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.
Busi
ness
-to-B
usin
ess M
arke
ting
Busi
ness
-to-B
usin
ess M
arke
ting
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
101
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.
Ope
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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
egre
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pro
duct
sta
ndar
diza
tion
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
18
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
16
21
21
26
26
14
12
12
7
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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
166
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16
21
9
4
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.
3
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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
33
10
18
50
42
15
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
Man
yN
ubm
er o
f alt
erna
tive
sup
plie
rsS
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