Customers don’t buy products or services. They buy value -- the total package of product performance, access, experience, and cost.  Enterprises that understand how customers define value across these dimensions consistently achieve superior long-term profitable growth.  Unfortunately, many enterprises are not well aligned to understand their customers. 

Most enterprises have a product-centric view of their business. Often, their history and cultures are defined by the development of a single product or service innovation that a founder created to fulfill an unfulfilled need in the marketplace.  This and other management realities often combine to create an inside-out culture in which the enterprise is convinced it can imagine and create the products and services that customers and markets want. Unfortunately, many enterprises are not sufficiently equipped to understand their customers. 

To address this situation, the following proposes a concise three-step approach designed to enable companies to:

1.      define and quantify what customers value 

2.      systematically deploy their resources to deliver greater value than the competition, and

3.      capture a greater share of the value delivered to customers. 

Enterprises that follow this approach over time consistently see an increased flow of value to their bottom line. 

As shown in Figure 1, enterprises often create a product and then push it to market, expecting that customers will accept it.

Figure 1: Creating Products and Pushing Them to Market

These enterprises often fail to develop a true understanding of the total context in which their customer consumes an offering and, especially, of customer needs.  This leads them to create value propositions that are, at best, focused on how a product performs rather than on which elements of an offering combine to create value for the customer.  Incomplete and often vague value propositions do not allow the enterprise to differentiate its offerings from the competition. 

 Unfortunately, there are inherent pitfalls resulting from this all too common inside-out approach:  First, customers begin to narrowly define the enterprise and its capabilities solely based on its current products.  This is a major drawback, because the competitive market is continuously changing and, in the process, value migrates from one step in the value chain to another.  Competitors and other market influencers create discontinuity by introducing new products and developing alternative business models.  The enterprise has an increasingly difficult time trying to break out of its existing product lines as new alternatives emerge.

 Second, the enterprise begins to define itself based on its current customers.  But, these are often customers that it acquired coincidentally, rather than through a planned and measured effort.  In their drive to satisfy existing customers’ demands, managers often fail to consider whether their customers are the right ones. Is the customer base the most profitable one available in the market?  Are the company’s assets and capabilities well-suited to meet current customers’ needs? 

 Managers who think narrowly about their businesses often think in terms of product delivery.  But, as products age and become more commoditized, product-focused managers often run short on ideas about how to grow their businesses.  Frequently, they are sucked into the vortex of price-cutting strategies, cutting prices to gain more of the same type of customers.  This can negatively affect profitability as the enterprise continues to attract undesirable, unprofitable customers motivated solely by price and exhibiting little or no loyalty to the enterprise.  Over time, the enterprise finds itself increasingly hampered by a lack of available capital as it fails to earn competitive returns above the cost of capital.  Without acquiring an understanding of how its customers consume their offerings and without true customer-focused innovation, enterprises increasingly face irrelevance and, ultimately, extinction.

 There is a way out of this myopic, product-centric view.  The enterprise must focus on the customer needs it fulfills today and those that it can fulfill tomorrow—with little regard to any specific product or service it might currently offer.  As shown in Figure 2, the enterprise must change the lens through which it looks at the market and focus on the value it exchanges with customers instead of the products it delivers during transactions.  

Figure 2: A Value Focused Company

In short, managers and must shift their view from “Inside out” to “Outside in”.  In the new view, actual products and services become only one part of the total value that the enterprise creates and delivers to its customers.  With this view, it becomes clear that not all customers are the same; that different customers value different elements of the enterprise’s offerings; and that customers have radically different contexts in which they consume an enterprise’s market offering.

 Consider the case of a polyethylene manufacturer who sells polyethylene to two types of customers – plastic bag manufacturers and food packaging companies.  The two companies may currently buy the same product today, but the plastic bag manufacturer buys primarily on price and places little value on his polyethylene supplier’s ability to deliver innovations.  The food packaging company, on the other hand, is always seeking innovations that will extend a food product’s shelf-life or freshness.  The latter is more willing to pay a premium to maintain a relationship with an innovative polyethylene supplier.  An enterprise that takes the same approach to serve these two very different types of customers will end up performing sub-optimally for both.

 Understanding the Value Creation Cycle

 Companies that continue to grow profitably follow this three step approach to growth management:

 First, they develop a complete understanding of the way they create value for their customers today and how they can best create value in the future.   Successful companies not only define customer needs, but also take their understanding one step further by quantifying the value they provide to their customers.  They link each source of value to their customer’s balance sheet and income statements.

 Second, they develop a deep understanding of how value is delivered through the value chains in which they compete. They understand the true drivers of demand, the current profit pools at each step of the value chain, and, most importantly, the steps where profits will pool tomorrow. They create operational processes from the “Outside-In”, keeping the customer at the center of the transformation; ensuring that they are aligned to deliver optimal value to the most valuable customers.

Third, having optimized the creation and delivery of value, companies take a disciplined approach to capturing for their share holders as much of the value as possible. First, they seek to optimize the share of profit per transaction. Then, they maximize their customers’ share of wallet or the share of like transactions in which their customer participates. Last, but not least, they optimize their share of the overall market to increase shareholder wealth.

Figure 3: Tapping the Value Cycle

Following this approach offers valuable insight and improves many companies’ efforts to find a unique, defensible position in the competitive marketplace.  Enterprise Cars is an example of this approach.  Instead of competing head-to-head with the bigger companies like Hertz and Avis, Enterprise focuses on a completely different market:  namely, car owners who need rental cars while their primary car is in the repair shop.  These customers highly value the conveniently available cars located close to repair shops.  By co-locating their rental shops within the repair shops themselves, Enterprise has begun to corner this segment of market demand.  It is now one of the most profitable rental car companies.

 In the remaining sections, we examine each of the three steps in the Value Creation Cycle and outline the tools and approaches that leading companies use to maximize shareholder wealth.

 Creating Value

 It is extremely important to fully understand the key elements of value in the eyes of the customer.  As companies go through this exploration, they realize that customers perceive value in many areas that are readily visible.  Leading companies don’t stop at uncovering these new value delivering attributes of their offerings.  The best companies not only understand the value that customers place on the various attributes of their offering, they quantify these in real terms--dollars and cents. Without this detailed understanding, many an enterprise is left to hang its hat on benefits statements attached to their product’s specifications and fail to articulate the real value they deliver. 

In most cases, a procurement agent does a detailed analysis of technical specifications to ensure that a product meets customers’ technical requirements.  However, without a quantitative metric for the differential value that a supplier adds, the procurement agent is left to focuses on the one quantitative measure he finds on the bid sheet– the price.  This is a key driver for the ongoing downward pressure on prices that most companies feel.

 To make their value clear, leading companies group the value customers receive from an offering under four broad categories: Product, Access, Experience, and Cost.

Figure 4: Uncovering Customer Value

 o        Product Attributes

Of the four elements of value delivered to customers, this is the category that enterprises relate to most easily. After all, most enterprises tend to have large numbers of people in R&D, engineering, product design, and operations.  These people configure and reconfigure their product’s features and functions to gain a competitive edge.  Unfortunately, we find that even these people spend more than 90% of their time focused internally. They are not out in the market understanding customer requirements or the value that customers place on performance features or the trade-offs they are willing to make.  This inward focus is drives products that are over-designed and loaded with features and functions that, while adding to manufacturing and other costs, offer little or no added utility to the customers.  A good example of this rampant phenomenon is the Microsoft Office family of products where 80% of the functions remain largely unused by the majority of customers.

 o        Access Attributes

The second category of value drivers is defined by how accessible an enterprise’s products and services are to the marketplace.  Many enterprises fail to recognize this source of value they provide to their customers. Ask Dell, which requires its suppliers to deliver orders 15 minutes after it places them, about the value of accessibility of supply. A single unavailable component can bring an assembly line to a grinding halt. When selecting a supplier, proven availability and reliability is a key element in the selection of one supplier over another.

 By developing a clear understanding of the different access requirements of each unique market segment and customer, leading enterprises optimize the deployment of their resources to ensure that their operations can deliver their customers’ accessibility and availability requirements.  For example, the enterprise that knows its products are critical to their customers and that their customers maintain low inventories, will often keep a safety supply on hand.  The customer comes to rely on the supply consistency and will often pay a premium for the availability.

 o        Experience Attributes

The third category of value drivers is defined by the overall experience that customers have as they use an enterprise’s products and services. Though experiences are initially shaped by impressions of a firm’s brand, they are more strongly influenced by direct interaction between the customer and each of the enterprise’s employees.  These interactions take place at many stages of the purchase-pay-use cycle.

 Brand-leading firms pay close attention to the way they design their customer-facing processes, how they train their service providers, and how they develop their brands.  Enterprises that pay careful attention to customers’ experiences across transactions are able to reap the benefits of superior pricing, higher margins, and the creation of high switching costs.  In the PC industry, the perception of quality that the computer marked with “Intel Inside” conveys is an example of brand value.  Couple this with the ease of a transaction involving purchase of a Dell product, and it is easy to see why Dell continues to build market share notwithstanding better performing alternative products from suppliers like AMD and others.  

Figure 5: Affecting the Experience

By developing a deeper understanding of the overall context in which customers use products and services, the enterprise can uncover market gaps—i.e., customer needs not being satisfied by competitors.  In fulfilling these needs, leading enterprises build customers’ value perceptions above and beyond what the competition has to offer by providing a uniquely designed solution that leverages the enterprise’s products and services, accessibility, and experience.

 In many markets, integrating product sales with after sales services contracts offers companies an opportunity to de-commoditize their core businesses. An example of this is provided by the copier market and the services offered by IKON. Over the last decade, IKON has transformed itself from a distributor of copier products to a service company focusing on helping companies manage document flow and efficiency. Thus, IKON has influenced customers’ perceptions of value by combining a world class collection of copiers and printers with superior service offerings ranging from document management services to financing services. 

o        Cost Attributes

Cost attributes are often the most difficult ones around which to build consensus.  Too often, both the enterprise and the customer take a myopic view of cost by limiting the discussion to the purchase price.  The most astute buyers and sellers realize that the invoice price is merely one of the costs associated with using a product or service.  Perceptive enterprises and customers focus on the customer’s total cost in buying and consuming an offering.  This allows the enterprise to better communicate the value of its offering over its entire useful life and allows the customer to make a more economically effective purchase decision.

 Customers incur a range of costs in consuming an offering: search costs associated with finding the right product and right vendor, vendor management and legal costs associated with contract negotiations, product disposal costs associated with getting rid of the used product or waste, personnel costs related to training for product sale or consumption, and last, though hardly least, the costs associated with whatever differentiates the product’s performance from a competitive alternative.  Enterprises that understand value management will appreciate how each of these costs impacts its customers ability to make money.  Brand-leading enterprises will work with customers to reduce the total system costs experienced over the life of an offering and thereby add additional value for their customers.

 By understanding how each of the attributes of product, access, experience, and cost contribute to the overall value perceived by the customer in different markets, enterprises can leverage value-based segmentation and fine tune their offerings to each market’s unique situation.  This allows the enterprise to effectively differentiate its offerings from its competitors’ based on total system value. 

Figure 6: Quantifying Customer Value

Delivering Value

 Shifting focus, we turn from how the enterprise understands customer value to how the enterprise actually creates and delivers value to its customers.  Two common missteps occur as companies act to create and deliver value.  First, they usually take a supply-chain-oriented view of value delivery rather than a value-chain-oriented view.  The latter is a 180 degree shift for most enterprises.  The second misstep is having internally-focused business processes, which sacrifice flexibility in meeting varying customer needs in favor of standardization implemented to drive down total costs. 

 o        Value Chain Versus Supply Chain

Depending on the level of detail, this figure captures all the steps needed to produce and deliver a product to an end customer—i.e.,the flow of product from raw material through end-product distribution.  It exposes the inventory positions, cycle times, and different throughput requirements at every step.  Enterprises that fully comprehend the supply chain are well positioned to squeeze out all of the costs that can be removed from the system.  However, while the supply chain does a great job in tracking the flow of supply, it fails miserably in capturing the flow of demand from the end customer up the chain.

Figure 7: Typical Supply Chain Associated with a Hypothetical Process Manufacturer

Analysis of the demand value chains in which the enterprise participates reveals the true sources of demand and enables the company to track the flow and pooling of value at different steps. In short, it allows the enterprise to define where each of its value-creation opportunities resides, and to determine how close these opportunities are to the enterprise’s core competencies.  This view also highlights the market players who control demand flow and shape the economics for all participants. An enterprise can only shape the position of profit pools by developing a profound understanding of the value chains. By developing expert insight into their value chain economics, the enterprise can transform itself from a supplier of inputs to a power partner of choice.

For the true value-chain-mastering enterprise, this view identifies arenas beyond the enterprise’s current focus and into which it can expand to significantly change its revenue, profit, and competitive profile.

Figure 8: Typical Value Chain

o        Re-engineering Operations from the “Outside in”

In the 80s and the 90s, many enterprises jumped on the quality band wagon and implemented TQM or Six Sigma programs.  They worked hard to remove all of the causes of variance and defects from their business processes. For many enterprises, and even entire industries, this movement lead to dramatic improvement in production efficiencies.  However, what was often lost along the way was a focus on the things that matter at the point of competition—that is, the customer.  Unfortunately, for every enterprise that got Six Sigma right and correctly applied it to true customer requirements, there were many others that blindly applied statistical tools and techniques to remove variance from their processes.  The science of determining what customers really need and what they will pay for was often put to the side or entirely excluded. 

Figure 9: Re-engineering the Corporation from the Outside-In

Brand-leading enterprises are redesigning processes with the realization that these processes impact the value-creation categories discussed above.  These enterprises are designing their operating processes to serve customers faster and better, to reap rewards in terms of improved customer satisfaction and business profitability. For example, consider the case of one of the largest telecommunications carriers in North America, which decided to incorporate the voice of the customer into its internal processes. Customer surveys revealed that a major challenge confronting business customers concerned the way they accounted for service usage within their internal departments.  Customers received a single bill and were forced to parse the costs out to the individual departments manually.  The telecommunications company worked with these customers to design a new bill format that delivered department-level detail in the bill. The telecommunications company achieved a 20% increase in customer satisfaction scores by delivering more value as a result of a minimal investment.

 Capturing a Greater Share of Value

 Executives incapable of capturing maximum value from the market leave money on the table and fail to provide their shareholders with the best possible return.  Enterprises that excel at value capture are rewarded in the financial markets with higher shareholder returns than their peers.  Every enterprise has three  dimensions available for measuring its ability to capture value for its shareholders – customer profitability, share of wallet, and number of customers.

Figure 10: The Value Cube

“Customer profitability” measures the share of economic value that the enterprise is able to capture for its shareholders from the total value that it creates for its customers.   Most customers use more than one supplier to meet their requirements. “Share of wallet” measures the percentage of customers’ total spending that the enterprise is able to capture. So, while the first measure tries to maximize the profitability per transaction, the second measure optimizes the number of transactions per customer. The final measure, “number of customers,” is aimed at optimizing the enterprise’s market share.

Most enterprises focus on capturing value from one or two axes of the Value Cube.  As a result, they end up missing much of the value they can extract from their marketplace. The Value Cube framework allows the enterprise to map out its current position in the total value space.  The “Could be” state represents the additional value-capture potential that exists for the enterprise with large capital investment.  The more practical “Should be” state shows what value could be attained in a 1-5 year horizon with focused investments.

Understanding the space the enterprise occupies “today” in its value cube is the first step towards increasing value capture. The shape of the company’s current Value Cube and the desired future shape helps to prioritize the strategic initiatives that the enterprise should undertake.

Figure 11: Strategic Priorities

For example, the enterprise that has a high share of wallet and a high market share should focus its resources on increasing customer profitability. Customer profitability improvement opportunities present themselves in the form of cost reduction or price improvement.  

Benchmarking a company’s operations against competition can uncover areas where cost reduction is possible.  Figure 13 contains the results of a competitive financial assessment of a Fortune 500 industrial company versus its competitors. It highlighted areas where the company’s operations were best in class and others where improvements were appropriate.

Figure 12: Competitive Financial Analysis

Conclusion

 A customer-value-based approach to management can help companies instill a fact-based decision-making process in the enterprise.  This promotes faster growth through differentiated customer investment.  It ensures that the highest return initiatives are prioritized.  Enterprises using this disciplined three step approach focus on understanding value potential, creating and delivering value, and managing their market position to maximize the value they capture.  Enterprises that are attuned to the Value Creation Cycle build deep moats around their customers that competitors find difficult to cross. Mastering the Value Cycle enables these enterprises to win in both the customer markets and the financial markets.  In short, it leads them to long term profitable growth.