Archive for August, 2010|Monthly archive page
When it comes to large companies changing and adapting to new conditions, conventional wisdom especially around Disruptive Innovation theory, is not optimistic:
- Due to a number of factors including size, reward systems and culture, it is extremely difficult for large companies to reinvent themselves.
- For change to be successful, companies need to bring in outsiders untainted by functioning in the culture.
- Since change has a low probability of success, firms should concentrate on their key competencies and customers and be cautious about moves beyond their core.
A recent study out of Stanford’s Graduate School of Business on IBM’s successful transformation from hardware to solutions provider challenges the above thinking and suggests that large companies are well-suited to reinventing themselves.
Back in 1999, IBM was a large company facing significant financial and market pressure and an uncertain future. Internal analysis revealed that the company had failed to capture value from 29 separate technologies and businesses that where internally incubated. Examples included the first commercial router (Cisco later dominated that market), new technologies to accelerate web performance (Akamai captured this market) and desktop PCs (Dell and Compaq took over this business). The Stanford authors summed up IBM’s issues this way: “The maniacal focus on short-term results, careful attention to major customers and markets, and an emphasis on improving profitability all contributed to the firm’s ability to exploit mature markets — and made it difficult to explore into new spaces. The alignment that made the company a ‘disciplined machine’ when competing in mature businesses was directly opposite to that needed to be successful in emerging markets and technologies.” Not surprisingly, this assessment may sound familiar to other executives.
IBM understood that their traditional business model was unsuited to capitalize on emerging technologies and market opportunities. So, what did they do to change? Use their global size, client & channel intimacy, and substantial resources & talent to their advantage while ignoring the cliché that large companies can’t be agile.
To focus sufficient management attention and resources, IBM situated its new technologies and products in a new, measurable line of business called the Emerging Business Organization (EBO). In the past, high potential technologies and products were lost in the shuffle when they were sprinkled across traditional business units. In addition, IBM put internal, experienced managers at the top of the new business units, a sharp departure from past practice. These managers had some key advantages that were crucial to success. They knew their way around the company, they had internal credibility and they were proven leaders. The logic of the earlier strategy was that younger leaders would be less imbued with the “IBM way” and more likely to try new approaches. More often than not, those leaders failed. As well, IBM cycled top managers through the EBO, helping cross-pollinate new products, technologies and processes throughout the entire company. This built internal awareness of EBO products, drove cross-selling and triggered new innovation. Finally, IBM’s used its strong cash flows to put its money where its mouth was. They properly invested in the EBO and its initiatives from R&D through to product commercialization.
These innovations have generated impressive results. Between 2000 and 2005, EBO projects added $15.2B to IBM’s top line. When compared to IBM’s M&A strategy at the time, EBOs added 19% to IBM’s top-line while M&A delivered 9%.
As the IBM case shows, scale and pedigree can be significant weapons to enabling change. Indeed, other companies such as P&G, J&J and Corning have successfully followed a similar approach to reinventing their business model or shifting product focus. When it comes to change, size does matter.
For more information on our services and work please visit the Quanta Consulting Inc. web site.
During recessionary times, most companies focus on maintaining market share and margins by slashing prices and cutting costs to the bone. However, this is a shortsighted strategy for all but a few firms. For one thing, only a small number of categories can support more than one low cost “value” brand. Moreover, it is extremely difficult for any firm – outside of those with the largest scale economies – to achieve and sustain a leadership cost position. As a result, competing on price turns into a Faustian bargain: battle it out with other price cutters (who usually have the same access to technology and supply chain) to keep market share while watching your profitability erode.
Harvard Business School researchers Frank Cespedes, Benson P. Shapiro, and Elliot Ross suggest another approach, Performance Pricing, which offers companies a way to increase profits and maintain if not grow share. Traditionally, most managers set prices according to simple but crude cost-plus or average pricing policies or merely follow competitive moves. PP is a different strategy. It sets price levels based on the functional and intangible value delivered by the products. PP uses premium pricing as a signal to the consumer of superior product performance, image and value. As such, PP seeks to maximize both the customer benefit and the selling company’s profitability.
According to the researchers, PP seeks to create the largest possible gap between the total basket of benefits provided to customers and the unit cost, as a function of the product’s benefits, brand image and ability to exploit favorable pricing situations (e.g., time sensitive delivery). Larger value gaps allow the firm to raise prices without compromising their value equation based on the premise that consumers will gladly pay higher prices for receiving more relevant and compelling benefits.
Fundamental to the notion of providing differential value is “framing” the price appropriately by customer need, purchase moment and type of buyer. Specifically, a product can and usually does have different value depending on the context, thereby supporting different prices for specific transactions. In other words, the product is what the product does at the moment the customer purchases it, not what the industry or organizational culture thinks it is. PP also has important implications for investment spending. Capital and marketing investments would flow only into product and service initiatives that consumers value highly and that they are willing to pay higher prices for.
PP makes no assumptions about standard pricing levels or industry returns on capital. Performance-priced brands can deliver price premiums across the business cycle even in unattractive or declining markets. A number of industries have benefited from this approach – also called value-based pricing – including logistics (Fed Ex), cement (Cemex) and truck manufacturing (PACCAR)
The following are key success factors in deploying a PP strategy:
- Dispense with the notion of “fair” prices or industry-driven pricing. Companies don’t determine what is fair, customers do and their assessment is based on the total value you bring.
- PP requires work. It is not a simple exercise to understand your product’s value or what, how, when and why consumers buy.
- Firms must relentlessly communicate and monitor their delivered value to justify premium pricing.
- Don’t ignore costs. Lower costs enable higher profits and help fund value-building activities.
- PP is an organization-wide process. Bring together the “cost counters” like finance and the “value generators” like marketing so they can truly understand both sides of the equation and what the levers are.
For more information on our services and work, please visit the Quanta Consulting Inc. web site.
Word-of-mouth (WOM) marketing, also known as referral marketing, is growing in popularity as a customer acquisition strategy. Basically, referral programs use financial incentives to encourage existing customers to solicit their friends or family to purchase a new product. While such programs have been used for decades, WOM marketing is now being adopted in a wide range of industries including financial services, newspapers, hotels and automobiles. Although many managers intuitively understand the power of referral marketing, they have had little third-party research to validate the ROI. Thanks to a first-of-its-kind study, “Referral Programs and Customer Value” (to be published in the Journal of Marketing), companies can now understand how customer referral programs turn social capital into financial capital. These findings are timely given the rapid growth of community-building social media and viral tools and the increasing cost of traditional media. And, this research is helpful in providing many marketers with a methodology to study WOM effects that can work with their existing data and tools.
The study analyzed information from a database of 10,000 customers acquired by a German bank in 2006. Approximately, half of the customers came through the firm’s referral program and the other half came through traditional marketing efforts such as direct mail and advertising. There were some important conclusions:
Referred customers are more profitable in the short term
Referred customers generated higher margins than other customers. This difference was quite sizable at first, but eroded over time and came down to zero after about 1,000 days. The differences traced to the lower marketing spend per referred customer – even with a referral bounty – versus customers acquired via traditional marketing efforts.
Referred customers are more loyal
Referred customers were about 18% more likely to stay with the bank than other customers, and that gap did not fade over time. This occurs because individuals tend to have a stronger attachment to a company or brand if their friends or acquaintances also share a bond to the same organization. Moreover, referrer behavior is a good example of the superior-match theory: An existing customer knows both the company and the prospect, and so has superior information to assess to what extent there is a good fit between the two. In other words, people only refer prospects who they feel will match well with their own brand.
Referred customers have higher lifetime value to the firm
The margin advantage combined with higher customer retention creates a significant net gain in long-term customer value of 16% to 25% (read: the net present value of all the profits a customer generates over his or her entire association with the firm). This higher value traces to the presence of the “superior match” phenomenon as well as the fact that referred customers are less expensive to acquire.
Despite these findings, some marketers may not completely buy into all WOM programs. For example, there are concerns over cheating whereby opportunistic customers bring in unprofitable or problematic new customers just to earn a referral fee. (The research, however, indicates that the financial benefits of a customer referral program will still outweigh these negatives.) Secondly, referral programs will likely remain a B2C practice since paying referral fees to B2B customers’ employees could be conceived as a bribe. Of course, the absence of financial pay-outs does not mean that customer referrals are any less important in B2B markets. Companies just have to be more creative in finding proper incentives enabling them to capitalize on their existing customers’ networks.
Given their compelling benefits, marketers should look to deploy WOM marketing programs – where it makes strategic and brand sense – to grow their business.
For more information on our services and work, please visit the Quanta Consulting Inc. web site.