and can be used to build more trusting relationships with customers. Here’s a telling quote from one such customer. “The simpler stuff we did offshore; the stuff that needed more talented tool making, we did locally. To have that kind of flexibility is very important… It gives you the ability to make the most capital-efficient decision.”
Here are two questions to ponder. Do you trust your sales team and customers to have discussions that lead to better informed decisions? If not, is it really a capabilities issue or are you trying to defend a broken business model by hiding what you’re doing? Inelastic Business-to-Business Markets
Commentary By Dr. Reed Holden
We recently had a discussion with senior managers of a company that contacted us to do work with them. During one meeting, they asked if we would be willing to do "elasticity" research for them. Our answer was: "Yes, but it's probably not what you need." We could tell they didn't like the answer. Many Business-to-Business (BTB) marketing and pricing managers research the price elasticity of their markets and use the results to drive their pricing strategy. The difficulty is that the strategy can fail miserably in certain situations. Why? The reasons are actually quite simple.
But first, let’s make sure we are on the same page. Price elasticity research tries to determine a market's responsiveness to changes in price. Elastic markets are quite responsive to changes in price. Inelastic markets are not. Elasticity research informs us when price decreases are going to bring us more revenue as we see in elastic markets. And when they are going to bring us less revenue as in inelastic markets. Simple? Not really, for these three primary reasons in a BTB environment.
The first is that demand in BTB markets is derived from some downstream market. This means that demand for your products is not going to be responsive to price changes, it’s going to be responsive to how the demand in the downstream market (the customer’s customer demand) changes. As an example, General Electric sells headlights to General Motors. Demand for the headlight bulbs is "derived" by demand for GM automobiles. Any price changes in GE bulbs are unlikely to impact that demand. This makes it, by definition, inelastic. Demand at both the customer level and, generally, at the industry level is going to be inelastic.
The second reason comes down to customer behavior. Some customers will change suppliers at the drop of a hat. They don't change their volumes, something that elasticity research tries to capture. They change their suppliers, often due to price. We call that cross-elasticity of demand. If we measure cross elasticity of demand, we can determine a market's responsiveness to our changes in price, but it is unlikely that the volumes will change. That's because of the derived demand. This means that the "elasticity" we see isn't going to bring more volume into the market.
Finally, you need to include competitive behavior in the mix. Unless you include competitors' willingness to respond and likelihood of responding, you are missing the most important element of the mix. Even if a market is "elastic," when a competitor matches your price decrease, they negate any market effect. If your market is "inelastic" as most are, you've just wasted valuable resources on an elasticity study that misses most of the important elements of market dynamics. Ignore the Critics: Cutting Costs is Only Part of the Picture
Commentary by Mike Lawson
From “Leading Change From the Top Line,” Harvard Business Review, July 1, 2006
Schering-Plough, like many companies, is facing an all too familiar dilemma – should we focus on increasing revenue or cutting costs? CEO Fred Hassan has focused on increasing revenue and more importantly, on improving sales’ capability to return Schering-Plough to profitability. Making the decision to increase revenues over cutting costs is tough in today’s environment, but the overall impact on the bottom line is often much greater.
While Mr. Hassan is focusing on increasing revenue for Schering-Plough, the bigger issue is organizational transformation. Aligning corporate strategy with operations and tactics is a recipe for success. In the case of very complex pharmaceutical companies, marketing, the managed care sales force and the detail sales force [which visits doctors to influence prescriptions], must be rooted in the same go-to-market plan to effectively serve doctors and managed care organizations. Mr. Hassan has effectively forced these groups to work together operationally and tactically by outlining a clear corporate strategy. The change in the sales compensation structure also enables sales to better align with the overall corporate strategy rather than act as independent agents. Aligning organizations is no easy task, but Schering-Plough is well on its way.
Most organizations suffer from disconnects between sales and marketing. Essentially, this means that either marketing is not providing the strategy, or sales is not tactically executing within that strategy to reach the stated goals. Although each company has its specific nuances, one solution is to have marketing develop sales tools and training for sales to justify and defend value. This creates a working relationship between sales and marketing with a common goal of achieving a better, more profitable end-state for the company. Another benefit is that marketing stays engaged through the sales process and can develop products and services that better meet the needs of customers. When sales and marketing work together to accomplish the goals of the organization, revenues will naturally increase and the focus becomes growth – not cutting costs.
Commentary by Mark Burton
From “Why Bike Prices Are Shifting Higher,” The Wall Street Journal, August 1, 2006
Many of you weekend warriors may have noticed that you are paying more for the latest and greatest golf clubs, bicycles, tennis rackets, and boats. If so, you are seeing the timeless laws of supply and demand conspiring to make your leisure time much more expensive. Why is this happening? Thank the likes of Boeing and Airbus. Strong demand for aircraft means that demand for exotic materials like titanium and composites that make up the products mentioned above is leading to tight supplies and thus making that brand new TaylorMade driver that you covet that much more expensive.
Here’s the problem – the raw materials suppliers have it backwards – and the evidence is there in the report. “Zsolt Rumy, chief executive of St. Louis-based Carbon Fiber maker Zoltek Companies Inc., says he is trying to keep prices lower for bigger customers by raising prices for smaller ones, such as bike and golf-club makers, who constitute 15% of his company's business. ‘We really jack up the price’ for smaller customers, he says. He's passed on more of the 60% to 100% increases to sporting-goods customers.”
Sounds like another case of dumbbell pricing. (Feel free to interpret that phrase literally and figuratively.) What should the materials suppliers do differently? Increase their leverage with large, more price sensitive customers by reserving a significant fraction of scarce capacity for those low-volume sporting goods suppliers who invariably pay higher unit prices. In times of constrained capacity, smart suppliers use the aggregated demand of these smaller players to force their high-volume customers to pay more. Call it jiu-jitsu pricing – using the apparent weakness of less powerful, smaller customers to create leverage against the largest and most powerful customers. The end result? Improvements in key financial measures, including gross margins and return on capital employed and added leverage with large accounts throughout the business cycle. Destroying Customer Value: What Happens When Customers Talk
Commentary by Curtis Bingham
In this age where information is communicated so easily and trade/cultural barriers are disappearing, it is increasingly common to find that customers are talking to each other and sharing pricing information. Prices, discounts, and terms and conditions too often vary widely between customers because they are set according to customer negotiating skill or proximity to quarter-end. When pricing discrepancies are discovered, value, revenue, and relationships are destroyed. To prevent this destruction of value, companies must establish and rigorously adhere to value-based pricing rules.
In a recent client engagement, we discovered that US customers had joined buying consortiums where all conditions for many vendors were being shared openly. In another engagement, we learned that a group of customers in Europe were meeting regularly and sharing pricing information. In both cases, as differences were discovered the customers returned to the vendor with a vengeance to renegotiate the contracts. They wrung many more significant concessions from the vendor. As a result, trust was destroyed and value was lost—both in terms of the revenue derived from the customer as well as the overall potential value of a now disgruntled customer with a higher likelihood of switching to a competitor.
To prevent this destruction of customer value, you must assume that customers will share information and treat all of them fairly. However, this doesn’t mean that you should charge all of them the same price. Although seemingly contradictory, this differentiation in price, and other incentives can be achieved and defended with differences in product/service offerings. Different “versions” of products, services, and bundles thereof can be created at different value points and corresponding price points. For example, an enterprise software company can create two different versions: a low-value/low-price version with minimal functionality, limited number of users, and minimal technical support and a full-featured package with extensive customer support. Should customers of each package compare notes and demand concessions, you can offer the full-featured customer the option of trading down to the lower-value package in exchange for the lower price or greater concessions. When pressed for lower prices, you can almost always find a way to remove product functionality, minimize the level of service provided, decrease acceptance testing levels, shorten payment grace periods, increase minimum order quantities, etc.
To protect customer value you must ensure that a change in price, terms and conditions, or other incentives is accompanied by a change in value. In this fashion even though customers may share pricing information, the prices are defensible because the customers chose an offer best suited to their needs and one that is available to all customers that meet established criteria. Only by closely connecting price with value can you protect customer value, revenue, and customer loyalty.
Why Pick-up Trucks and Software Pricing Ought to be More Alike | New Evidence of Insanity: Price Competition in a Mature Duopoly | Deliver the Information with the Right Price Metrics | Moving Beyond Customer Satisfaction | Another Vote Against Dumbbell Pricing | Reed's Rapid Rejoinders | Good Reading!
Why Pick-up Trucks and Software Pricing Ought to be More Alike
From “Putting a Price on a Virtual Computer,” CNET News.com, July 17, 2006
By Mark Burton
This article presents a great brainteaser for pricers of all stripes. What do you do when technological advances in your industry threaten to make your pricing models and possibly your entire business model obsolete? With advances in “virtualization” technology and microprocessors that have multiple cores, this is exactly what is happening to old-line software companies.
These changes are starting to make life extremely difficult for Microsoft as the traditional model of charging per user and/or processor becomes less relevant in this new world. Their reaction has been cautious and at times has unnecessarily restricted the ability of leading-edge customers to take advantage of technological advances by limiting the numbers of processors, servers, and virtual machines that can legally run the software.
Often the best way to solve tough problems is to look for other, simple parallels that exist in entirely different contexts. A few years back I bought a full-sized Ford F-150 pick-up truck. My “practical” wife pointed out “There is no way that we are going to really use all of that truck.” Well, maybe I don’t always, but my father-in-law, brothers-in-law, neighbors, and co-workers sure push the truck towards “full utilization.” Now picture what would happen if instead of owning the truck, I “licensed” it. I might have to get permission from and/or pay Ford for every new or currently unauthorized use of MY truck. You get the point.
When you start putting burdensome restrictions on how customers can use your products in order to protect a business model whose time is coming to an end, something is seriously wrong. Maybe Microsoft CEO Steve Ballmer should buy a pick-up truck. New Evidence of Insanity: Price Competition in a Mature Duopoly
From "MD Cautions of Revenue Drop as Intel Cuts Prices" by Don Clark
By Dr. Reed Holden
In last month's newsletter, in his article "Staring Down the Giant," Mark Burton gave kudos to AMD in how they are competing on performance and value in the mature home computer market. Their dual core and 64-bit processors have, until recently, been far ahead of Intel in performance and consumer appeal. It's no wonder that they seem to have the same shelf space as Intel in some of the of the more popular computer retailers. Then why have they just announced declines in revenue? Well, Intel, the master of the value sell has adopted a scorched earth policy by dropping prices, forcing AMD to follow in a mature industry.
This is worth a few comments. Usually, when someone says that they have an irrational competitor, we find that it's not true. In most cases, competitors in the same market view each other as irrational for their price competitive behavior. This comes from poor external communications and discipline from most competitors in a given market. In the semiconductor market, however, most analysts agree that the current price competition is nuts since all it does is depress overall market price levels and depress the stock prices of both AMD and Intel.
So what should you do when a competitor is irrational? First, make sure you are right. Second, take the prices that they are giving to your customers and feed them back to their own customers so that their pain is worse than yours. Third, adopt a neutral pricing strategy that mirrors what the competitor's price strategy is and keep trying to compete on relative value. Finally, adopt a market pricing communications approach that agrees with the analysts. In no case should you try to out duel a competitor, especially when they dominate the industry.
I guess this is a good game to watch, but it is sad to see that the craziness is continuing in this business. Deliver the Information with the Right Price Metrics
From “Copyrights and Wrongs,” BusinessWeek, June 22, 2006
By Mike Lawson
Information providers come in many forms and cross many industries. But one thing is clear: protecting the value of intellectual property is only one part of business success. The other part is having a sustainable competitive advantage that creates demand for your product, information or service. Too many companies, like the Recording Industry Association of America (RIAA), are too focused on stopping behavior and innovation rather than creating price metrics where everyone wins.
Any type of information that is copyright protected must have two things to serve customers the best way. The first thing is the right price metric. In the case of the RIAA and XM Satellite Radio, establishing the right price metrics for content would solve the problem for both groups. The key is to identify the price metric to capture the value you are delivering through your information, whether it’s music, ratings, investment algorithms, specialized information, or other data services. Typically, the right price metric will allow a company to charge based on how the information is being used. In the case of XM Satellite Radio, a metric should be designed to allow XM Satellite Radio and users the capability of storing songs or information. In this case, the right metric is clearly a “pay for use” where users would pay a small fee, maybe as low as five to ten cents per play. The technology exists to permit this approach, but the RIAA is blocking rather than embracing it.
The second thing a company must do is use versioning to capture what customers value. In this example, RIAA could have one version of service (or offering) that allows customers to store songs through XM Satellite Radio. In another version (or offering), RIAA would not offer that option in a package. In both cases, the RIAA is protecting the interests of the recording artist, XM Satellite Radio is getting paid for the information and service it provides, and the customers who really value the information or service pay for it. Moving Beyond Customer Satisfaction
From "Client-Satisfaction Tool Takes Root" by Kathryn Kranhold, The Wall Street Journal, July 10, 2006
By Dr. Reed Holden
We have long agreed with Fred Reichheld, author of The Loyalty Effect, that customer satisfaction measures are poor predictors of whether or not a customer is going to buy your product again. They are terrible predictors of whether or not your pricing is any good, especially when you are asking a purchasing agent.
Major firms such as General Electric and American Express have begun using more effective measures of repeat purchase and are spending lots more time talking to customers to find out what dissatisfies them in their product approach and business operations and are using that feedback to improve both their performance and their customer retention.
If you use customer satisfaction tracking or have a market research company that is trying to get you to use one, this is a good article to go back and read, because it points to a much better way. Another Vote Against Dumbbell Pricing
From “JetBlue Earnings Ascend on Higher Fares,” Forbes.com, July 7, 2006
By Rachel Jacobsen
Major airlines have dumbbell pricing - they charge higher and higher prices to their loyal customers, often business travelers, and they charge much lower prices to price sensitive customers, often vacation travelers. The net result of dumbbell pricing is a full aircraft but with lower total revenue as their high-price customers move to airlines that take better care of them (often at lower prices) and their “value mix” falls apart.
This pricing tactic is also preventing the major airlines from taking advantage of price increases. As we pointed out in the May newsletter, price increases land mostly on the loyal business traveler and increases their defection rate. By avoiding dumbbell pricing and employing a simple tiered price structure with a reasonable range between the highest- and lowest-priced ticket, JetBlue is not only effectively raising prices but also capturing these increases in its profits.
JetBlue has raised prices on all tickets and at the same time is experiencing increases in passenger traffic. JetBlue’s across-the-board price hike maintains a tight range between the highest- and lowest-price tickets, so the financial hit is felt by all travelers, not just business travelers. All passengers see that the fare hikes are justified by the rising fuel costs as well as JetBlue’s continued service to major airports with low-price airfares on new airplanes with better seats and services. Even after the fare hike, the highest-priced JetBlue ticket is still a low-price ticket at the major airlines, so defectors are minimal. Whether the increase in passenger volume is due to defectors from major airlines or comfortable leather seats (probably both) isn’t clear, but the bottom line results are. Increases in price and volume combined with a simple fare structure provide a double hit to profitability. Another vote against dumbbell pricing. Well done, JetBlue.
Staring Down the Giant | The Market Share Trap | The Market Share Trap | Innovation is More Than a Product Focus | Reed’s Rapid Fire | Good Reading!
From "AMD Sets a Course for 2008," By Tom Krazit, CNET News.com, Published on ZDNet News: June 1, 2006
Commentary By Mark Burton
How do you take on a giant? It would be trite to say “carefully” but perhaps a better answer is “with resolve.” In either case our hats are off to AMD for the way they have managed a never-ending series of competitive confrontations with that 800-pound gorilla named Intel over the past couple of years. Through a series of technological innovations, smart capital investments, and stronger sales and marketing they have, at times, made Intel look ordinary. What caught our attention in this particular article, however, was not the details of the announcement of a new laptop chip. It was the communication about their competitive intentions and capacity that really jumped out.
So what was the “money” quote? "We are fully positioned to service one-third of the market by 2008," Daryl Ostrander, AMD's vice president of manufacturing, said at the meeting. "We will manage, as we always do, these capacity additions. We aren't going to build too much, we aren't going to build too little." This is a terrific example of how to calmly communicate your capabilities and intentions in a fiercely competitive environment.
Key pieces in implementing changes in strategy and positioning are effective communications planning and the skills to carry out the plans. What does this look like?
Daryl Ostrander and AMD have clearly gotten the message.
From “Major Airlines Fuel a Recovery By Grounding Unprofitable Flights,” The Wall Street Journal, June 5, 2006
Commentary By Nelson Hyde
Too many companies in mature, slow-growth industries become obsessed with protecting their market share. They do so at great peril. Legacy airlines have recently learned this, and by redirecting themselves they are turning a profit again.
On the surface of it, greater market share should mean more profits, more market power, and greater cost leverage – especially in scalable commodities and high, fixed-cost industries that can produce more revenue per capacity unit. But in fact, pursuing or protecting market share for its own sake can be self-destructive. For years that strategy triggered massive rebating in the auto industry, destroying profitability and contributing to GM’s flirtation with bankruptcy. In airlines it led to aggressive price wars and $40 billion in losses since 2001.
What good is market share if it doesn’t make you more profitable? Or if you give away in pricing the very gains you make from scale or leverage? Recognizing this, airlines are now focusing on profitability, not market share. They are closing unprofitable hubs and taking out capacity by systematically reducing the number of planes and flights they fly.
This works because customers in slow-growth industries are price inelastic. That is, they aren’t that responsive to changes in price. This means that price wars don’t generate much new demand. If pricing can’t grow your demand, the smarter strategy is to manage the supply side: take out excess industry capacity. In mature industries, bigger is not always better, and more market share is not always profitable.
If you really want market share, you can always get it – just ask your sales force how to grow market share, and they will tell you a million ways you can drop your price. But if it’s profitability you want – ask your sales force for that instead. Innovation is More Than a Product Focus
From “HP has High Hopes on High End Moves,” Financial Times, June 4, 2006
Commentary By Mike Lawson
We are cheering on the changes that seem to be embracing HP’s tagline: invent. There is renewed focus on innovation and HP is finally developing new ways to meet customer needs now that the printer market is saturated and profit margins are continuing to drop. While new products are being developed at HP, there is also focus in developing different outlets for printing, such as in-store photo printing, networked printers/copiers, and the acquisition of Snapfish.
Innovation is much more than developing new products. It’s about developing new ways of reaching customers and re-engineering existing processes to better meet customer needs. So just by making a few small changes at HP, Vyomesh “VJ” Joshi (who runs HP’s imaging and printing group) is meeting the five percent revenue growth goal for his business line. While new products account for some of this growth, finding new outlets for existing products is where Mr. Joshi is having the biggest revenue impact.
A great practice for companies is to focus on the other “P’s” of marketing with innovation rather than just products. Determining new targets, new pricing strategies, and outlets for products are just as important as products themselves. When marketing in organizations become strategic and deal less with day-to-day issues, this becomes very possible. The trick is to keep sales focused on the customers of today and keep marketing focused on the customers of tomorrow. This is what allows companies to innovate in areas other than just product development. Cost Increases Lead to Profits in the Airline Industry
From "Major Airlines Fuel a Recovery by Grounding Unprofitable Flights" By Evan Perez and Melanie Trottman, The Wall Street Journal, June 5, 2006
Commentary by Dr. Reed Holden
I've been hard on the airline industry lately, unfortunately with good reason. For a change, they seem to be doing something right. With increases in fuel costs, the airlines have had to work harder (aka, manage better) to try to figure out where they can make a profit. Guess what, they are finally able to get price increases to stick, even with the discount carriers who are under the same cost pressures.
Why? Because cost increases, especially ones that hit all competitors the same are a great platform to a) push through price increases and b) encourage other competitors to do the same. The first action is easy – customers know that your costs are going up and expect to get the increases. If you hold prices, you don't accomplish anything unless the increases represent a quick spike that you don't want to take advantage of. The second action is a little harder, and you have to work hard to stay on the legal side of public announcements. It takes a few press releases and well-placed speeches about your concern that costs are going up and that you are going to raise prices to reflect those cost increase.
Now, here's the secret. Raise prices a little bit more than what you raised your costs. If you do that, you can actually dramatically increase profits and it's all due to higher costs.
Recommendations from Dr. Reed Holden
Dell: Violation of the "Law of Holes" | Playing Innovation Roulette | Innovators: Understanding the Value DisciplineSM | Theatre of the Absurd Continues: Airline Cost Increases Lead to Price Discounts | Good Reading!
Dell: Violation of the "Law of Holes"
From "Dell Pares First-Quarter Forecast as Price Cuts Fail to Spark Sales" by Christopher Lawton, The Wall Street Journal, May 9, 2006
Commentary By Dr. Reed Holden
Surprise of Surprises. Dell profits are down because their price cuts have failed to spark sales of personal computers. They must be the only company in the US/European PC business that thinks they can still do that. Understand that their fall from fame has been a slow affair, but the signal of it came last quarter when profits weren't what they expected.
Dell is learning what most other high-tech firms learned in 1999 & 2000 – that price cutting works if you have a cost leadership position in growth phases of market cycles. If you a) don't have the cost leadership position and/or b) the market slows down, you need to switch from a penetration prices strategy to a neutral one. Period. It's no more complex than that.
How can you tell? Look at the graphs of price discounting vs. gross sales growth. When one line starts heading up (discounting) and the other starts heading down (sales growth), it shouldn't take much more to signal that it's time to at least start thinking about changing your strategy. Dell's responses to the market are beginning to sound a little too familiar from quarter to quarter. CEO Kevin Rollins says they are "accelerating price adjustments." What does that mean? When firms move to neutral pricing strategy, letting other firms know is a good idea. Confusing statements not only fail to do that but they actually will increase the price discounting by other firms.
Dell is guilty of the "Law of Holes" – that is, when you find yourself in one, stop digging. And this is to a firm that five months ago almost, yes, almost got the Value DisciplineSM of the Month Award. Ah, the fast pace and complexity of business today – don't you just love it?
From "Tech Firm Spending Too Much?," The Wall Street Journal, May 10, 2006
Commentary By Mark Burton
One of the most talked about management topics right now is innovation. Hardly a day goes by without some prominent publication featuring exhortations from consultants and academics about how the key to break-away success is the ability to out-innovate the competition. Thankfully, our financial markets have a wonderful way of keeping companies that buy into the latest pronouncements of management gurus honest – it’s called your stock price.
This Wall Street Journal article seems to portray a world that is being unfair to companies that have been known as innovators such as Microsoft, Amazon, and eBay. First they were criticized for not spending enough money to stay ahead of the competition. Now their share prices are being depressed because many investors feel as though they are spending too much. What gives? In general, investors will value investments in the business on the basis of management’s perceived ability to convert those investments into returns – and to do so more effectively than the competition. Given this perspective, we can see why the firms in this article are getting squeezed and Google, a firm with a strong recent track record, isn’t. What has Google done that the others haven’t? They continuously roll out smaller, revenue-producing innovations that cover their investments in longer-term, “big bang” products and services. One look at their corporate history vividly brings this point home.
What lessons can be taken from this squeeze? First and foremost, if your company has been consistently out-innovated by the competition, you better check your forecasted returns on new product and service development programs. Wall Street may very well continue to punish you for past failures until it’s blindingly obvious that you have mounted an effective counter-offensive. Second, recheck your sources of ideas and processes for bringing innovations to market. Here is a quick checklist:
Companies that really understand value to the customer can absolutely tear through this list. They get more and better ideas to market more quickly and more successfully – and Wall Street sees the wisdom of their ways. Innovators: Understanding the Value DisciplineSM
From "The World’s Most Innovative Companies," Business Week, April 24, 2006
Commentary By Mike Lawson
Creating and maintaining a competitive advantage is critical for a company’s survival and overall profitability. Innovation is the way to create this competitive advantage, but today, innovation means much more than developing new products. Innovation is about improving internal processes and developing creative ways of competing in the market place. Companies such as Apple, BMW, and Southwest have figured out the trick to innovation that we all can learn from.
Apple has gone beyond delivering financial value to customers and focuses on the overall user experience. Not only did Apple develop an easy-to-use device, but it did an exceptional job branding the iPod, negotiating with music companies to sell content online, and developing the right price metric to sell songs online. The iPod by itself still would have created a revolution in digital music, but Apple’s other innovative steps made it a clear leader in the MP3 player market. Through combining different types of innovation, Apple was able to create Valuable Customers (a core component of the Value DisciplineSM).
Getting cross-functional teams together to design products and services is a key to success for any company. BMW does this when developing new car models and it is clearly successful. In the Value DisciplineSM, we call this Transformation since all parts of an organization are coming together to tie competitive strategy, execution, and valuable customers together. Companies need to operate across organizations and break down functional silos. Although we typically see silos between sales and marketing in most companies we work with, innovative companies clearly have an advantage in that everyone in the company is working toward a common goal.
Understanding the marketplace and developing the right competitive strategy is another focus of innovation. Although several low-cost airlines have entered the market to compete against Southwest, it continues to innovate and create Operational Leverage (another component of the Value DisciplineSM) in the marketplace. Southwest began with a great business model, but its continued innovation to decrease aircraft costs and improve operational process efficiencies enables it to maintain a strong competitive advantage in the airline industry.
The final piece of the Value DisciplineSM which ties to innovation is Execution. Determining the right price metric, who the target market is, and developing competitive responses are key to executing well. Innovators have figured this out, but more importantly they understand that innovation is more than having a new product or service – it’s about tying the pieces of these disciplines together for the best and right marketing strategies. Theatre of the Absurd Continues: Airline Cost Increases Lead to Price Discounts
From "High Oil – Low Prices," Fortune, May 15, 2006
Commentary By Dr. Reed Holden
You have to love the absurdity of dumbbell pricing in the airline industry. Why? Well, listen to this latest flash. Everyone knows that fuel costs are going through the ceiling and the natural tendency is to raise prices. Great idea? Sure. Problem is that the airlines will be raising prices to their high-value customers, business travelers. And what are we going to do? Head over to Jet Blue and Southwest where the prices are lower and the services are often better.
The result to the majors like Delta, Continental, and United will be to reduce their load factors which will trigger the opening up of more low-cost seats. So, you see, raising prices will actually open up more low-cost seats in the majors. Higher costs should lead to higher prices, but if it drives high-priced business out and forces the sales of low-priced seats – what’s the sense. Wouldn’t they be better off, then, leaving prices just the same? What would it take to make the price increases stick? First, the airlines need to dump the dumbbell and get high and low prices closer together. Second, they need to get more credibility with their customers. Finally, they need to do a better job of understanding price sensitivities and model the net results. Wishful thinking? Ok, sure. We expect to be able to report on more of this lunacy in the coming months.
Recommendations from Dr. Reed Holden
Mark Hurd: Increase Your Pricing Power with Uniform Global Pricing | Bold, New Profits: Extracting More Value from the Customers’ Value Chain | Value Competition | Good Reading!
Mark Hurd: Increase Your Pricing Power with Uniform Global Pricing
From "Hurd's Big Challenge at Hewlett-Packard: Overhauling Corporate Sales" by Pui Wing Tam, The Wall Street Journal, April 3, 2006
Commentary By Dr. Reed Holden
Kudos to new HP CEO Mark Hurd for spending time listening to customers (over 400 in the past year) and developing decisive actions for solutions. What did he hear? A whole bunch of things. First, customers didn't know who their reps were, and when they did, they didn't spend much time with them (roughly 33%). Second, sales planning is a nightmare with over 30 different software packages used in tracking deals. Yikes! Third, salespeople and the company as a whole are slow to respond to customer requests. Finally, global customers are getting very different price quotes in different parts of the world.
I give him lots of credit for moving swiftly to solve the first three problems. What did he do? First, he eliminated three levels of management to simplify the process and had remaining managers eliminate a lot of their meetings. Does that sound like a familiar problem? Second, he placed the sales function under each of the business units to give the business units control. That's a terrific move since, as we often mention here, sales is tactical and needs direction and support from the strategic side of the business unit. Third, he was willing to touch the "third rail" of selling – compensation systems. “Gutsy move Maverick” – and a necessary one. Tying compensation systems to profitability gives salespeople some skin in the profit game. Chances are he will find out that it's not enough but a terrific first step. Finally, he forced all managers to adopt a single sales software system. That guarantees that the process will be used effectively in the organization.
Hey? Wait a minute! What about the pricing? No comments on how he is fixing that. Yet, this is perhaps the most important element of regaining customer trust. Pricing that varies widely across markets is terrific if you don't have global customers and/or customers don’t care what the prices are in different markets. The ubiquity of information on the internet has made the later unrealistic, yet marketers and pricers have failed to respond by pushing global uniformity in prices and pricing policies. Most favored nation's clauses in contracts can help solve the problem, but suppliers are hesitant to put them in a contract, because they like to lift prices in high-value markets. The problem is that customers become alienated and don't trust their vendors. The net result: they become price buyers.
To solve their final problem, HP needs to bite the bullet and adopt uniform global prices. Now that's a problem that Mr. Hurd should move on quickly. Extracting More Value from the Customers’ Value Chain
From “Tunnel Monsters at Work," Popular Science, April, 2006 (Online article…)
By Curtis Bingham
Many companies focus somewhat narrowly on their key product—adding to it bells and whistles of sometimes questionable value in hopes of outperforming competitors. What is needed instead is a more detailed focus on the value customers derive from their products, i.e. ways in which customers use the products, the situations or conditions leading up to or following the use of the products.
Robbins manufacturing makes the largest tunneling tool in the world at 47 feet in diameter. Robbins has examined their Value Chain and produced a suite of complementary products that adds tremendous value to their customers from project start to finish. Their primary product is the fastest cutting tool in the industry at 22 feet per hour. While this may be a competitive advantage, the competitive advantage of the system as a whole is made significantly stronger due to the fact that they delivered additional products that shorten setup times,and significantly reduce downtime due to innovative tool design, waste removal mechanisms, and even end-of-project assistance.
From the beginning, Robbins’ engineers are involved in the route and logistical planning of the tunnel, ensuring realistic tunnel design according to machinery constraints—resulting in more accurate cost estimates. Using Robbins’ simplified setup methods, tunnel project engineers estimated they were able to begin drilling in one-third the time budgeted. Robbins designed an easily replaceable, integrated cutter system on the face of the boring tool to dramatically reduce downtime and associated costs. Waste disposal is a huge issue that could result in massive downtime. To address this area of the value chain, Robbins has created innovative, flexible conveyer systems that unroll behind the cutting tool allowing it to move much further without requiring work stoppage. In some cases, workers would have to follow behind the tunneling tool and drill holes in the ceiling into which concrete is injected for strength. You guessed it—the holes are now bored in the ceiling by the tunneling system, further saving manpower, time, and costs. Finally, at the end of the project, Robbins has helped companies recapture a portion of the huge capital outlay by brokering the sale of used machines.
When was the last time you looked at your customers’ value chain? Like Robbins, can you earn additional revenue by helping them with their design processes? Are there steps in their processes that you can do to enable them to either generate additional revenue or minimize expenses? Through examination of the value chain, you can extend your competitive advantage beyond your core products, locking in new revenues that competitors cannot touch. When a “Pricing Problem” Isn’t
From "Why the Price Must be Right," The Financial Times, March 29, 2006
Commentary by Mark Burton
Software is perhaps one of the most difficult offerings to price effectively and this article from The Financial Times makes it clear why. The struggle of industry leaders to get pricing right was made abundantly clear a few years back when PeopleSoft was fighting Oracle in court over the latter’s unwanted acquisition offer. The Wall Street Journal ran a front page story that detailed ugly facts such as average discounts on licenses of 60% - 70% and end-of-quarter dealing that typically drove 80% of sales volume.
Despite the title, the article isn’t about pricing per se. The Financial Times details a number of sources of customer frustration. For example:
The result is that these customers do not see adequate return on their investment.
So how does the software industry fix its “pricing problem”? By not trying to fix pricing. What these examples represent is a profile of an industry that is struggling to consistently deliver good value to its customers. This is what is leading to tough negotiating stances on the part of customers. Until the concept of value-to-the-customer is internalized and then manifested in products that deliver the levels of value that customers want, the way that they want it, customer unhappiness and tough price negotiating will continue.
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Cable Programmers Cry About Tiers | The Danger of Smoking Guns | Value Competition | Has Dell Truly Reached its Breaking Point? | Oh No, Not Again! | Do You Trust Your Salesperson? | Good Reading!
Cable Programmers Cry About Tiers
From “How We Pay For Cable is About to Change,” USA Today, March 1, 2006
Commentary by Mark Burton
Many cable and satellite programmers have been vocal in their opposition to the concept of offering unbundled programming. They appear to be fighting the inevitable. The issue is whether customers should be able to choose individual channels or, as some programmers claim, get the “good deals” with ever-growing expanded basic channels bundles. A look at three key areas of the Value DisciplineSM: offering optimization, customer profiling, and operational leverage will help us understand why.
Bundling is a tool to maximize revenues from customers that place different levels of value on products and services. The idea is simple: package related elements of the offering together and offer a discount relative to a la carte prices to get customers to willingly buy more than they might otherwise. Where the programmers have gone wrong is in forcing consumers to take things in the extended basic bundle that most don’t want. This “defensive” bundling only serves to alienate customers who will defect when a quality, unbundled option comes along. That’s STRIKE 1.
Why would programmers force customers to take something they don’t want? Because it makes programming appear more valuable to advertisers. What do advertisers want? Customers. What do programmers sell them? Eyeballs. By inflating the expanded basic bundle, the number of eyeballs (and prices) increase. Problem is that what really matters is actual response and revenue generated from each incremental increase in response. Programmers don’t want to have this value conversation, because they are worried that they can’t sustain current pricing. STRIKE 2. A basic tenet of Customer Profiling tells us that pricing power derives from a fair assessment of value.
Next, when you look at Operational Leverage and the programmers’ cost-based argument that without the marginal channels, prices for popular channels will go up as costs are spread over fewer channels. By making this argument, it is clear that the programmers are using average costing. STRIKE 3. If they were using incremental costing, they would realize that the lead channels (think ESPN) do cost more than derivative channels (ESPN II).
What’s the solution?
This is the short-term future of television. The key question is whether incumbents will embrace it before new entrants or whether the new entrants will be allowed to play the game that Sprint and MCI played in bringing down AT&T. This could get interesting.
From "Battling for the Eyes of Texas" by Jim Morrison in Business Week, March 20, 2006
Commentary By Dr. Reed Holden
Price competition in a mature market is nuts. Why? Simple – price competition works in high-growth markets because there are plenty of new customers coming in to increase sales and help drive down costs. In mature markets, there are no new customers – the very definition of a mature market. With no new customers to either increase sales or drive down costs, competitors need to stop competing on price and compete on value. That's exactly what is happening with the consolidations in the telecommunications business. First, as a result of fewer competitors, it's easier for them to all see the damage they are doing with price. Desperate competitors that used to compete on price to survive get swallowed up by aggressive players trying to establish a national footprint. They are the players that have learned about the dangers of price competition in a mature market.
The net result of all of the consolidations we're seeing should be reduction of price competition and increase in value competition. Verizon is testing its roll-out of high-speed cable. Cable? Yup. It's all part of their desire to be the only communications wire going into local households. And, in this case, it will be high-speed fiber optic cable. Cable that is capable of not only delivering high-quality phone service but TV and movie services as well. This will be the battle of titans – like Verizon and SBC, now AT&T, who is also in the process of swallowing up Bell South. It's interesting to note that Verizon is testing its new service in Fort Worth, Texas – the back yard domain of the new AT&T.
I don't know about you, but I'm going to enjoy this battle, because the net result will be better, faster internet service, cheaper long distance calling, and finally, combined bills for all of the household communications. And the movies will be glorious – lots of them and whenever we want them. I think I'm going to stock up on popcorn! Has Dell Truly Reached its Breaking Point?
From “It’s Dell vs. The Dell Way,” Business Week, March 6, 2006
Commentary By Mike Lawson
Everyone knows that Dell is successful due to their low costs and direct sales strategy, but it’s clear that Dell needs to change how they do business. Sales growth is projected to be 6%-9% in the next quarter – not even close to the 16% growth noted a year earlier. To continue to grow, Dell must use multiple sales channels and use vendors other than Intel and Microsoft.
Markets go through natural cycles and strategies must change with the cycles for companies to survive. Dell’s strategy was simple – gain market share through a penetration pricing strategy (this means using price to gain market share) and use a different sales channel to gain operational efficiencies. The result: Dell became the low-cost provider in the marketplace and largest computer manufacturer in the world. However, things are changing as Dell has saturated the target segment where it is most effective.
For Dell to maintain profitability, it must figure out how to serve several segments in the marketplace. The way to do this is to use a combination of skim, neutral, and penetration pricing strategies. Just to review, skim pricing is typically higher and is used to serve higher-value segments in the marketplace – most effective in emerging markets. Neutral pricing is used to charge prices similar to the competition. Penetration pricing is used to gain market share at low prices.
Although companies can use just one pricing strategy, the most successful companies have figured out how to use a combination of pricing strategies to better serve and further saturate the marketplace. Some ideas for Dell would include introducing flanking products – this could be the difference between an Intel or AMD processor in the computer. Other ideas would include making high-value components only available through one sales channel and not another.
From “Northwest to Charge Extra For Aisle Seats” by Susan Carey in The Wall Street Journal, March 14, 2006
Commentary by Dr. Reed Holden
In last month's newsletter article Nickel and Dime Pricing of Services Leads to Alienation and Price Buying – Go Figure, we talked about how pricing for some services leads to alienation of loyal customers and turns them into price buyers. Now, Northwest Airlines is trying to do just that by charging $15 for those who want to sit in the roomier front and exit rows. What? Isn't that the domain of the loyal customers who are in the frequent flier program? It used to be but is no longer.
In my view, businesses should be adding services to loyal customers, not taking them away and charging for them. Certainly, this is a desperation move by an airline that is trying to cut all possible costs, renegotiate bad contracts, and emerge from bankruptcy a leaner organization. The problem is that their planes will also be flying lighter – read that as fewer loyal customers.
When are companies going to learn to take care of their loyal customers? The road to success is littered with the burnt out hulks of the businesses that forgot this rule. Do You Trust Your Salesperson?
By Dr. Reed Holden
I recently went to our office supplies store to buy a new printer. When I was checking out, a salesperson came up to me and told me that a) I need to purchase a special cable and b) that the ink cartridge supplied would only print a few hundred copies. Since I trusted the brand name of this store, I added both items to my purchase. When I got home, I found that the old printer cable worked just fine. Also, the printer has produced well over two hundred copies and the original cartridge seems to be doing just fine.
So what was going on in that transaction? First, it was end of the month and the salesperson was probably trying to make his sales quota. Second, the store sells the printers with no profit to drive more store traffic. Where do they make their money? Selling the peripherals like cables and ink cartridges. They most likely train their salespeople to pack those items onto every sale they can. But now I no longer trust their salespeople. Big deal? Maybe not if I was a single consumer buying a printer – but I'm not. I'm in a small company that purchases in the mid five figures from this company.
What's going to happen in the future? We will probably continue to buy from them. After all, they are quite convenient. But the next time a salesperson recommends something, I’m certainly going to do a gut check on his motives and may wait until I get home to see if I really need what he or she is recommending. And now I'm going to be more price sensitive.
Here's a question for you. Do your salespeople do this with customers? It only takes once but more than likely these types of things are going on all the time in your business. Any time a salesperson or a manager’s advice is not in the best interest of customers, it undermines trust. That causes customers to become more price sensitive. Is it as simple as that? Yup.
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Nickel and Dime Pricing of Services Leads to Alienation and Price Buying | The Danger of Smoking Guns | Up Against the Wall | Capturing Obscene Profits from Competitors in Underserved Markets | It’s Not Just the Boss Who Deserves the Big Picture | Oh My: How Did We Get Like This? | Good Reading!
Nickel and Dime Pricing of Services Leads to Alienation and Price Buying
From "Air Cargo Customers Complain About Carriers' Surcharges" by Daniel Michaels, Mary Jacoby, and Melanie Trottman
Commentary by Dr. Reed Holden
I suppose that the same consultants who helped commoditize the banking business back in the 1980's are now doing the same thing in the air cargo business. For those of you who don't remember, the banking crisis of the early 1980's led banks to do everything they could to improve profits. The focus of those efforts, often recommended by outside consultants, was to significantly raise fees for services. The net result was predictable. The banks made some short-term profits, but they also alienated loyal customers and forced all customers to become price oriented and switch their business to the best deal of the week. This caused the commoditization of the banking business.
Here we see the same thing happening in the air cargo business. It is brutally price competitive. The carriers have learned that they can be competitive on rates and earn a profit if they tack on an array of fees for fuel, inspections, and a host of other things. This is a great strategy if your total focus is on price buyers. Unfortunately, like most businesses, the air cargo companies do have a range of loyal customers who feel like they're getting a bad deal with the current approach.
What's the solution? Simple. Have a dual services bundling approach that has a low price, bare bones offering and a higher price full service offering. This prevents alienation of loyal customers and also gives salespeople some choices when selling to Poker Players to better ferret out their position. Believe it or not, in most markets, there are more value- or relationship-oriented customers than price oriented ones. It often doesn't seem like that, because suppliers do so many things like tacking on surcharges that cause customers not to trust us. When that happens, all customers act like price buyers. We trained them!
By Dr. Reed Holden
No, this is not a jab at Dick Chaney's recent hunting exploits on the fields of Texas. It is a warning to companies who want to establish improved competitive information management systems to blunt the impact of price-oriented poker players in mature markets. The risk of a system like this is that the resulting price stabilization among main competitors becomes so successful that it attracts the attention of the Justice Department.
Successful competitive information systems move competitors to a neutral pricing strategy and effectively stop them from competing on price. What also happens is that they begin to adopt similar prices for products and services. An example is what has happened with the air carriers in the above article. This is called “conscious parallelism”—that is, competitors move with prices in parallel or unison. This is not illegal, but it does often cause the Justice Department to take a close look inside the various competitors to see if there is a “smoking gun” or illegal activity, like having direct discussions with competitors, even if it is done at low levels of the firm. The problem is that historically, conscious parallelism does come from direct, and therefore illegal, discussions with competitors.
To protect against the treble damages that might result from illegal activity, companies in mature markets must be especially vigilant through policies, procedures, and training to prevent illegal anticompetitive behavior. Something as simple as a casual comment between two competing salespeople at a health club can lead to company-wide charges, if it is not prohibited by policy and reinforcement training controlled by reporting systems. Any "smoking gun" that is not controlled by policy can be the basis for a successful suit against a company. Capturing Obscene Profits from Competitors in Underserved Markets
From “A Cheaper Way To Refill Your Printer,” The Wall Street Journal, January 26, 2006
Commentary by Curtis Bingham
In the November 2005 issue of our newsletter, Mark Burton described Black Gold: the $182,784-a-barrel market for inkjet printer cartridges. Given that companies such as HP, Lexmark, and others actually use huge profits on cartridges to make up for losses in the sale of printers, Mark identified a number of ways in which manufacturers can withstand or neutralize the success of low-cost competitors.
An interesting question is how can you effectively compete from the low end with entrenched competitors? This article describes how inkjet refill technology is becoming a viable alternative to HP and other high-priced cartridges. For example, Walgreen is rolling out in-store ink-refill services. Also, OfficeMax and Office Depot are piloting refill services. Similar services are beginning to show up in malls, hotels, and smaller storefronts.
What lessons can we learn from these low-end competitors to ensure success and effectively compete against established manufacturers?
Competing on value doesn’t necessarily mean avoiding price competition. Price buyers value low-cost products and services. Unfortunately, price alone won’t establish the position. Through savvy marketing and positioning, sellers can leverage a low-end beachhead to greater success. It’s Not Just the Boss Who Deserves the Big Picture
From “Giving the Boss the Big Picture,” Business Week, February 13, 2006
Commentary By Mike Lawso
In “Giving the Boss the Big Picture,” the main premise is to give senior executives visibility of real-time information to enable them to better manage their business. CEOs such as Larry Ellison and Steve Ballmer use dashboards religiously to keep up with real-time changes in their business, but this is only part of the story. What needs to happen is that the entire organization needs access to real-time information to make the best decisions for the organization. Transforming strategy into tactics is how to do this, but it includes sharing information across the entire organization.
Having information to make decisions is critical in today’s business environment. Many managers make decisions with outdated and unreliable data while other managers just do not know what key performance indicators to use. Having reliable data that is almost real time can take care of this problem for managers. While using a dashboard may give senior managers the ability to have up-to-date information for decisions making, dashboards must be used at every level in an organization to be effective.
Today’s managers face unique challenges in their respective companies. Technology drives change at an alarming rate, managers must now collaborate instead of competing against each other to meet company goals, and the customer must still be served. Dashboards are a great tool, but if used only at the senior level, they can backfire. Employees may feel that big brother is watching them, and they may feel increased pressure to perform or the need to protect information.
Making dashboards available to all managers in a company would increase their efficacy. In today’s environment, companies must depend on managers to make decisions in the field or on the factory floor. Having access to real-time information at every level would enable managers to make the best decisions for the company. There must also be a high level of trust between senior management and other levels of management within a company. If lower levels of managers have the right skills and information, they can make decisions that support the company’s goals instead of working against them. Oh My: How Did We Get Like This?
By Dr. Reed Holden
We were recently in a meeting with a potential new client and I was struck by how disconnected they were from their customers. My reaction is the title of this piece. I am, and will always be, appalled at how companies get disconnected from a) how customers think about them and b) what customers really value. My reaction was based not only on the company we were meeting with but how many companies are like this.
In this world of spray-and-pray marketing, there is absolutely no wonder that sales people are disconnected and customers want to commoditize what we do sell. Both groups know that we are disconnected and don't know what it is like in the real world. Their reaction: to focus on price, because in many cases, it's the only thing that salespeople can sell and customers can detail. What's it like in the plan-it-and-jam-it world of product development? It's the same–internal focus on the next new thing that has absolutely no connection with what customers really need from their suppliers.
In the words of Pogo: "We have met the enemy and it is us." I am a firm believer in getting out from behind your desk and visiting with customers. You can never do too much of that. What should you talk about? What they need, how you can help, and the value of providing the product or service. Simple questions. Fahgedabout the sales pitch for once in your life. Try it, you'll like it.
Outsourcing: $100B Up for Grabs | How Much can We Leverage Intellectual Property? | Up Against the Wall | How to Compete Against the 800lb Gorillas Using Segmentation | Good Reading!
Outsourcing: $100B Up for Grabs
From “Can Offshore Outsourcers End Reign of Big Six?” CNET News.com, January 12, 2006 by Steve Ranger
Commentary By Rachel Jacobsen and Mark Burton
According to outsourcing advisory firm TPI there are almost $100 billion in outsourcing contracts up for grabs in the next two years. A full $50 billion of that are contracts currently with IBM and EDS that are up for renewal. Along with Accenture, Affiliated Computer Services, and Computer Sciences – Hewlett-Packard, EDS, and IBM comprise the “Big Six” of the outsourcing world accounting for 72% of the contract value to be renewed in the next two years. There is some high-stakes poker coming and given the way the Big Six compete and with continuously improving offshore competitors, it could get ugly.
If the Big Six continue to compete with offshore outsourcers by touting their ability to increase productivity and thus lower their cost-to-serve over time, then 2006 and 2007 will be difficult years for new business. Regardless of how many global locations the Big Six maintain, competing with offshore outsourcers with a cost take-out value proposition while maintaining time and materials pricing is a sure fire way to put more business up for grabs. In order to compete with low-cost competition, the Big Six need to first look to value to the customer. This knowledge must be used to push the conventional thinking past “cost reduction” to value propositions that capture the additional economic value that outsourcing provides. The value of outsourcing can generally be grouped into three major categories: risk mitigation, more rapid and higher revenue generation, and total cost of ownership reduction. An outsourcer who understands and effectively communicates how its service impacts these drivers of value propositions can alter the competitive landscape.
Armed with good information about customer value, the Big Six must take on one of the biggest problems in the industry – time and materials pricing. Among its many problems is a focus on inputs (as opposed to value-adding outputs) that encourages customers to scrutinize and vigorously negotiate labor rates thus playing into the hands of low-cost, off-shore providers. Developing new pricing models that align with value to the customer will reduce the opportunity for offshore competitors.
For example, many clients view outsourcing as a method of reducing costs but are also extremely risk averse. A time and materials price metric is not suited to such clients, as they bear all of the financial risk or negotiate lower prices to put the risk back on the outsourcer. To move forward with a change of this magnitude, we recommend a methodical approach. The first step is deploying a fixed price approach. If managed with discipline, this is a win-win. If work is tightly scoped, customers get cost certainty and the outsourcers get well-defined objectives and deliverables, thereby reducing their risk. The next evolution is pricing to value. Consider the client where there is a strong tie between the outsourced service and revenue generation. If the results are predictable, measurable, clearly linked to the project, and understood by the client, then there is an opportunity to move to an output-based pricing model where the outsourcer is paid per unit of output that is clearly linked to the value creation.
The risks and costs of switching an outsourcing relationship are higher than most customers will admit to their current suppliers. Weak value propositions and an antiquated pricing model only serve to reduce these costs and undermine what could be strong relationships. The outsourcing industry has ignored this problem for too long and the result has been the growth of a cohort of strong, low-cost competitors. Unless the Big Six up their games, the damage could be breathtaking. Given that two of the six, CSC and Affiliated, have been “in play” with buyout firms, it will likely be fatal for some. How Much can We Leverage Intellectual Property?
From “Patent Epidemic,” Business Week, January 9, 2006
Commentary By Mike Lawson
Today, companies are spending record amounts to protect their intellectual property – even to the point of using defensive patents for products that never hit the marketplace. Most companies have some form of intellectual property that is the bread and butter for their business. Pharmaceutical companies depend on patents to survive, beverage companies use trade secrets to protect the formulation of their drinks, and service companies have copyrighted processes to remain competitive in the marketplace. However, how effective is intellectual property protection in driving the number one or two position in a company’s market?
It depends on what form of intellectual property a company is using. If it is a patent and they can effectively leverage that IP in the marketplace, they typically retain their monopolistic market position and reap huge profits until a patent expires. Although the company owning the original patent may still retain market leadership, new competitors may be more profitable as a result of their low-cost/no-research approach – as is the case with generic pharmaceutical companies.
Trademarks and copyrights pose a different series of issues since competitors can re-package and reword these ideas to avoid legal intellectual property challenges. If competitors repackage something as simple as content successfully, companies lose any competitive advantage they have gained by securing a trademark or copyright. For trade secrets, once the secret is out, there is really no recourse other than contact enforcement, but this does not help the fact that a trade secret is now public and can easily be replicated. Trade secrets only provide a competitive advantage to the extent that a secret can be protected.
While we agree that protecting intellectual property is extremely important and necessary, capitalizing and leveraging competitive advantages as fast as you can with an effective go-to-market strategy is even more important. Designing and executing a clear business strategy is what enables companies to be successful – not the number of patents or copyrights that a company produces. After all, it is only a matter of time before a patent expires or someone improves on your original idea.
From “What’s New in Air Travel for 2006,” The Wall Street Journal, January 3, 2006 and "How U.S. Auto Industry Finds Itself Stalled by Its Own History,”
Commentary By Nelson Hyde
What if you were in an industry that had lost $32 billion over the last 4 years, had a third of its capacity in bankruptcy, and was facing growth of 3-5%? And your product looked almost exactly like everyone else’s? How do you price out of that one?
Welcome to the airline industry. In that kind of situation, the pricing trap most companies fall into is to believe they can squirm their way out of it – if they can just act fast enough and be the first to lead down with price, they’ll win. Dropping price does give them an advantage – for a few days. But with everyone facing the same desperate conditions, competitors will simply match the price and everybody loses. That does not often change the long-term market share equation. It’s a little like fighting to grab a better deck chair on the Titanic.
U.S. car makers have recently been through that, and the deep discounting didn’t work for them either. GM’s $5,000 rebates did not stem market share loss – they simply sucked the profit out of the share that GM could manage to hang on to. Now analysts give GM a 40% chance of going into bankruptcy. In a mature industry, penetration pricing or deep discounting to preserve share is a death spiral.
The far better – and far harder – solution is to manage capacity for the long-term. For example, we noted with some hope a year ago that airlines might have begun inching toward profitability by reducing their capacity on selected unprofitable routes. That trend is exploding and now analysts expect 5% further capacity reductions industry-wide in 2006. That will allow airlines to raise their prices and (get this) it may even make American, Alaska, AirTran, Frontier, Delta, and US Airways profitable. That’s a pricing strategy – capacity management rather than wildcard discounting. Instead of just trying to play the game harder and hope you survive, it changes the whole game. How to Compete Against the 800lb Gorillas Using Segmentation
Commentary By Curtis Bingham
Until this month I was convinced that the phrases “customer loyalty” and “personal banking” couldn’t be used in the same sentence. With all the bank mega-mergers and the significant drive to eke out every ounce of profit from bank customers, the two phrases are nearly mutually exclusive. However, an article “Banks Work to Bond with Seniors” in the December 12th issue of USA Today described how community banks have begun offering social events and travel opportunities to their customers at least “50 years young” as well as higher interest rates on certificates of deposit and free safe-deposit boxes. One bank official said, “We can’t make a mistake that’s bad enough for our customers to leave us.”
Perhaps implemented merely as a customer retention effort to prevent customers from defecting to larger, national competitors, community banks have struck gold with their new focus on a very profitable segment of their customer base. For one bank, the average senior customer has 4.46 accounts compared with the 3.13 accounts of other members. While only one-fifth the bank’s customers are seniors, they account for 34% of all deposits and 50% of all retail deposits. Given these figures, it makes very good sense to find out what these customers need and want from a bank – namely a relationship. By providing these tailored products and services, community banks are able to effectively compete with the 800lb gorillas who can’t provide what these customers really need.
How long has it been since you looked at your customer base to find that segment that accounts for a large portion of your revenue, or could account for much more? How can you find out more about what they need, want, and are willing to pay for?
May we all follow the example of these community banks and increase our revenues while increasing the loyalty of our customers.
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