Business-to-BusinessBusiness-to-BusinessMarketing:Marketing:a cornerstone ofa cornerstone ofprofitable growthprofitable growth

Thomas Baumgartner

Alex Bhrer

Philipp Kobus

Hajo Riesenbeck

Hermann Ude

Felix Weber

McKinsey & Company, Inc.

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McKinsey & Company, Inc.

Dsseldorf

1st edition 1998

2nd edition 2000

Printed by Frhlich Druck AG, Zollikon

McKinsey & Company, Inc.

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ContentsContents

Prologue 1

Strategy: Setting the stage 7

Understanding customers and market 9

Pinpointing the right segments and customers 13

Defining a distinctive value proposition 18

Operations: Putting the system in place 25

Standardized product businesses: 27

learning from consumer goods

System businesses: 37

profiting from integrated solutions over the whole lifecycle

Project-based businesses: 46

providing economic value to the customer

Organization: Capturing the opportunities 55

Building an attractive platform 57

Executing a well-orchestrated set of initiatives 59

Ensuring implementation and adjusting the organization 62

Confidentiality

We invariably treat information about our clients as confidential. To

make the case for business-to-business marketing come alive without

compromising this confidentiality, we have only mentioned by name a

number of companies that are acknowledged marketing all-stars or tal-

ented specialists in a particular area. Their success stories, drawn from

public sources, are supplemented by further disguised examples from

our consulting work.

Foreword

In most industrial companies, marketing used to be a lower-level man-

agement job. Often it was synonymous with supporting the sales force;

sometimes it was associated with creative advertising. Most companies

were centred on engineering and on offering a wide range of standard-

ized and/or technically advanced products.

Those days are ending. More and more managers are realizing

that developing and selling are not enough. Knowing how to position,

value, price, and brand your product or service is now the key factor

for success. Companies that very early on adopted a systematic market-

ing orientation based on a good understanding of these fundamentals

have gained share and outperformed competitors.

Their success has generated intense interest in business-to-busi-

ness marketing or B-to-B for short. It is a vast arena. Last year, more

than 20 million businesses around the world sold more than $20 tril-

lion dollars of products and services to other businesses. As one of my

American colleagues put it: It is BHP Steel selling processed metals to

Motorola; Motorola using that metal to make semiconductors, which

are sold to Arrow Electronics. Arrow Electronics reselling those same

semiconductors to IBM. IBM using the semiconductors to build main-

frame computers, which in turn are sold to Boeing. Boeing using its

mainframes to build airplanes, which are sold to GE Capital. GE Capi-

tal leasing those airplanes to Delta Air Lines, which then uses those

planes to provide special charter flights for Coca-Colas annual meet-

ing of bottlers.

Of course, B-to-B marketing is never this linear. The market is

really a multiplicity of user communities; the customer is a multi-

plicity of decision-makers. Suppliers who already have strong market-

ing processes naturally have an advantage.

With this brochure we would like to summarize the great benefits

of developing a superior marketing orientation, the levers that can be

used to do this, some examples of successful practical approaches from

companies in various types of businesses, and a roadmap for doing it,

using consultant support to accelerate the process.

On behalf of the authors, I would like to thank the clients and

colleagues who generously shared their views with us. My special thanks

go to Terry Gilman, whose great dedication and skilful editing have

enabled a diverse team of authors to produce a readable whole, and to

Charles Whitehouse for his invaluable contribution to design and pro-

duction.

In my own experience, the focus on delivering value to the cus-

tomer that is at the heart of marketing makes it an infinitely fascinating

and satisfying field of professional activity. I hope we have managed to

convey our enthusiasm.

Hajo Riesenbeck

Director

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Prologue

As an introduction to excellent business-to-business marketing, here

are some brief answers to the five key questions on the back cover:

Why learn to sell your customers products to their customers?

Because the industrial companies that grow profitably are the ones

that focus obsessively on their customers business needs. They put

themselves in their customers shoes and think about how to satisfy

their customers. This helps them to identify the main points of leverage

to improve customers performance in the marketplace a source of

hard-to-copy ideas for even better products and services.

Why have a list of customers you dont want to serve? Because all

customers are not created equal. Even the best understanding of cus-

tomer conduct is no guarantee that a particular account will be profit-

able. But if your basic market segmentation reflects customer needs

and attractive earnings potential, a hard look at individual accounts

will make plain where to focus your energy and adjust your offering.

And for great growth, excellent marketers know that Its better to own

80% of one customer segment than 10% of the market.

Why go all-out to convince customers that your offering is distinc-

tive? Because you can only own a segment if customers believe there

is no substitute for your product offering. Rapid short-term growth can

be achieved by developing a value proposition that, in customers eyes,

offers benefits they cannot get elsewhere. It is often enough to have a

profile just 510% better than your competitors in carefully selected

areas. But the higher the real or perceived price-value positioning, the

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eharder it is for competitors to copy. It also deflects competitive attacks

based solely on savings from restructuring.

Why worry if customers pay a competitor more for products with

fewer technical features than yours? Because they are building a rela-

tionship you may never be able to penetrate. Instead of just relying on

the technical advantages of a product to attract and retain customers,

top competitors like SAP, Federal Express, Intel, Cummins Engines,

and Gore-Tex have also actively invested in branding the value. They

have forged a link between their names and customer satisfaction, lay-

ing the basis for lasting customer relationships.

Why figure out how much you could earn by giving customers your

equipment for free? Because knowing all the numbers gives you an

edge. We are not advocating selling below cost, but understanding the

entire lifecycle of the customers investment. System suppliers like Otis

and Tetra Pak are professionals at this. They have grown by thinking

through the total profit stream that can be generated over the useful

life of the initial investment, whether an elevator or a packaging line.

Their bundled product and pricing solutions for equipment plus

services, spare parts, software, and supplies are being emulated by more

and more industrial companies. The lifecycle perspective points the

way out of the commoditization trap of pure price competition and

eroding profit margins. It also suggests new strategies for teaming up

with suppliers and customers to create more value.

Why ask yourself questions like these? Because they go to the core

of marketing strategy. Coming up with explicit answers here will help

your company or business unit to identify the two or three activities

that really drive profitable growth, and then to perform them excel-

lently, day by day.

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Marketing makes the difference

Our studies in the international electronics, machinery, and compo-

nents manufacturing industries confirm that what distinguishes the top

companies is not better restructuring skills. What makes the difference

is a much greater aptitude for high growth combined with great mar-

keting skills. Figures 1 and 2 quantify the impact of the way successful

companies use growth levers to expand and increase their revenue.

Of the two main ways to expand, strategic growth meaning prod-

uct innovation, mergers and acquisitions, and expansion into emerging

markets poses major investment, time-lag, and culture clash prob-

lems. By contrast, operational growthaccelerated by outstanding busi-

ness-to-business marketing and sales skills is usually a more cost-

effective choice. And, because it involves an evolutionary build-up, it is

a more reliable way to create a sustainable competitive advantage. Each

step up the growth staircase captures opportunity, builds capability,

and creates new options for the next step.

Putting marketing to work

This brochure offers a sample of the best practices we have observed

for developing excellent insights into customer needs, adjusting your

marketing approach and tools to the nature of the business, and posi-

tioning your company or brand name as superior to that of your com-

petitors.

Our observations are grouped around the main strategic, opera-

tional, and organizational tasks involved in pursuing excellent market-

ing:

Chapter 1 Setting the stage discusses how to set the strategic

direction understanding your customers and market, developing a

good segmentation, and defining a distinctive value proposition. The

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Percent

Restructuring and growth by less successful companies

100 105 12 928 30

893

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ROS9%

ROS5%

Figure 2

Volumeloss fromexistingproducts

Cost dueto addit-ionalvolume

* New products, new customers, new regionsSource: McKinsey Excellence in Electronics survey

Main source of differencebetween successful andless successful companies

Restruc-turinglevers

Priceerosion

Growthlevers*

Volumeloss fromexistingproducts

Cost dueto addit-ionalvolume

* New products, new customers, new regionsSource: McKinsey Excellence in Electronics survey

Percent

Restructuring and growth by successful companies

Main source of differencebetween successful andless successful companiesFigure 1

10089 11

5 14

55

35 113

136

OutsetRestruc-turinglevers

Priceerosion

Growthlevers* 2 years later

ROS+17%

ROS+11%

SalesCostSales Cost

Outset 2 years laterCost SalesSales Cost

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ideas gathered here are applicable to business-to-business marketing

in general.

In Chapter 2 Putting the system in placewe turn to the opera-

tional levers. Unlike the strategic levers, the basic operational levers in

marketing managing customer access, pricing the product offering to

capture an adequate economic surplus, and building a brand name or

reputation need to be handled differently depending on the type of

business. We therefore take a closer look at successful marketing ap-

proaches in three main types of business:

u Standardized product businesses

u System businesses

u Project-based businesses.

Chapter 3 Capturing the opportunitiesdiscusses the organiza-

tional aspects of implementing excellent marketing processes. Often

the biggest hurdle is not figuring out the right strategy, but rather

building the few right capabilities and attitudes into the organiza-

tion that are needed to execute the strategy consistently.

Developing effective business-to-business marketing takes years of

leadership by example and hard work on all fronts. In our experience,

however, quick wins and a huge motivational effect can be achieved in

the short term with coordinated actions to create and focus energy and

promote learning.

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Strategy:Strategy:Setting the stageSetting the stage

Great marketing is built upon a foundation of solid industry under-

standing coupled with creative insights into customers, competitors,

and the companys core manufacturing/operating skills, including its

dealings with suppliers and distributors. In all types of businesses, a

three-step cycle helps set the stage for success:

u Study customers and the market to know what products and serv-

ices will create economic value

u Develop a segmentation that also reflects customers economic

attractiveness for you

u Come up with a distinctive value proposition for each segment.

Many managers believe that their companies already have a solid

foundation in these areas. Yet market dynamics are now much faster

paced than even a decade ago. To get and stay competitively fit, most

companies need a 10,000-mile check-up every two or three years to

review and strengthen their market research, segmentation, and value

proposition, the three main levers for developing marketing strategy.

Figure 1 sets out the various elements involved in achieving excellence

in business-to-business marketing, along with key factors for success

and tools for achieving it.

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yAchieving excellence in marketing

Walking in your customersshoes (understanding yourcustomers customers)

Expansive mindset (broadmarket definition); threehorizons for the future

High market share in chosensegment instead of low share inmarket as a whole

Meeting both business andmarketing criteria

Basing segmentation oncustomers key buying factorsand breakpoints

Leaving some white space(follow 80/20 rule; dont go for100%)

Best price/benefit ratio forselected segment

Migration from selling toconsulting

Tailoring supply channels tocustomer segments (control,programming)

Distinguishing betweencoverage and penetrationissues

Perspective on life-cycleeconomics(not: single sale)

Pricing tactics geared tocapturing maximum economicsurplus over lifetime

Evolutionary build-up of brandedrelationship (vs. placing an ad)

Communicating customer valueeffectively

Understandmarket/customerneeds

Come upwith rightsegmen-tation

Define valueproposition

Manage access tothe customer

Capture theeconomic surplus

Brand/communicate thevalue

Systematic marketresearch (ear to theground)

Conjoint analysis

Price/value framework

Key accountmanagement

Sales forceeffectiveness

Channel management

Product management

Price management

Risk management

Branding

New workshop formats

Key factors for successElements Levers/tools

Source: McKinseyFigure 3

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Understanding customers and market

Because they are over-focused on developing proprietary technological

breakthroughs as a source of growth, many industrial companies grow

blind to what customers really want. Classic symptoms of this are over-

engineered products, muddled sales arguments, and idle capacity.

The best way to correct this situation, or avoid it altogether, is a

steady stream of information from the market. At companies with strong

marketing processes, knowledge of customers is detailed, fact-based,

broad, and collected systematically and never anecdotal. They always

use a mix of methods. The three most important are: discussions with

individual customers about existing products and their strengths and

weaknesses, customer focus groups led by a neutral third party, and

statistically reliable research and analysis.

Allen Bradley, a US subsidiary of Rockwell International and a

leader in industrial automation control technology, achieves customer

intimacy with very highly systematized core processes for collecting

and analyzing information. Customers are the main source of ideas,

and the company conducts a worldwide survey every year to get the

real facts about the pros and cons of its product lines. Suggestions

made by multiple customers are prioritized for action, and new prod-

uct concepts are monitored and developed with an idea tracking data-

base. The market intelligence department systematically adds to the

companys store of knowledge by doing reverse engineering of competi-

tive products and regularly combing the sales force and channels for

news.

Combining these techniques into systematic, cross-functional ap-

proaches gives excellent marketers both microscopic insights into

customer needs and a telescopic overview of the market and market

trends. Doing this involves far more than just going through the mo-

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ytions. Marketing-minded industrial companies succeed by paying extra

attention to detail and to intangibles. For example, a superior un-

derstanding of the power structures in their markets helped both Intel

and Gore-Tex to tap the value of ingredient branding creating brand

awareness among consumers, thereby generating a pull on their imme-

diate customers.

Walk in your customers shoes

The industrial companies that are growing profitably are the ones that

focus obsessively on their customers business needs. They put them-

selves in their customers shoes and think about how to help them

reach their customers. This helps them to identify the main points of

leverage to improve customers performance in the marketplace a

source of hard-to-copy ideas for even better products and services.

Cummins Engines, a US manufacturer best known for its engines

for tractor trailer trucks, pleasure boats, and mobile homes, gets close

to customers by sending out cross-functional teams for seven-day cus-

tomer walks (scripted on-site interviews) to bring back the informa-

tion the whole company needs to deliver superior customer value.

Cummins also measures marketing system performance against tough

external standards. The system includes six main processes that are

measured against best-in-class external benchmarks, for example,

AT&T for Customer Satisfaction.

Because they are fundamentally outward-looking, marketing-ori-

ented companies know their customers all the way down the value

chain not just their immediate channel or distributor, but also down-

stream processors, customers, users, and consumers. This often helps

them know what their customers need before the customers know them-

selves.

Some companies use their knowledge to team up with their imme-

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diate customers to create win-win solutions. US-based Mead Packaging

has grown, for example, by helping a brewery in South Africa to en-

hance its marketing activities. Arrow Electronics, a distributor of semi-

conductors to companies initially too small to buy direct from Motorola,

Intel, etc., has shaped its industry by extending its brand to its custom-

ers, contract manufacturers (CM), designating them Arrow-certified

CM, thereby giving them a reason not to switch to buying direct from

the major manufacturers. Taking a slightly different approach, Cummins

Engines has increased its bargaining power vis--vis its direct custom-

ers, the original equipment manufacturers (OEMs), by deliberately learn-

ing more about the consumers the people who actually drive the

tractor trailer trucks, boats, and motor homes than the OEMs do.

Look for new value horizons

An intense interest in and curiosity about customers helps excellent

marketers think broadly about how and where to apply the companys

strengths to create new value. The dimensions for expansion are multi-

ple: offering a new product or a product line extension, serving a new

region or a new industry, or a combination thereof. Gillette is an in-

structive example of growth driven by such an expansive mind-set in

the consumer goods industry. Its history clearly reflects an evolving

definition of the product markets in which it competes. From a solid

base in mens shaving products, Gillette expanded its horizons to mens

grooming products, achieving 24 straight quarters of double-digit

growth without missing a target, as Business Week noted when Gillette

announced a further expansion into personal use/personal care con-

sumer products.

Imaginative approaches in the business-to-business context often

lead to integrated solutions for new products, for instance, by enrich-

ing the product transaction with a variety of services (installation, main-

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ytenance, financing, and advice on processing) or, as another example,

offering not just a microscope, but an entire system for early disease

detection including computer, image processing, and other peripheral

equipment. The next horizon may be forward integration, taking over

operations for the customer. One supplier of heating equipment we

worked with now provides heating. It seized the opportunity to cre-

ate value by uniting previously fragmented activities from making

boilers to monthly billing. This cuts unnecessary costs and provides

customers and consumers with better value for money.

SAP offers an example of successfully looking for and finding new

value horizons in multiple dimensions. Its evolution from a local Ger-

man software house into the leading vendor of enterprise application

software is the result of a superb combination of excellent product

development, international expansion, and successful strategic alliances.

The touchstone of its expansion is a customer-focused vision centred

on using standard business software to address top managements need

for transparent financial data. From successful completion of its first

project in Germany, SAP evolved geographically, first to the other Ger-

man-speaking markets, then across Europe, then internationally, in each

case following a philosophy of being there locally for its major ac-

counts. Once established internationally, it focused on increasing its

resource network and deepening its relationships by forming partner-

ships in hardware, consulting, and service. It also used this stepping-

stone approach to build its customer base first in process industries,

then in manufacturing. It is now emphasizing joint industry solutions,

for example, in its development agreement with Microsoft, and build-

ing bridges into new customer segments, such as retailing.

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Pinpointing the right segmentsand customers

The strategic value of a good segmentation is that it makes it easier to

tailor your approach and thus monopolize customers in a selected

segment. With this approach and a good understanding of the market,

a company can influence industry trends in favour of its own profitable

expansion, even in highly competitive markets, for example, petrochemi-

cals and steel.

Markets can be segmented in various ways for different decisions

ranging from selecting a product/market strategy to optimizing sales

force deployment and channel management. At the most basic level,

what is important is that the segments reflect both customer conduct

and substantial earnings opportunities:

u From a marketing perspective, a good segmentation passes the

following tests: (1) Customers are classified by buying behav-

iours and needs into distinct groups whose members are simi-

lar and (2) the profile of each group suggests a practical course

of action for satisfying its requirements.

u From a business perspective, a good segmentation: (1) Contains

more than one segment offering a sizeable profit potential and

(2) at least one segment offers a good chance to build a com-

petitive advantage because its requirements can be met by a

capability that you already have (or can realistically attain).

What extra steps do best practice marketing companies take? How

do they differentiate themselves from ordinary performers? First they

come up with a macro-segmentation of the relevant customers by iden-

tifying and ranking customers key buying factors (as opposed to geo-

graphic location and demographics). Then they develop a micro-seg-

mentation by assessing existing and potential customers, account by

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Source: McKinsey

Buying factors Relative importance to customer, points

Non-price factors

Importance of buying factors

Technical service

Commercial service

Logistics

On-time delivery

Product range

Waste management

Technical service

Price/terms of payment

120

120

355

113

89

81

75

70

Figure 4

account, in terms of mutual customer-supplier attractiveness. This

knowledge expands the potential market by pinpointing accounts

which offer good chances of increasing volume and margins.

Macro-segmentation: identifying

and ranking key buying factors

An excellent understanding of market mechanisms lays the basis for

identifying the key buying factors (KBFs). Price may be a knock-out

factor in most industrial purchasing contexts, but successful marketers

keep in mind that, as shown in Figure 4, non-price factors such as

quality of product, logistics, and on-time delivery often account for 60-

70% of the customer decision.

Starting from a conventional regional/customer-industry segmen-

tation, a European chemical company that sells petrochemical prod-

ucts successfully redefined its approach to serving its main customers

in terms of the key buying factors quality, speed of service, and

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low price. The analysis helped managers recognize a latent strength

in technical advising that they could exploit in the high-tech, quality-

oriented segment. They also discovered an area of vulnerability in their

relatively slow delivery, which was driving another group of customers

to competitors.

The real challenge is not coming up with a list of relevant factors

such as quality and reliability, but understanding their relative value

to different customers in order to rank their importance in and across

segments. A useful tool for this is conjoint analysis, used to identify the

perceived value of product features in various combinations. Obtaining

the data involves detailed interviews with a number of customer deci-

sion makers to identify the relative importance of the factors associated

with a purchasing event. The rankings are used to group customers

with similar buying behaviour and preferences.

Within the segments (or, if you have few customers, for specific

accounts), you need to identify the things you can do that will build

customer loyalty. Identifying breakpoints increases in the perform-

ance of the supplier that will lead to a significant increase in the value

perceived by the customer helps excellent marketers decide where to

apply their energies and determine how much better they have to be in

order to beat the competition. Figure 5 shows the concept, using the

example of a machinery manufacturer. The first breakpoint was the

introduction of a 24-hour emergency service for its customers. The

second, which really provided the customer with added value, was mov-

ing to continuous remote diagnosis of the machinery, thus preventing

unexpected problems and downtime occurring at all. To take another,

classic example, Federal Express crossed a new benefit threshold by

providing guaranteed overnight delivery. It has grown so strong in North

America that you hear Just FedEx it nearly as often as the Nike

slogan Just do it!

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Performanceof supplier

Value tocustomer

Breakpoints

Source: McKinsey

Performance breakpoints concept

Figure 5

Micro-segmentation: evaluating each major account

in terms of mutual attractiveness

Besides determining what level of performance will offer the most value

to customers in each of the macro-segments, excellent marketers are

better able to target the customers that will be attractive for the com-

pany to serve. They develop this understanding by classifying and group-

ing accounts from two perspectives: supplier attractiveness to customer

and customer attractiveness to supplier. Figure 6 shows how these

two perspectives can be combined to form a matrix, which can then be

used to define and position the various types of customers and non-

customers. The object of the exercise will ultimately be to move the

customers and non-customers in the top left and bottom right squares

into the top right square.

This dual perspective is important because customer profitability

varies widely, and it pays to find out exactly where the profitable cus-

tomers are. In our experience, as much as 3040% of a typical indus-

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trial companys revenue comes from customers who are too expensive

to serve, as measured by pocket contribution margins. These customers

rarely provide enough other intangible value in the form of new ideas

or new customer referrals to compensate for the low or negative mar-

gins they generate.

Dropping unprofitable customers is the easy-to-understand extreme.

In competitive markets and when moving into new arenas, the dual

perspective helps companies plan ways to achieve higher volumes and

margins with their target customers by:

u Raising the profitability of marginal customers, using a combi-

nation of sales force productivity levers, channel management,

pricing, business scope expansion, and customer integration ac-

tivities.

u Improving the profitability and retention of attractive custom-

ers through key account management, customer loyalty man-

agement, and pricing.

Attractiveness portfolio

High

LowLow High

Attractiveness of supplierto customer Value delivery Price/benefit positioning Available alternatives

Attractiveness of customer to supplier Customer size/growth/profitability Repurchase loyalty

Content, lessattractive exist-ing customers

Attainable, butunattractivecustomers

Source: McKinsey

Attractive exist-ing customers

Attractive,attainable non-customers

Malcontentunattractivecustomers

Undesirablenon-customers

At-risk, attractiveexistingcustomers

Desired non-customers

Figure 6

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yu Enhancing the value proposition to high-potential customers

by improving both the value offered to the customer and the

ability of the sales force to communicate this value.

A common misconception is that focusing only on certain groups

of customers will rob a company of volume sales. This might occur

temporarily, but if the basic segmentation passes the business tests, any

loss will be offset by a better, more profitable competitive position in

core segments and correspondingly higher margins and higher sales.

As SAP and other companies show, this platform produces the ideas

and funds needed to successfully expand into new arenas.

Defining a distinctive value proposition

I dont know the key to success, but the key to failure is trying

to please everyone Bill Cosby

An exact understanding of customer needs and, building on that, a

well-thought-through segmentation give marketing-minded companies

what they need to formulate a distinctive value proposition. Again, the

point here is to draw firm boundaries between your product offering

and your competitors in ways that give you a distinct profile and thus a

natural advantage. As an executive at Mead Packaging put it Find a

strategy to play the game differently: dont just do what your competi-

tors do.

Examples from various industries indicate that persuasive value

propositions have clear strong points or spikes plus a few weak

points. This makes the value proposition more credible in the eyes of

the customers than claims to all-round excellence. The products with

clear spikes in their value proposition have much higher shares than

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those with a flat profile provided the spike is relevant to the cus-

tomer segment. To illustrate this: a sports car with very high perform-

ance has a more distinctive and credible appeal for sporting driv-

ers if the value proposition admits to the cars weaknesses in terms

of comfort, space, and ease of use. Figure 7 sets out the essential ele-

ments of a well-thought-through value proposition.

Offer the best price/benefit ratio

Customers do not buy simply on price; they buy on value, which is the

perceived benefits that a product provides minus the perceived price.

Checklist for value proposition

Benefits explicit, specific, clearly stated

Price explicitly stated

Target customers clearly identified

Value proposition superior for target segment

Evidence of adequate demand

Evidence of acceptable returns

Viable in the light of competitors value proposition

Achievable with minor changes in current businesses system

Clear and simple

Source: McKinsey

Figure 7

Benefits are defined here as the attributes of a product or service that

determine customer choice, such as product quality, features, perform-

ance, design, technical service and support, and sales staff competence

and friendliness.

To decide where to take a stand vis--vis competitors, best-practice

marketers use the value map, a basic tool for understanding value posi-

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Figure 8 Value map

Perceivedprice

Perceivedbenefits

Value disadvantage

Valueequivalence line

Value advantage

Sharegainer

Shareloser

Source: McKinsey

tion issues and opportunities, shown in Figure 8. The horizontal axis

quantifies the benefits that a product provides to a customer. The verti-

cal axis reflects its price. The dots on the map represent the price-

benefit positions of the offerings competing in the market.

In a stable market, perceived benefits will equal perceived price,

that is, there is a clear, logical choice for all customers at each price/

benefit level. Graphically, the competing alternatives in the market will

line up along a straight diagonal line, the value equivalence line.

In a turbulent market where market shares are changing, some

competitors will be below or above the value equivalence line. Over

time, competitors below the line will win share as they are perceived to

deliver greater benefits for the same price, or equal benefits at a lower

price, compared with competitors on the value equivalence line. Com-

petitors above the line will lose share as they are perceived to deliver

fewer benefits for the same price, or equal benefits at a higher price.

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Basically, there are two main points to observe:

First, the higher the price-benefit positioning, the more difficult

it is for competitors to copy. At the same time, a high positioning also

blunts competitive attacks that are based only on price cutting, made

possible, for example, by restructuring.

Second, repositioning along the benefits axis tends to damage prof-

its less than price reductions would. It is also easier to withdraw ben-

efits that are rejected by the market or are uneconomic to provide than

to try to raise prices after reducing them.

The value map sheds light on why some strategies that sound

sensible at first turn out to be major mistakes. Three common mis-

takes, shown in Figure 9, are:

1. The market leader introduces low-price products, but leaves

the benefit level too high, resulting in cannibalization of the

Value map mistakes

Perceivedprice

Perceivedprice

Market leader in-troduces low-endproduct but leavesbenefit level toohigh

Value-disadvan-taged player justlowers price to getback to value equi-valence line

Leader upgradesproduct but doesnot raise priceto match ...

resulting in can-nibalization of leadingproduct and a down-ward shift in priceacross markets

and takes hugeand sustained loss inoperating profit

resulting in adownward shift inprice across markets

Perceived benefits Perceived benefits

Source: McKinsey

Figure 9

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yleading product and a downward shift in price across the whole

market.

2. A player at a disadvantage over value just lowers price to get

back in line with competitors, and takes a huge and sustained

reduction in his operating profits.

3. The leader enhances benefits but does not raise the price com-

mensurately, resulting in a downward shift in price across the

whole market.

Excellent marketers naturally also take into account the fact that

customers do not necessarily view benefits and prices in a linear way.

Just as there are price-capped accounts that cannot spend beyond a

stipulated limit (often found in the public sector), there are benefit-

bracketed customers who explicitly want minimum or maximum ben-

efit levels and find other combinations unacceptable.

Move from selling to consulting

In marketing-minded companies, marketing and sales people think and

act like business consultants. Their offering is not limited to selling a

traditional product line, but aims at solving a problem or capturing

an opportunity linked to the suppliers product portfolio. For more

conventional sales people, the transition to consulting means thinking

much more actively about how customers currently use products (or

could use them). Excellent marketers continually expand this knowl-

edge and make it readily available to the sales force.

For example, some years ago, a software house developed a sys-

tem that dramatically increased transmission volume per time unit

in telecommunications networks. Despite the products undisputed tech-

nological superiority, the market did not respond initially. It was only

after the software vendor had made a significant investment in market

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research and developed sales support materials that explicitly described

the benefits of the product for customers, outlined ways for customers

to capture business opportunities with the product, and enabled sales

people to calculate customer-specific profits that the new system finally

took off.

With this understanding of the product, the suppliers sales peo-

ple approached customers much more successfully. When describing

the customer benefit, they emphasized how the system helped to im-

prove effectiveness and efficiency in the customers day-to-day business.

In explaining how to capture the benefit from the customers point of

view, they made specific suggestions for consumer marketing to increase

the customers market share. Finally, with clear-cut calculation of the

value to the customer, they demonstrated that using the suppliers prod-

ucts would generate additional profit for the customer.

For a typical order, the benefits for the supplier were threefold:

u First, by presenting a complete picture of an attractive business

opportunity in effect, a revenue stream that can be bought

by purchasing the new system the supplier easily persuaded

the customer not to spend a lot of time and effort haggling over

price, as it only represented 35% of the total system costs (and

an even smaller share of the projected sales).

u Second, the suppliers demonstrated understanding of the mar-

ket as a whole not just one corner of it thoroughly im-

pressed the customer and led to a new level of trust in their

professional relationship, raising barriers to entry for the sup-

pliers competitors.

u Third, as a by-product of the trust-based relationship, the sup-

plier gained an excellent source for replenishing the idea pipe-

line for more business.

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yAs the examples suggest, setting the stage for profitable growth is

nine-tenths driven by fact, not by fancy. A large measure of the success

of excellent business-to-business marketers is due to their consistently

taking a more systematic and penetrating approach at each stage of

strategy development, from researching and segmenting the market to

defining a distinctive value proposition.

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Operations: Putting theOperations: Putting thesystem in placesystem in place

Once the stage is set with a good marketing strategy and product defini-

tion, how do you uncover specific opportunities to grow profitably?

How do you decide which marketing levers are key profit drivers for

your business? What is the best way to apply them for the highest

economic payoff?

In answering these questions, it helps to consider the type of busi-

ness you are in. In our work, we have found that if you analyze indus-

trial businesses in two dimensions the degree of product standardiza-

tion and the average order size three types of businesses emerge:

standardized products, systems, and project-based businesses.

In Figure 10, the three types of industrial businesses are arrayed

along a continuum with consumer goods. While this perspective over-

looks many details and differences, it also raises some useful questions.

For example: in what ways could you standardize your products or

parts of the business system to build an advantage in cost-efficiency or

consistency of execution? How could you increase your average order

size, or how vulnerable are your orders to being shrunk or un-bun-

dled by customers or competitors?

This way of thinking cuts through the clutter to the most powerful

marketing tools for your business. For each type of business, we have

given the toolkit a thematic label to describe the richest source of ideas

for competitive differentiation.

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sFor standardized products , which are most beset by the problems

of commoditization, the predominant theme is learning from consumer

goods; in other words, from the branding, channel management, and

product management approaches that work to make everyday items

like cars or microchips distinctive.

In system businesses , where the customers capital investment is

typically combined with recurrent, and usually more profitable sales of

services, the central theme is understanding both the whole and the

parts and, on that basis, profiting from integrated solutions over the

total investment lifecycle through creative product bundling and pric-

ing.

Type of business

Source: McKinsey

Selling tailoredprojects to a few well-known customers

Selling complexproducts to morecustomers

Selling largelystandardizedproducts tolargely unknowncustomers

ConsumergoodsbusinessesSelling fullystandardizedproducts to themass market

Large Medium Small

Low

Med

ium

Hig

hD

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pro

duct

sta

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Average size of transaction

Project-basedbusinesses

Systembusinesses

Standardized productbusinesses

Figure 10

For project-based businesses , where most deals are mega-deals and

customers are usually few in number and well-known, the predominant

theme is providing economic value to the customer typically a group

of decision-makers. While any business must provide value to survive,

the special importance of this theme in project-based businesses is that

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the complexity of the potential investment often makes it a black

box for customers. The competitor who is most likely to get the order

is the one who can identify and effectively communicate the potential

value of the investment in practical terms.

The approaches discussed in the following sections are not ex-

haustive. They are real examples, intended to highlight ways to apply

and adjust the settings of three main operational levers of marketing,

namely, managing customer access, pricing to capture economic sur-

plus, and branding or communicating the value. We discuss these le-

vers for that type of business in which they are especially relevant for

profitable growth; this does not necessarily mean they are unimportant

for the other types of business.

Standardized product businesses:learning from consumer goods

How many people know the name of even one of Intels or Gore-Texs

main competitors? How come Compaq is growing fast whereas Apples

market share is shrinking, despite a technically superior product? What

powers Hewlett-Packards growth? All these companies are successful

suppliers of standardized products who support their ability to offer an

ever-better price-benefit ratio with great marketing skills.

As in the consumer goods sector, standardized product businesses

are characterized by a fairly large number of anonymous customers who

individually do not influence the design and manufacturing of a

product. The excellent companies in this field are typically distinguished

by three characteristics, which they share with excellent consumer goods

companies:

u They stabilize existing business and create opportunities for

future growth by creating and cultivating strong brands

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su They design their channel configurations to ensure distribu-

tion power that is unparalleled within their industry

u They invest heavily in understanding customer value and ar-

range decision processes around this competence often a prod-

uct management function.

The value of a strong brand

In the consumer goods industry, active management of a brand and

using it as a vehicle for growth is a core management activity. In indus-

trial settings, branding is less common, but can be just as powerful. A

strong brand can play different important roles. It can serve:

u As a shorthand emblem, representing a promise of superior

customer value to those buyers who have no time to investigate

the differences between competing products

u As a security provider for managers who have to take a risk

using the product and want to be on the safe side

u As a swayer that tips the scales in the customers mind in fa-

vour of the promise reflected in the brand name

u Or as a saviour to the supplier, maintaining sales even when,

for a limited time, product features fall behind those of com-

petitors.

An example of how brands work as a shorthand emblem and secu-

rity provider is ingredient branding or co-branding, which has be-

come a buzzword thanks to Intels success with Intel inside. Ingredi-

ent branding puts pressure on PC OEMS; vendors who do not use Intel

chips are perceived as scrimping on quality. After Intel inside was

introduced, the share of buyers who preferred a PC with an Intel chip

jumped from 60% (1992) to 80% (1993), making Intel the third most

valuable brand in the US, after Coca-Cola and Marlboro. Intel also

benefited from the power of its brand name as a provider of security

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and as a swayer in the case of the Pentium. This brand was introduced

by Intel because Cyrix and AMD could not be forced to stop cloning

the 386 and 486 chips (a court ruling prevented Intel from trademarking

those numbers). Successful exploitation of the Pentium chips intro-

duction has greatly strengthened Intels position in the market.

We have recently done some 13 studies on the impact of a brand

name on customers decisions in business-to-business marketing acrossa

range of industries. The results are summarized in Figure 11, which

makes it clear that the brand name itself plays an important role in

the customers decision.

Figure 12, based on research with various clients, shows the rela-

tive importance of a strong brand identity in different markets.

In many cases, Original Equipment Manufacturers (OEMs) can

also benefit from branding standard products to create a pull effect to

support existing push concepts. Take a product as mundane as water

taps. Fifteen years ago, it was the plumbers or contractors who selected

Figure 11Relative impact of brand name on customers decision

Source: McKinsey

Percent

Factors influencingcustomer decision

Brand name

The influence of brand nameranges from 7% to 26%

100

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82

Other factors Product Service Price Channel Other

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ssuch fixtures for a construction or renovation project. Under pressure

from the trends to do-it-yourself work and design quality, Grohe,

the dominant supplier in Germany, worked to establish a strong brand

name among consumers and further documented its success by going

public. This effort created a pull effect that helped the company double

sales in seven years.

The Intel and Grohe success stories are still fairly unusual, illus-

trating the fact that, in industry, branding initiatives have mostly been

undertaken as a defensive reaction to competitive pressure. Thus, a lot

of potential is still untapped. In a market research study some years

ago, people entering a car repair shop were asked which company they

thought was the best maker of brake linings. More than 50% said Bosch,

the brand name of Germanys largest auto parts supplier. They also

said that they were willing to pay a premium for Bosch quality. The

only problem was that Bosch neither made nor sold brake linings. Could

it be that your own brand is underutilized as well?

Figure 12 Relative importance of brands for purchasing decision

Source: McKinsey

Type

Importance for purchasing decision by industry, percent

Telecom mobile

Telecom international calls

Airline

Electronics computer

Electrical utilities

HMO

Electronics computer

Electronics computer

Telecom mobile

Brand importance

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Creative channel concepts to increase

distribution power

In addition to branding, many companies would benefit from thinking

more boldly about channel management. Few push beyond the conven-

tional questions such as Should we have a direct sales force or sell

through indirect channels? Weve experienced a huge drop in prices;

how can we reduce the sales margin of our dealers or retailers? Do we

really have to spend so much on sales support, advertising/promotion,

etc.?

Questions like these are certainly worth asking. But in practice

they tend to distract managers from the full spectrum of options avail-

able. In a sample of fifty companies we found that increasing efficiency

and effectiveness allowed the successful, fast-growing companies to re-

duce the number of sales employees per value-added by 44 % within

seven years, whereas their less effective competitors added another 43 %

more sales employees without realizing the desired impact. The excel-

lent marketers became effective by building more rigour and discipline

into their customer-facing activities, no matter whether these concerned

their own sales forces or their partners, by:

u Exerting control over the purchasing event to ensure consist-

ency between mission and execution

u Programming operational excellence into the sales-and-service

network.

Focusing on these activities when designing their channel configu-

rations has made successful companies more effective in achieving su-

perior growth performance.

Control: vital to ensuring customer value

Control refers to the influence that the supplier exerts over the pur-

chasing event. Control instruments help the supplier make sure that

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scustomers are consistently treated in ways that conform with a superior

understanding of customer value. Contrary to popular belief, exerting

a strong influence on distribution channels does not necessarily mean

having a direct sales force. Control methods can also be executed with

a well-functioning franchise system, or other indirect channel approacher.

For instance, Braas, a construction materials supplier based in

Germany, exemplifies the approach of a number of other excellent

marketers of standardized products. It exerts a strong control over the

customers purchasing experience by applying control instruments in-

cluding appropriate contract design, effective training for sales people,

powerful argumentation support for front-line people, efficiently com-

puterized order processing, and detailed rules for those business proc-

esses that can be designed and managed centrally, and tough monitor-

ing of execution and customer satisfaction levels. Customers are served

exactly the way Braas wants them to be and keep coming back. Since

1990, the company has been growing from DM 790 million in rev-

enues in 1988 to over DM 2.7 billion in 1998.

Figure 13 uses a client example from the electronics industry to

show how more successful companies concentrate on working with the

leading distribution partners in a region. They also spend over twice as

much, relative to turnover, on support for their distributors.

Rather than trying to decide on one right approach, be it a

direct sales force or other solution, it is far better to give internal and

external partners identical instructions and measure their performance

against the same targets so that the performance of good external deal-

ers and good sales employees is essentially identical. To be sustainable,

it is best to combine top-down control over distribution with front-line

training and support programs to spread excellent execution at the

direct customer interface.

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Programming operational excellence

Programming operational excellence refers to the systematic transfer

of internal or external best practices throughout the distribution net-

Figure 13Concentration on leading distribution partners

Source: McKinsey

Distribution partners by regional market position

Number >5

100% = 300 regions

Number 5

Number 4

Number 3

Number 2

Number 1

Spending ondistributor supportPercent of turnover

No distribution partner

Less successfulcompany

Successfulcompany

1.1% 2.6%

In 70% of theregions thesuccessful com-pany cooperateswith the regionalNo. 1 or 2distributor

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318

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work. The basic approach is probably best exemplified by McDonalds,

which offers customers the same quality, friendliness, and cleanness

worldwide and invests heavily in the roll-out of internal best practice.

Toyota in the US takes a similar approach upstream with suppli-

ers, having set up the Bluegrass Association as a way of systemati-

cally transferring good ideas from individual suppliers to the group as

a whole. Downstream with dealers, Toyota also arranges meetings and

provides information via in-house magazines, one for its industrial equip-

ment dealers and one for car dealers. Both publications summarize

media coverage of Toyota models for example, J. D. Powers scores

translated into punchy graphics that dealers can show customers; they

also disseminate best practices among dealers for example, the excel-

lent call-centre operations of a dealership in the Pacific-Northwest.

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sApproaches like these can be adapted to program your sales or

service network for consistent excellence. Adopting a programmed ap-

proach helped a country-wide service network with around 50 loca-

tions in Europe increase its profit contribution by some 15 percentage

points. The basic steps this company took are also transferable to sales

forces as well. First, every site was measured against a set of very specific

key performance indicators to obtain a company-internal ranking. Then

each location was given targets. One target for the best locations was to

collect and test new ideas from other countries and industries as the

basis for upgrading internal best practice. They worked on Internet pilot

projects and also visited international best-practice companies in other

industries. Below-average locations were told to shape up by applying

the internal best-practice concepts in all processes, for example, in han-

dling customer reception and local promotional spending.

Smart programming directed from the centre but with consider-

able responsibility delegated to local managers and supported by rel-

evant training modules helped even service locations in supposedly

bad regions become highly profitable centres with strong growth.

The momentum is being maintained by regular events to exchange

experience, systematic controlling, research into the effects of changes

made, and new, specific targets supported by appropriate incentives.

Sometimes all it takes to get started is a simple question that, typi-

cally, only the excellent business-to-business marketers can answer: What

is the spread between best-in-class sales people or outlets in the industry

as a whole and our average performers?

Entrepreneurial product management

If they are to pay off, heavy investments in the development of a new

product or product line, in new channel concepts, and in manufactur-

ing processes and tooling obviously have to be based on a thorough

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understanding of the features customers are willing to pay for. Yet,

for standardized products, customers are typically anonymous, and it

is often not obvious not even to the customers what features they

need. The potential impact of making the effort to get close to your

customers, so as to find out what they want is shown in Figure 14.

Overall, successful companies spend over twice as much time with their

customers as do less successful ones.

In consumer goods companies, the task of managing customer

value from identifying it to getting it designed and produced and

communicating it to customers is performed by brand or product

managers. Dedicating an entrepreneurial individual to oversee product

management is how marketing-minded companies create and reinforce

the shared vision that guides people in a thousand different ways all

along business system from channel managers to R&D and produc-

tion operations to consistently deliver superior value.

In many functionally organized industrial products companies,

Product managers time with customers

Source: McKinsey

Hours spent with customer by activity, in %

Other activities

Troubleshooting

Sales support foractual orders

Discussion ofproduct/marketstrategy

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18

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42

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29

3

100% 100% = total hours spent with customer

x 5

Figure 14

Less successfulcompany

Successfulcompany

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showever, there is no one to manage these activities, as marketings job

is defined narrowly, for example, in terms of organizing the companys

participation in trade fairs and writing press releases. If product man-

agement is in place at all, it is often driven by product technology, not

by customer value.

For an electrical appliances maker, we borrowed from consumer

goods companies the concept of strong product managers smart engi-

neers with proven management skills who work closely with the CEO

as entrepreneurs (business builders) for distinct customer segments.

Their task is to resolve cross-functional conflicts into solutions that

provide superior customer value for their assigned segment.

Asking the right questions turned up surprising answers that pointed

the way to profitable growth. Previously, the company had been ex-

tremely proud of its reputation for exact fulfilment of customer specifi-

cations, but had seen its market share slip within three years from 21%

to 17%. A lost-order analysis showed that its highly customized prod-

ucts had lost ground mostly against cheaper off-the-shelf products.

At this point, the company contacted us for a fresh perspective. It

was decided to undertake a major market research effort, including

techniques such as focus groups and conjoint analyses. For top manage-

ment, the results were completely counter-intuitive.

Technical features whether customized or standardized were

not a key buying factor at all. Furthermore, the market research tech-

niques borrowed from consumer goods marketing showed that there

were actually two fairly distinct segments. The shrinking Segment A,

which contained many of the core customers, gave the highest ratings

to extended warranty and brand followed by specification sup-

port. Segment Z smaller but growing gave the highest ratings to

delivery within 2 hours and ease of installation. Thus, what the

company really needed to do was to differentiate not what it supplied

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but how. Without product management, there was simply no one there

to look at the links between plant logistics and customer value.

Some industrial companies are already meeting the two main chal-

lenges of successful mass-marketing: gathering and translating anony-

mous customer data into a vision of customer value and pushing this

vision consistently through the entire organization from channel man-

agers to R&D and production operations. These are the companies that

are attracting and retaining talented people people who can interpret

market data in value-creating ways, have a feeling for business, and can

provide inspiring leadership.

System businesses: profiting fromintegrated solutions over the wholelifecycle

Otis, the US-based maker of elevators, is a pioneering system seller. It

evolved early on into a provider of integrated solutions over the total

life of its equipment, including engineering, intelligent monitoring sys-

tems, pre-emptive maintenance services, and trade-in and rebuilding of

used equipment. Management characterizes the transition as a shift in

corporate mind-set from manufacturing elevators to transporting

people. This shift has strengthened Otiss already dominant and profit-

able position. Of a total of 3 million elevators in service worldwide in

1995, 1.2 million were from Otis. More importantly, the company is

able to win service contracts where most of the profit is to be made

on 80% of its new installations, far above the industry average of 60%.

Like Otis, companies in the system business have typically inte-

grated product-and-service business systems under one roof, and their

bundled offerings play an integral role in their customers business

systems. What system offerings have in common is that the initial equip-

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sment sale serves as an installed base for follow-on sales. Combinations

can range from hardware plus software (a solution), hardware, soft-

ware, and services (a solution that works), to hardware, software,

services, and operations (a solution that works inside the customers

operations). In this context, hardware refers to the product or equip-

ment elements, whereas software refers to items needed to operate the

system; that is, not only computer software in the strict sense, but also

supplies such as packaging materials in the case of Tetra Pak filling

lines in the food industry or chemical reagents for diagnostic analyzers

in the health care industry. Services includes spare parts supplies, main-

tenance, training and consulting.

To achieve sustainable profits that provide a return on the knowl-

edge embedded in the complete system, system suppliers need to base

their marketing efforts on lifecycle economics the value that can be

extracted from the system throughout its working life. The crucial

marketing levers for system business suppliers are:

u Designing integrated solutions to address opportunities over the

entire lifecycle of the system

u Applying value and transaction-based pricing together with risk

management concepts to optimize total lifecycle profits.

Designing integrated solutions

If suppliers of standardized products sell customers an off-the-shelf

value proposition, the proposition for systems suppliers is a tailored

fit over a series of transactions. Success for the supplier depends on

analyzing the customers business system in sufficient detail to identify

the points where the suppliers offering can make the biggest contribu-

tions to lowering the customers costs, increasing his revenue, or both.

This information is critical for assembling the parts of the system into

an integrated solution one that both gives the customer an invest-

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ment providing a superior net present value, and also generates an

adequate return for the supplier. This should be done by tailoring a

combination of standardized modules, rather than making changes to

the modules themselves. Ideally, providing the promised value over

time will lock in the customer and open doors for additional follow-

on sales above and beyond the contents of the initial system bundle.

To grow, and as a hedge against the uncertainty over follow-on

sales, system suppliers must constantly revise the way they define their

products and expand them into packages for specific customer segments

or accounts. By doing this they will be able to develop increasingly

strong relationships with their customers. In selected cases, this will

extend to partnering, in which buyer and seller agree to change how

they do business, jointly control some part of their mutual business

system, and share in the benefit.

Adaptation and tailoring also underlie the process of recycling the

integrated solution through second-hand sales. Second-hand sales can

be a good way to get market intelligence and start developing relation-

ships in emerging markets, laying the basis for new equipment sales. A

supplier of press systems for fruit-based beverages who is pursuing this

approach to expansion expects it to pay off in profitable new system

sales as the emerging markets mature, and is already earning a slight

profit on the second-hand business. The process is shown diagramatically

in Figure 15. By moving second-hand equipment into an emerging mar-

ket, not only does the supplier create room for new sales in the mature

market; he also gains a foothold in the emerging market, which would

be impossible with new products. He is thus well placed to build rela-

tionships as the market matures, until the point at which he can start

selling new equipment into it.

Services play a preeminent role within the system suppliers offer-

ing and are the strongest lever for growth and profitability. For system

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suppliers, services normally account for 20% to 40% of total revenue,

and a much larger share of total profit. Over the lifetime of the equip-

ment, services can generate revenue of three times the original pur-

chase price. In a survey of industrial companies in Germany, we found

that the service-minded companies have been able to grow their serv-

ice businesses by more than 5% a year, earning a return on service sales

of up to 40%.

Growth in services is achieved by continually renewing this part of

the overall solution and adapting it to the needs of new and existing

customers. It is made easier by the continuing trend among customers

to outsource non-strategic work. Successful ways of expanding the serv-

ice range may thus include full-service modules and preventive mainte-

nance contracts over the life of the original equipment and third-party

systems, scrapping of third-party machines, scheduled retrofits or up-

grade releases, overall project management and systems integration.

They may also go beyond the system itself, to include operator support

and training, advising on matters of design (e.g., food packaging or

Second-hand business

Phase 1Sale of second-handequipment toemerging markets New sales in mature

markets

Time

Market maturity

Newsales

Second-hand sales

New sales

Source: McKinsey

Phase 2New sales in emergingmarkets New markets for new sales Good competitive position

on account of existingcustomer relationship

Figure 15

Customer acquisitionand establishment ofrelationships in emergingmarkets

Support for marketdevelopment

Mature markets

Emerging markets

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drive-train layout) or business administration, and even operating

equipment on behalf of the customer. Waste treatment, for example,

has evolved into just such a make-and-operate business.

Improving service performance offers further possibilities for ex-

panding and tailoring a distinctive systems offering. Traditional service

approaches, which often have local service technicians and service sta-

tions responsible for assigned regions, can be supplemented, stream-

lined, or even completely replaced by solutions based on mobile serv-

ice crews for optimum customer support, remote diagnosis via phone

lines or satellite, expert systems for diagnosis by machine users, or

maintenance initiated by early-warning systems. For example, Otis has

developed sophisticated equipment to track elevator usage on an ac-

tual operational basis by measuring operations instead of using calen-

dar-based record keeping, as this is a more accurate predictor of serv-

ice requirements and cost.

Optimizing lifecycle profits

For industrial businesses, we have found that a 1% price increase re-

sults, on average, in a 12% improvement in a companys operating mar-

gin. This is four times as powerful as a 1% increase in sales volume.

Not surprisingly, industrial companies that excel at pricing have been

able to increase their return on sales by 37%.

The pricing challenge for system suppliers lies in setting a profit-

able price for a multi-stage moving target. Because utilization rates

and inherent business risks differ, potential lifecycle profits will vary

among customers, even for similar systems. The marketing task here is

to first understand customer potential measured in expected lifecycle

profits (calculated as net present value) and then to develop and com-

municate integrated pricing and risk management concepts that reflect

this potential.

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sApplying value-based pricing

Because the customers initial purchase is only one source of the total

value that the system is expected to produce over its lifetime, systems

pricing is also bundled, that is, it has to reflect not only the original

equipment sales, but also the net present value of all subsequent serv-

ices over the lifecycle of the system. The cost involved in getting an

installed base into place is often subsidized by the margins on the fol-

low-on sales, in order to achieve an overall package price that is attrac-

tive to the customer. Figure 16 shows a sample lifecycle profit calcula-

tion for a company operating in the assembly sector.

The value to the customer (which equals perceived benefits minus

perceived price) and the target margins obtainable are determined by

comparing the offerings strong and weak points with competitors, tak-

ing into account competitors pricing, and alternatives in the product

segment. For example, a company in the packaging industry succeeded

in beating the market leaders ink jet technology with its laser marking

system (despite the competitors lower initial price tag) because the

sales staff were able to communicate effectively that the laser system

allowed higher packaging speed with lower failure rates and thus less

downtime and lower lifetime running costs for the customer.

Value-based pricing is also relevant for spare parts. Through com-

puter modelling of customer preferences and the effects of the suppli-

ers own and competing products on customer economics, a supplier of

electronic systems saw that its approach to pricing spare parts was leav-

ing money on the table. It now determines the value of spare parts to the

customer by looking at two key dimensions. As shown in Figure 17, the

company calculates the cost of failure for the customer due to stock-

outs. Failure costs are identified as loss of production, loss of products,

additional labour costs, and rework costs. It also considers the alterna-

tive sources of supply available to the customer. As a consequence, it has

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reduced prices of certain commodity-like parts to prevent customers

from defecting to low-price third-party suppliers, and now charges higher

mark-ups on the complex components that are essential for continuous

operation.

Including a risk management component

In view of the uncertainty inherent in pricing today for performance

in the future, leading systems suppliers are including risk manage-

ment elements throughout the entire lifecycle of their offering. Risk

management systems, including risk-based pricing and early-warning

systems, are used to monitor profitability, quality, timeliness, or other

relevant factors. For both customer and supplier, the negotiated price

must take into account the systems value versus the risk incurred over

its service life.

An illustration of how risk management can be built into the price/

performance equation is provided by a manufacturer of electronic chips.

Profit over life cycle

Source: McKinsey

Net present value of discounted cash flows, US$ thousand

Equipment

Service contracts

Spare parts

Software (materials/components)

Total profit

180

650

170

210

850

Figure 16

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Its management was reluctant to invest in a particular production

line, despite the immediate benefits it offered, on account of concern

about increasing dependence on a single supplier. The supplier of the

production line agreed to provide a performance bond that guaranteed

that the system would continue to incorporate state-of-the-art technol-

ogy; the chip maker was then able to commit to purchasing a specified

number of systems.

Proactive risk management on this pattern is becoming an impor-

tant element in customer partnering strategies, creating win-win ap-

proaches to overcome common customer objections. Leading practi-

tioners set and communicate prices with a risk management compo-

nent to share, reduce, or provide insurance for the risk. Boeing has

recently begun designing multi-year, multi-unit contracts with several

major airlines as a way of reducing both parties financial risks. In this

way Boeing has secured a more predictable revenue stream, which

Figure 17

Value-based pricing of spare parts

Source: McKinsey

LowConsequences of failure at customer

Medium High

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ome

Few

/non

e

12

Sales price as factor of production cost

12

12 23

23

23

High price/margin

Low price/margin34 34

34

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enables more accurate planning of its enormous capital outlays. In

return, the airlines receive a price discount and service advantages,

both useful in the highly competitive market for air travel.

Reducing hidden transaction costs

Due to the more complex and long-term nature of system busi-

nesses, hidden transaction costs significantly influence the attractive-

ness of individual transactions. We estimate that up to 30% of revenue

is lost between the official list price and the suppliers pocket price, the

money that the company retains. Top system suppliers prevent such

revenue leaks from destroying their profit margins with the help of

pocket price analysis and marketing information systems designed to

report both on and off-invoice discounts.

The identification of transaction pricing opportunities begins with

an extended pricing and profitability analysis that includes all discounts

and costs incurred by an account. For a metal treatment systems manu-

facturer, for example, as shown in Figure 18, the pocket price water-

fall was a cascade of harmless-looking on-invoice elements (standard

channel and order size discounts) and off-invoice elements (acceptance

testing, adaptation, equipment give-aways, performance guarantees, war-

ranty extensions). Their full impact was significant: the final pocket

price was 31% off the list price.

To improve profitability, the largest sources of differences must

be identified (such as discount elements and service and distribution

costs), and the dimensions along which the difference is most relevant

(such as account size, industry segment, or type of selling arrangement).

For example, a surface coating equipment provider was surprised to

find that it was incurring significant costs due to a large customer who

systematically exploited the companys lack of management in the ar-

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seas of contract formulation and advisory services. These items were

not specifically defined or priced, but were being over-utilized by the

customer.

Pocket price waterfall

Source: McKinsey

List price

Competitive discount

Unbilled freight cost

Invoice price

Production-driven changes

Customer-driven changes

Handling for small orders

Forex losses

Pocket price

100

3

5

92

4

5

6

8

31%31%69

Figure 18

Project-based businesses:providing economic value to the customer

Since 1993, Ericsson Australia, a local subsidiary of the leading Swed-

ish telecommunications equipment supplier, has transformed itself into

a world-class benchmark for customer partnerships based on providing

real economic value to the customer. This change has meant a shift in

focus and accountabilities from products and tasks to customers and

end users in other words, to creating value that adds to customer

success. The old functional silos have been replaced with teams de-

fined by business and customer value, and people policies are marked

by a high level of trust and empowerment.

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What triggered this fundamental transformation? Obviously, a

fierce desire to stay competitive in a rapidly changing industry

environment a challenge that also faces other project-based

businesses, such as plant engineering or heavy machinery construction.

They all look back on a very stable and profitable past, in which they

needed to maintain a high level of technological expertise, but did not

necessarily focus on economic value to the customer.

Much of this has changed. Deregulation and privatization force

existing customers to invest more cautiously while new customers from

the private sector focus on the economic bottom line from Day One.

Technological change generates new business opportunities, but in turn

it also opens once-protected market segments to new competitors. Do-

mestic markets are increasingly saturated; emerging markets in Asia

and Latin America are hotly contested.

These changes have dramatic consequences. Seemingly overnight,

profitable core businesses are at risk, familiar sales processes fail to

work, traditional organizational structures crack with age. To respond

to these challenges, suppliers have to fundamentally refocus their mar-

keting and sales approach towards consistently providing economic value

to the customer. In our experience, two skills are critical factors for

success:

uMastery of flexible processes that will enable a company to sys-

tematically discover and develop new business opportunities

jointly with leading customers

uMastery of communication skills and methods that will enable

it to communicate the value to the customer effectively.

Joint development of new business opportunities

Dynamic industry environments offer many growth opportunities

shrouded in much uncertainty about which ones are worth developing.

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sTrying to make more accurate forecasts of the future seldom helps

more often than not, the figures turn out to be wrong. A more promis-

ing approach is to work with key stakeholders in the industry to de-

velop a common understanding of the major trends in technology and

consumer behaviour. The result is often a joint strategy based on shared

and thus robust hypotheses. Cooperation spreads the risk o