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8/31/2009 - Innovating Your Customer’s Value Chain to Increase the Value of Your Own Product Offering
The threat of commoditization and the resulting pressure on prices is nothing new – companies have always faced them. But for many B2B product-oriented (and service) firms, the current economy’s impact on profitability is especially challenging.
In response to these challenges, traditional product-oriented companies typically choose one of two paths. They pursue lower cost business models to maintain their profit margins at lower prices. Or they seek to enhance the value of their products by improving their quality, capabilities or other characteristics and – if successful – their customers’ willingness to pay higher prices.
However, some companies have created significantly more value through a third path that moves beyond their product orientation and focuses on innovating customer value chains – that is, the set of business processes that a customer employs to generate the value of its own product offering. Companies taking this approach have enhanced the value associated with their products by radically altering the customer’s business processes that are associated with their products in ways that achieve significant cost reductions – or increase their customers’ potential to grow revenues.
This third path differs from the product-oriented approach in that companies augment their product with a set of activities – they provide a solution – that not only increase the potential value associated with their original product, but also takes responsibility for achieving the full value. Four key factors drive a solution’s potential to create sustainable value…
* The degree to which the activities are non-core to customers (their willingness to forego “ownership”);
* The importance customers place on the source of value;
* The uniqueness of the solution and the difficulty of others (including the customer) to achieve the same value;
* The degree to which the company takes ownership (assumes responsibility) for achieving the desired results for customers
The construction industry provides an example. Construction companies primarily create value by completing projects through their core construction operations. Their logistics operations are usually non-core activities that enable the construction.
Professional grade tool manufacturers contribut
e to the construction industry’s creation of value to the extent that their tools are available to construction crews at the levels necessary to maximize labor productivity and minimize the amount of construction materials consumed. Although the quality and utility of the individual tools are critical, they comprise only one element in the broader Fleet Management Process that drives the rate of availability of individual tools to the crews. No matter how good the tool is, it does not provide value to the construction company if it is lost, out of tolerance, or requires maintenance.
Product-oriented tool manufacturers would typically focus on the tool to address competitive issues – reducing their cost to manufacture the tools or improving the tool itself. However, their efforts continue to impact only a smaller piece of the overall process that drives the construction company’s potential to create value. On the other hand, a company taking a solution-oriented approach might change its business model to not only provide the tools, but to alter customer processes to achieve higher availability rates for its tools at a lower cost than the customer could otherwise achieve on its own. What is a very different proposition – and one that can create significantly more value.
As described in “Reinventing Your Business Model” by Mark Johnson et. al. (Harvard Business Review, December 2008), Hilti provides an interesting case study of how a product-oriented company can successfully adopt a solution-oriented business model to increase the value of its product to the customer. By radically altering how customers procure and maintain their fleets of tools, Hilti not only avoided commoditization of its product offering, it created significant value for its customers – as well as for itself.
Typical Product –Oriented Approach to Supplying Construction Tools
The professional grade tool market is highly competitive. Suppliers generally provide high-quality tools and other applications to professional construction and facility maintenance companies. However, the quality, warranty and other attributes that are meant to differentiate their product lines tend to converge towards an industry standard. They essentially find themselves in an endless struggle to justify and achieve premium prices.
The purchase price of the average tool is typically a little less than half of the product’s total cost of ownership (TCO). Suppliers attempt to base their prices on the increased productivity and lower cost structures that result from their tools’ superior quality. However, a customer’s decision to select one professional grade brand over another often comes down to price. The industry’s typical product-oriented approach to the market provides little differentiation in terms of quality and the degree to which one supplier’s tools create higher productivity than a competitor’s.
Hilti’s Alternative Solutions Approach
Hilti chose to refocus on customer business processes in search of new opportunities to increase and capture a greater share of their product’s value. They eventually came to the conclusion discussed earlier - the customer’s objective was not to procure a fleet of tools but rather to procure high tool availability rates. It was the high availability rates of quality tools that increased productivity. Hilti’s Chairman, Dr. Pius Baschera, explained that his customers did not want to buy the drill; they wanted to buy less expensive holes.
In response to this new insight, Hilti developed a solution to manage customers’ tool fleets – one that increased tool availability at a much lower cost than customers could currently achieve on their own. This included financing; procuring new or replacement tools; managing and maintaining inventory; and reducing worksite theft.
Rather than sell the tools, Hilti leased them to their customers and charged a single monthly fixed fee that included the associated fleet management services. A single fixed fee ensured that customers would receive the lower cost structure that Hilti marketed. As important, it reduced the customer’s ability to gain price concessions by comparing Hilti’s pricing to competitors’. The customer lost transparency of the fee for the tool and that of the services – they were now indistinguishable and common components of a single solution.
Creating and Capturing Value
Hilti’s solution created significant new value for customers – increased fleet availability and reduced up to 50% of administrative after-sales management costs. As important, it created sustainable value. Fleet management was non-core to customers – they were willing to outsource it. The solution directly improved the construction process – the customer’s core competency. Neither customers nor competitors could achieve similar results – the solution was unique. And Hilti “guaranteed” the customer would achieve the results.
But just as important if Hilti wanted to benefit, it needed to capture a fair share of the value that the solution created. Allowing customers to keep all of the created value is tantamount to reducing price…exactly what Hilti was trying to avoid in the first place. As in Hilti’s case, this often requires new pricing strategies as well as new operating models with significantly different risk profiles.
However, with the potential upside comes the operational risk of non-performance and decreased profitability. Had Hilti not invested in a capable business model, excessive service costs might have exceeded the performance targets and decreased the company’s profitability. It could even have led towards a financial position worse off than that originally posed by commoditization.
The Critical Success Factors for Delivering Solutions
Hilti demonstrates the impact that solutions can generate when a supplier looks beyond its boundaries and focuses on customer activities that influence the value of its products. But if customer solutions provide such powerful opportunities, why aren’t more suppliers successfully providing them?
Quite simply, it’s not easy. More often than not, companies preparing to deliver new solutions do not invest the level of resources necessary to succeed. The new product development process – analogous to developing new customer solutions – sheds some light. Up to 40% of new product and service introductions fail – and about 15-20% of them never achieve a profit. Key reasons for failure include:
* Insufficient market analysis and understanding of customer needs; and
* Ineffective business models and excessive cost structures.
Avoiding these pitfalls requires that suppliers address four key capabilities:
* Business development;
* Consultative selling;
* Customer focused operations delivery and management processes; and
* Value based pricing.
Business Development. Suppliers must focus on achieving an in-depth understanding of customers and their value chains. In particular, suppliers must understand strategic as well as operating and marketing objectives. They must succeed in identifying inefficiencies, pain points and/or new customer revenue streams that have yet to be addressed in the customer’s value chains.
The supplier must also have the analytic skills necessary to value the opportunities across customer value chains. It must know how much value is available for the customer if it is to succeed in capturing a fair share for itself.
Consultative Selling Process.
One of the biggest problems companies face in trying to “internally sell” the concept of solution selling to their own sales force is the long duration of the sales cycle. The process begins in the business development process and can often take up to a year or more. The process itself requires the sales force to first “sell the problem ” and only then to “sell the solution”. This is not easy for those who are used to the relatively easy and short cycles of selling discrete products.
Suppliers’ sales forces must typically target customer managers that are much higher in the organizational hierarchy. While the product model allows purchasing departments to make purchasing decisions, solutions must be marketed to executives that are senior enough in the organization to encompass all of the different functions that share in the value.
Operations & Delivery Management.
The success of the solution comes down to the supplier’s ability to deliver the value. Operations must be externally focused – and often integrated – with the customer’s business process and information flows. A new management structure with P&L responsibility is often important. For internally focused product companies, this is often a major transformation.
Capturing Value.
As discussed earlier, the ability to capture created value is not a given; in many cases, a company’s inability to capture value leads to product failure. A value-based – rather than a cost-plus – pricing strategy requires both customers and supplier sales forces to change, not an easy task when management systems, processes and incentive programs are grounded in past practices.
While many services companies, and even some manufacturers, already posses many of these competencies, integrating them into a cohesive business model capable of developing, delivering and capturing customer value is a challenge. But success will be illusive unless each of these elements is present and all are integrated.
Sources
* Mark Johnson, et al., “Reinventing Your Business Model”, Harvard Business Review, December 2008.
* Hiti website - http://www.hilti.ie/data/editorials/-11541/FM_Supplement_01_09.pdf.
* Hilit website - www.hilti.co.za/data/editorials/-8161/Fleet%20Management%20June%202008.pd.
* Iacobucci, Dawn, “Kellogg on Marketing”, New York, NY: Wiley, 2001, p130.
About the Author:
Scott Landry (slandry@highlandgrowth.com) is a Managing Director with Highland Growth Partners based in Richmond, VA. He provides a wealth of experience developing and implementing successful organic and acquisition-oriented growth strategies as a strategic management consultant as well as a general management executive. He has an MBA from the Harvard Business School and a BS from the United States Military Academy. Scott is a member of BMA.
Copyright 2009 Business Marketing Association. All Rights Reserved.
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