© Kenneth B. Wong, May 2006 1 Competing for a Profitable Future by: Ken Wong Queen’s School of Business

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© Kenneth B. Wong, May 2006

Competing for a Profitable FutureCompeting for a Profitable Future

by: Ken Wongby: Ken Wong

Queen’s School of BusinessQueen’s School of Business

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TO DETECT…TO DETECT…

TO DESTROY…TO DESTROY…

TO AVOID…TO AVOID…

MARGIN-SUCKINGMARGIN-SUCKING

MAGGOTSMAGGOTS

The Objectives of All Great InnovationsThe Objectives of All Great Innovations

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The Challenge is NOT to Innovate, It IS to MAKE MONEY

Price

Cost

Minus

NetIncome

AssetsManaged

DividedBy

MarketShare

MarketSize

Times

UnitMargins

UnitVolumes

Times

Return OnInvestment

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The REAL Questions

What kinds of innovations will get PRICES UP?

What kinds of innovations will get COSTS DOWN?

What kinds of innovations will give us the BEST SOURCES OF VOLUME GAIN?

Should I be more worried about prices, costs or volume?

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A Comparison of Profit Levers

Volume

Variable Cost

Price

3.3%

7.8%

11.1%

(Average economics of 2,463 businesses in Compustat)

A 1% change in...

Creates a change in operating profit of ...

KW-210

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GETTING PRICES UP

Competing FOR price versus ON price

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Understanding Pricing Challenge

WHICH PRODUCT IS CHEAPEST?WHICH PRODUCT IS CHEAPEST?

A: $1.01A: $1.01

B: $1.00B: $1.00

C: $0.999,999,999,999,999,999,999,999,999,999,999,999,999C: $0.999,999,999,999,999,999,999,999,999,999,999,999,999

WHICH PRODUCT HAS THE BEST QUALITY?WHICH PRODUCT HAS THE BEST QUALITY?

A: “Wonderful Quality”

B: “Great Quality”

C: “Smokin’ Good Quality”

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Pricing Challenge 1: Raise Your Price Ceiling

THE VIAGRA RULE:

People DON’T buy products or services, they buy solutions to problems

Customer willingness to pay a premium price increases: with the importance of the problem being solved the complexity of the work the number of alternative suppliers

DON’T TELL PEOPLE WHAT YOU DO – TELL THEM WHY THEY SHOULD CARE ABOUT WHAT YOU DO

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THE COLA RULE: Show customers why they SHOULD care

Interest expenses Opportunity costs Storage/handling Installation Quality control

(of your product on installation)

Tax and insurance Shrinkage Obsolescence

Training User's labour

costs (especially if re-engineered)

Longevity Replacement/

repair costs Disposal

costs Regulatory

Cost-in-Use

Price

=Acquisition

Costs + PossessionCosts + Usage

Costs

Paperwork Shipping time Expediting orders Cost of errors in ordering Pre-purchase activities Purchase evaluation© Kenneth B. Wong (2005)

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Pricing Challenge 2: Don’t Commoditize Yourself

THE TELEPHONE RULE

People are creatures of habit and convenience – your task is to make it their habit to think of doing business with you

KEY QUESTION: What is the problem the customer is looking to solve when they pick up the phone and choose to call you?

IF THE NEED IS GENERIC, YOUR PRICES WILL BE TOO!

Do you “build an association” with distinctive problems OR are you trying to be all things to all people?

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Pricing Challenge 3: Understand REAL Quality

Improving the Retail Experience (Sample Advice) Improving the Retail Experience (Sample Advice)

Personalize/localize the experiencePersonalize/localize the experience

Help the customer find their wayHelp the customer find their way

Explain product differencesExplain product differences

Show them you careShow them you care

Show them why they “get what they pay for” Show them why they “get what they pay for”

EDI, E-tailing, etc. etc.EDI, E-tailing, etc. etc.

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Pricing Challenge 4: Understand PERCEIVED Quality

THE CHINESE FOOD RULE (3 Parts)THE CHINESE FOOD RULE (3 Parts)

(Part 1): “Quality” is in the eye of a beholder(Part 1): “Quality” is in the eye of a beholder

- Different buyers will use different measures - Different buyers will use different measures

(Part 2): Buyers may lack 20/20 vision...(Part 2): Buyers may lack 20/20 vision...

-- They may lack theThey may lack the technical competencetechnical competence to make rational valuationsto make rational valuations - They may lack the - They may lack the timetime to make rational valuationsto make rational valuations - They may lack the - They may lack the interestinterest to make rational valuations to make rational valuations

(Part 3): Uninformed or uninvolved buyers will use (Part 3): Uninformed or uninvolved buyers will use certain cues or “proxies” to infer the presence or certain cues or “proxies” to infer the presence or absence of desired qualitiesabsence of desired qualities

- - Managing “perceived quality” requires us to distinguish between how the Managing “perceived quality” requires us to distinguish between how the buyer buyer definesdefines quality versus how they quality versus how they measuremeasure quality quality

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Putting It All Together

If customers think your prices are too high…

1. Are you spending too much time talking about what you do instead of why it matters? (VIAGRA & COLA RULE)

2. Are you focusing too much time talking generic needs instead of your specialized talents? (TELEPONE RULE)

3. Are you defining quality in too narrowly based on your craft instead of thinking about what quality REALLY means to different customers? (LINGERIE RULE)

4. Are you confusing how the buyer DEFINES quality versus how they MEASURE the presence of quality? (CHINESE FOOD RULE)

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One Last Thing

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Can You Say It All in 60 Seconds or Less?

Part One: What We DoFor the target marketWho want the "consumption problem"

(what "need" do you serve?)

Our product is a our portion of the "solution" (how do you help satisfy that need?)

That features key benefit provided (what are the one or two things you want them to

remember about you?)As measured by how the customer infers quality

(how can you convince them you are for real)

Part Two: Why We Will WinUnlike our main competitorsOur product provides key point(s) of differenceAs supported by what makes our difference possible

(why they should believe us… TODAY)

And protected by why the competition cannot easily overcome it

(why they should believe us… TOMORROW)

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COMPETING ON COST

How to reduce cost WITHOUT destroying quality in the process

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The Four Key Determinants of Cost

How you think

What you do

How much you do it

Who your “friends” are

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THINKING ABOUT COSTS

Do you THINK about MARKETING as an

EXPENSE or INVESTMENT?

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Pick A ONE DIGIT Number from this list…Pick A ONE DIGIT Number from this list…

135128398084666412342985813512839808466641234298581902514090365828948425390190251409036582894842539008595330456911104893134800859533045691110489313480529904520366666249135820952990452036666624913582090501372541684986314215928050137254168498631421592883245801324666689531248088324580132466668953124808

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Now Pick a Number… This is the power of a great AdNow Pick a Number… This is the power of a great Ad

113351285128339808466641298084666412334298584298581902514090190251409033658289484256582894842533909008595085953333045691110489045691110489331133480480529904520529904520336666624916666624913358209582090501050133725416849867254168498633142159281421592888332458012458013324666689524666689533124808124808

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Now? This is the power of a great BRANDNow? This is the power of a great BRAND

135128398084135128398084666666412342985841234298581902514090319025140903665828948425390582894842539008595330450859533045669111048931348091110489313480529904520352990452036666666666249135820924913582090501372541050137254166849884986631421592831421592883245081324832450813246666666689531248088953124808

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OR Maybe this is….OR Maybe this is….

24680501372541384989314215928142159282468050137254138498931421592814215928 83242576508132483242576508132424680246809531248088324508195312480883245081 13534291283980841353429128398084666666412342985819025140412342985819025140 66841902514090366841902514090366582894842539048425390582894842539048425390 03708859533045037088595330456691110489313480234298589111048931348023429858 23045299045203230452990452036666666666249135820953124808249135820953124808 04307501372541043075013725416684988498663142159283512839231421592835128392 89671324508132489671324508132466666666895312480808595397895312480808595397 13512228883980841351222888398084123123412342985853904842412342985853904842 45081102514090355828948425390128398094508110251409035582894842539012839809 15928159283341234050137254948425390494842534123405013725494842539049484253

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Still not convinced?

Describe this product…

What if it carried the logo…

How much would FP need to spend on EACH product to convince you it had those traits IF IT HAD NO BRAND?

© Kenneth B. Wong (2005)

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WHAT YOU DO

Do You See All Costs As Bad?

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LowerCosts

Higher Pricesand Sales

Increase“Value”

Reduce“Waste”

Add “Good”Costs

Reduce “Bad”Costs

WHAT YOU DO: How Great Businesses Spend “More”

Total Costs

Higher Profits

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HOW MUCH YOU DO

Are You WINNING or BUYING

Market Share?

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HOW MUCH YOU DO: Why Everyone Wants Market ShareHOW MUCH YOU DO: Why Everyone Wants Market Share

100100

11

5050

22

12.5012.50

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Unit costUnit cost

VolVol

The Large Firm’s PROFITThe Large Firm’s PROFIT

TheTheSmallSmallFirm’sFirm’sLOSSLOSS

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Via experience effects,economies of scale,market power, etc.

MOREMORESCALESCALE

LOWERLOWERCOSTSCOSTS

HOW GREAT BUSINESSES USE SCALEHOW GREAT BUSINESSES USE SCALE

Via businessplanning

LOWERLOWERPRICESPRICES

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Volume-Based Price ReductionsVolume-Based Price Reductions

100100

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Unit costUnit cost

VolVol

COSTCOST

PRICE CUSTOMERS

ARE WILLING TO PAY

InitialInitialVolumeVolume New Volume New Volume

PRICEPRICENEW PROFITNEW PROFIT

A’s PROFITA’s PROFIT

WHAT A DEAL!!!WHAT A DEAL!!!

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Why Price isn’t the Best Way to Add Value

Short strategic window

Inefficiency relative to quality enhancement

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MOREMORESCALESCALE




BETTERBETTERQUALITYQUALITY

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2525

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??SPEND TOSPEND TOADD NEW ADD NEW

CAPABILITIESCAPABILITIES& FEATURES& FEATURES

NEW PROFITNEW PROFIT

Volume-based Value-Added

100100

5050

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12.5012.50

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Unit costUnit cost

VolVol

Initial PROFITInitial PROFITCOST

PRICE CUSTOMERS

ARE WILLING TO PAY

INITIAL VOLUMEINITIAL VOLUME NEW VOLUMENEW VOLUME

NEW FEATURESNEW FEATURES

NEW PROFITNEW PROFIT

LOWER PRICELOWER PRICE

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HIGHERHIGHERSALESSALESVia sales and

marketing MOREMORESCALESCALE




LOWERLOWERPRICESPRICES

SUPERIORSUPERIORVALUEVALUE

Via execution andimplementation

BETTERBETTERQUALITYQUALITY

AND/OR

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How WHO YOU KNOW Effects Costs

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The BRAUN Rule

FILTER

CARAFE

STAND

BASE- On/off

FILTER

CARAFE

STAND

BASE- On/off- Timer

FILTER

CARAFE

STAND

BASE- On/off- Timer- Flavour controls

© Kenneth B. Wong (2005)

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MODELA

MODEL ASALES

MODELB

MODEL B SALES

MODEL C

MODEL C SALES

How Common Components andModules Create Value

100

11

Unit cost

Vol

COST IF COMMON COMPONETS USED IN MODELS A+B+C

ADDEDPROFIT

FORMODEL A

ADDED PROFIT FOR MODEL B

ADDED PROFIT FOR MODEL C

COMBINED SALES OF A+B+C© Kenneth B. Wong (2005)

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THE KEY TRADE-OFF

Differentiation versus Integration

You can’t get scale economies without

STANDARDIZATION

You don’t get sales by being only

SOMEWHAT RIGHT

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Why the Model Sometimes Fails – The Blue Jean Rule

Which size would you use? Which size would you use?

How would the customers react?How would the customers react?

How much of the blame for heavy promotional How much of the blame for heavy promotional spending lies in inappropriate attempts to use a one-spending lies in inappropriate attempts to use a one-

size-fits-all approach?size-fits-all approach?•

PAT MIKE

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Segmentation – The Most Important Thing We Do

Segmentation is the equivalent of off-the-rack sizes: we identify the average requirements of a group of customers based on some characteristic.

The BIG Issue:

What indicator(s) work best to discriminate the needs, wants and behaviors of different customers?

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When Should Independents Worry Most?

When everyone wants basically the same thing

Limited assortment and standardized practices (i.e. little customization) serves to reduce costs WITHOUT reducing quality to inadequate levels

Ability to leverage information and other technology to provide customer service and distributive services transforms scale-insensitive variable costs in scale-sensitive fixed costs

When you need “critical mass” to access the “instruments of scale”

There are some practices you have to be big to be able to afford

When smaller competitors cannot respond

buyers CANNOT be convinced their needs are unique

smaller competitors CANNOT form marketing, buying or administrative consortia to counter your advantage

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COMPETING FOR THE RIGHT VOLUME

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The Profitability of a Transaction Focus

Profitcontributed by:

Time

Profit

Base profit

Cost of newcustomer

Source: Bain & Company (Frederick Reicheld) KW-153

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The Value of Customer LoyaltyThe Value of Customer Loyalty

Price premiumPrice premium

ReferralsReferrals

Lower costsLower costs

Increased volumeIncreased volume

ProfitProfitcontributed by:contributed by:

00 11 22 33 44 55 66 77

YearYear

ProfitProfit

Base profitBase profit

Cost of newCost of newcustomercustomer

Source: Bain & Company (Frederick Reicheld)Source: Bain & Company (Frederick Reicheld)

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Profit Impact of a 1 PercentProfit Impact of a 1 PercentIncrease in Customer LoyaltyIncrease in Customer Loyalty

00 44 88 1212 1616 2200

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SoftwareSoftware

Industrial distributionIndustrial distribution

Credit cardsCredit cards

Auto serviceAuto service

Auto/Home insuranceAuto/Home insurance

PublishingPublishing

Bank branch depositsBank branch deposits

Advertising agencyAdvertising agency

Percentage Increase in Profits per CustomerPercentage Increase in Profits per Customer

Source: Bain & Company (Frederick Reicheld)Source: Bain & Company (Frederick Reicheld)

VolumeVolume 3.3%3.3%

CostCost 7.8%7.8%

PricePrice 11.1%11.1%

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What the “Great Ones” Know About Customer Relationships

No one ever switched suppliers for an offer that is only “just as good” Loyalty is a source of marketing-based cost advantage

Every business needs a “franchise” But you can’t grow a relationship by doing the “same old things”

Not everyone wants or needs a “relationship” – they’ll take it but ONLY IF YOU GIVE IT TO THEM FOR FREE

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CLOSING THE LOOP

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Marketing Services is Fundamentally DifferentMarketing Services is Fundamentally Different

The distinctive character of service offerings means you The distinctive character of service offerings means you cannot sell what your staff doesn’t understandcannot sell what your staff doesn’t understand* Intangible* Intangible * * InseparableInseparable * Variable * Perishable * Variable * Perishable

The Five Step “Service Profit Chain”The Five Step “Service Profit Chain”Profits growProfits grow from from satisfied customerssatisfied customers who receive who receive service valueservice value due todue to satisfied and loyal employeessatisfied and loyal employees who hadwho had proper training, proper training, coaching and supportcoaching and support

COMPANYCOMPANY

EMPLOYEESEMPLOYEES CUSTOMERSCUSTOMERSInteractive MarketingInteractive Marketing

ExternalExternalMarketingMarketing

InternalInternalMarketingMarketing

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What the Great Ones Know About What the Great Ones Know About Marketing to EmployeesMarketing to Employees

Employees often cite DIFFERENT value propositionsEmployees often cite DIFFERENT value propositions

Employees frequently lack knowledge of how they impact Employees frequently lack knowledge of how they impact on the value proposition in their day-to-day operations?on the value proposition in their day-to-day operations?

Employee training and development must be aligned with Employee training and development must be aligned with the value propositionthe value proposition

Employees’ “performance review” must be aligned with Employees’ “performance review” must be aligned with the value proposition? (i.e. Management by Objectives”)the value proposition? (i.e. Management by Objectives”)

You cannot have customer loyalty without employee You cannot have customer loyalty without employee loyalty.loyalty.

KW-055KW-055

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How to Survive the “Margin Sucking Maggots”How to Survive the “Margin Sucking Maggots”

1.1. Know the Arithmetic of ProfitabilityKnow the Arithmetic of Profitability

2.2. Think of Price as an OBJECTIVE, Think of Price as an OBJECTIVE, not as a TACTICnot as a TACTIC

3.3. Discriminate “good costs” from “bad costs”Discriminate “good costs” from “bad costs”

4.4. Know when to “go big” and when to “go small”Know when to “go big” and when to “go small”

5.5. Know Your Employees…and be certain THEY KNOW Know Your Employees…and be certain THEY KNOW WHAT YOU WANT AND WHYWHAT YOU WANT AND WHY

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FOCUS ON “EXECUTION”

The EXECUTION of theThe EXECUTION of the

MARGIN-SUCKINGMARGIN-SUCKING

MAGGOTSMAGGOTS

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Ken WongKen Wongc/o Queen’s School of Businessc/o Queen’s School of BusinessKingston OntarioKingston OntarioK7L 3N6K7L 3N6

tel: 613-533-2367tel: 613-533-2367fax: 613-533-2321fax: 613-533-2321

email: email: [email protected]

Documents

© Kenneth B. Wong, May 2006 1 Competing for a Profitable Future by: Ken Wong Queen’s School of Business