Back To Basics (geoffry Moore)

Back to Basics Managing for Shareholder Value in 2001 By Geoffrey Moore I do not know whether it is the influence of Year-in-Review articles or a surfeit of holiday punch, but in seeking to summarize the conclusions of The Chasm Group about what 2001 holds for executive teams in technology-based firms, the results came out in classic Vanity Fair fashionas in OUT/IN list: OUT

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Category Power CAP Value Chain Domination Partners VP of Business Development Lifetime Value of a Customer Internet Time Inside the Tornado

Company Power GAP Value Discipline Focus Customers VP of Sales Present Value of an Order Life Cycles Crossing the Chasm

Let me walk you through our thinking. OUT: Category Power IN: Company Power One way to describe the excessive valuations in the technology sector, particularly those surrounding the Internet, is that investors fell under the spell of category power. Historically when whole new paradigms have entered the sector, they have driven massive transfers of valuation, much of which accumulates in the market leading companies. Internet investors anticipated this trend and bid up the stocks of any company with a good story about how it would ride this latest hypergrowth category to wealth and power. The problem is that the market has no way to know when to stop this process except through going to excess and then experiencing indigestion. The excess point was reached in March 2000, and since then stocks have been repriced dramatically based not on company performance but rather recalibrating the value of the various categories, largely by returning to discounted cash flow models that measure returns adjusted for risk. This repricing continues to drive volatility in key indices as the market seeks a reasonably stable floor from which it can go forward. Until that stability is found, no management actions of any kind are likely to have much of a positive impact on the price of a given stock. As category valuations do stabilize, however, investors going forward will apply traditional tests of viability to individual companies. That is, they will examine the results of a few quarters of competitive performance before bidding up a stock. Instead of jumping on the bandwagon of companies declaring victory based on a strategy of 1

preempting market leadership, they will wait to see if that victory a) has been achieved, and b) is worth anything if it has been achieved. The implications for management are straightforward enough. Quit fooling around with strategy experiments and go make some money. Do it in your core business. Do it by selling something for cash, not barter, to someone who actually pays their bills. Launch a new and exciting product or service. Penetrate a new market with an unstoppable offensive. And when competition appears, show that you can hold it at bay not through discounts but through differentiated value. OUT: CAP IN: GAP As readers of The Gorilla Game and Living on the Fault Line may recall, GAP stands for Competitive Advantage Gapthe differentiated value of your company’s offerings when compared against those of your direct competitorswhile CAP stands for Competitive Advantage Periodthe length of time investors anticipate you can sustain that differentiated advantage. GAP times CAP is the basic formula that underlies stock price valuations. In the prior investment climate, all the emphasis was on catching the next technology wave. This represented a concern with CAP, specifically a fear that all current advantages would be summarily wiped out by the emerging new category. In the current climate the emphasis is on demonstrating results now. This is a function of GAP, the power to win business through differentiated offerings in current competitions. The implications for management are far reaching. In surveying where to invest scarce resources for competitive advantage, The Chasm Group uses a Competitive Advantage Hierarchy model that isolates five general domains where companies can focus attention. They are: Differentiated Offerings Value Discipline Focus Market Segment Leadership Value Chain Domination New Category Participation The lower you are on this list, the greater the focus on CAP and the long term; the higher on the list, the greater the focus on GAP and the short term. Investors are saying enough already with new category participation and value chain domination and heady visions of the future. Show us some differentiated offerings that make money today and demonstrate your ability to excel in oneand probably only onevalue discipline. In other words, show us you can block and tackle before running any more trick plays. OUT: Value Chain Domination IN: Value Discipline Focus

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Value chain domination holds forth the promise of immense competitive advantage sustainable over long periods of time. It is the driving force behind the valuations of Cisco, Intel, Microsoft, and all the other gorillas in the technology sector. No one doubts it is a great prize and worth much sacrifice to gain. But investors have learned in the past year that, as an outcome for any particular company, it is also an improbability. And so they are prepared for now to leave these gambles to others as they seek more reliable returns from their increasingly scarce capital. Value discipline focus is another matter altogether. It consists of a company privileging one of four ways to generate competitive differentiation, as follows: Discontinuous innovation Product leadership Operational excellence Customer intimacy Most companies need all four in some measure to meet market expectations, but a focused strategy will take one of the four to extremes that competitors are unwilling to match. From that position of excess, a company can create differentiated offerings for a class of customers who will pay higher margins for the value they receive. This strategy of focus has a high probability of success, assuming it is executed forcefully, and is completely under the control of management. It represents an attractive source of investment at a time when financial markets are recovering from a prolonged period of betting on phenomena outside management’s control. OUT: Partners IN: Customers As long as the focus was on value chain domination, investors eagerly sought news of emerging partnership announcements that would signal value chain formation and provide clues as to which companies were accumulating the most power. Thus Amazon, AOL, and Yahoo all validated their investors expectations by demonstrating value chain power over partners while their direct competitors could not. The nasty surprise that caught out these investors is that the value chain, once formed, was nowhere near as valuable as advertised, at least not so in the short term. As calls for capital continued, investors simply declared a hiatus, unilaterally and painfully. In the current climate they are simply making that most American of all requestsShow us the money! Partners do not pay money; customers do. Show us the customers. In this context, rich customers are preferable to poor ones, which translates into higher valuations going to companies with large enterprise customers than those focused on small business or consumer markets. But in all cases there is a focus on liquidity, on the ability to generate initial order and repeat business such that investments in fixed costs and customer acquisition can be paid down.

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OUT: VP of Business Development IN: VP of Sales A year ago the toughest hire in Silicon Valley was a great vice president of business development. This rare bird combined the savvy of a salesperson with the powerbrokering skills of a lobbyist and was sent out into the world to spin up a coalition of partners into a value chain. Every key announcement was greeted with an escalation in stock price. As stock currency grew cheap and plentiful, acquisitions became the preferred substitute for organic growth, further distracting investors from the dramatic outflow of cash from base operations. M&A indeed became the whole focus of everyone, and business development was at its epicenter. It was the era of the smooth operator. Well, as the raven says, Nevermoreor at least not for a while (for the salutary effects of hangovers, too, are of limited duration). Now the hot resume is for someone who can recruit and lead a direct sales force selling into enterprise customers offerings that have a six-figure average selling price, with large deals going into seven figures, and even higher in special circumstances. The call is for someone who has closed a quarter, has closed dozens of quarters in fact, making quota. These folks are not to be found among any business school graduates, nor in the outflow of personnel from the dot.coms. Instead, the sales organizations at big systems houses like HP, Sun, and IBM, along with large consultancies and integrators like Andersen Consulting and EDS, are the breeding grounds in which recruiters will now be trawling. OUT: Lifetime Value of a Customer IN: Present Value on an Order In the era just past most companies sought to validate their valuations by treating the lifetime value of a customer as their primary bookable asset. This is not a bad idea, but it is subject to abuse. The key learnings of the recent period include: ·

Eyeballs are not a proxy for customers. Orders may be. The real issue is switching costs.

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Any projections of future returns from current customers should include a churn rate validated by actual customer behavior.

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Customer acquisition costs are paid in present dollars; lifetime value is paid out in increasingly future dollars. Such future returns should exceed those gained by simply putting the same money in a savings account.

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This form of valuation is highly sensitive to changes in interest rates, and the actions of the Federal Reserve did in fact have a major impact on the dot.coms despite immediate appearances to the contrary.

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But perhaps the biggest learning was recognizing the sheer magnitude of the capital needed to achieve the lofty lifetime goals investors and management were pursuing. In all of these models it takes a long time and a lot of money just to get to break-even, and investors are now seeing that the model only works if customers can be persuaded to supply part of the needed funding through advance funding. Thus it is that the present value of an order is coming into sharp focus. In particular, management in 2001 will be focused on winning orders with down payments that frontload cashin effect license deals as opposed to subscription deals. The goal long term will be to revert to subscription basis, but only after the costs of building out the market have been absorbed. Once investors see companies able to raise their own working capital fromgaspprofits, then they will be more likely to put a premium on their stock and contribute their capital to the growing hoard. OUT: Internet Time IN: Life Cycles The mad rush to capitalize on the Internet is over. Now we can get down to the serious business of capitalizing on the Internet. It is a marathon, not a sprint. In this regard we must forsake Internet time as a usable work rhythm. In essence, Internet time was a synonym for tornado time, representing the highest possible speed of change, one that occurs right when the pragmatist herd breaks away from the old paradigm and stampedes to the new. It is absolutely a real phenomenon, but it is shortlived, existing in a much larger context of life-cycle time. Life-cycle time describes the shifting rhythms of technology adoption from the beginning of a market to its end. At The Chasm Group we have broken this market evolution model down into ten different stages, each with its own imperatives for creating shareholder value. In some of these stages the goal is to move swiftly, in others it is to extend the moment as long as possible. There is no one steady beat, no single setting of the metronome that can keep companies in sync. And so we come back to our own basics, specifically the very first exercise we do in any of our consulting engagements, namely getting consensus with the management team as to what stage of the life cycle each of the component technologies that make up their offer are in. That leads to an overall life-cycle placement for the offer itself, and that placement in turn drives every other strategic and tactical decision madeuntil the next stage in the life cycle is reached. OUT: Inside the Tornado IN: Crossing the Chasm This is a bit of a cheat, since both books actually work together to advocate the life-cycle thinking outlined above, but in spirit, 2001 is a year for letting go of tornado illusions and embracing chasm truths.

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The most important chasm truth, we believe, is that Darwin selects for companies that can accumulate their own power, granting them more power as partners and customers are attracted to their success. In this process the most universally recognized form of marketplace power is dominant market share. Therefore the core chasm prescription is to find a market you can dominate and then dominate it as fast as you possibly can. To guide this effort we intend to dust off something we call The Playbook, a binderoriented framework that leads management teams to address the key issues in this process. The playbook is organized around three major sections, the first devoted to lifecycle placement, the second to specifying market development strategy, the third to planning go-to-market programs. It is, in effect a product marketing manager’s blueprint for getting new offerings into the marketplace. It is all about blocking and tackling. There are no trick plays anywhere. This is the back-to-basics focus that executive management needs to empower in the coming year. To bullet it out, the prescription is to: · focus the entire company on the product (or service) marketing plan · to ensure that it executes flawlessly on basic go-to-market capabilities · directed toward dominating a target market · in order to increase market share power for the company · and create a platform for increasing shareholder value for investors. That in our view is the agenda for 2001.

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