Customer Value Creation

POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth by Gary Plaster and Jerry Alderman

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rofitable growth is an often talked about but seldom realized objective of industrial companies. The benefits of profitable growth are obvious but in reality most industrial companies do not have their processes, people and technology aligned to achieve profitable growth. What results for most companies is an ebb and flow with the general economy with intense focus on cost reduction during down times and confusion between good management and good markets during good times. Companies need to build a more robust and reliable growth platform.

Having worked with many companies across multiple industries, Charter Consulting has developed an approach that focuses on these two areas and has proven successful in driving profitable growth.

Profitable growth is governed by a simple equation: Profit Growth = Change in Revenue – Change in Cost

Customer Value Creation Customer Value Creation SM (CVC) is a customercentric framework for helping companies choose the best opportunities for growth by optimizing the value creation between the enterprise and its customers. CVC leverages the Outside-In approach through Customer Value Analysis along with Operational Excellence in customer facing processes to deliver profitable growth.

During the recent difficult economy, companies have honed their skills in cost reduction focused supply chain tools such as Six Sigma, Lean Manufacturing, and strategic sourcing. Now as the economy starts to improve and opportunity for growth presents itself, companies need to attack profitable growth with the same precision and focus. In order to do this companies need to: • Take an Outside-In approach to set the context for growth • Achieve Operational Excellence in customer facing processes to drive execution

© 2006 Charter Consulting

CVC = Customer Value Analysis + Operational Excellence

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POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth •

Number of Customers: Measures the proportion of the market space that a company controls as it relates to its footprint on the unique buyers of its offerings.

In addition to the three value axis shown in Figure 2, duration of customer relationship is also sometimes used. The duration component sums up value over time to provide a longer term view of the value potential. Defining Growth States Given these dimensions of value, growth is then defined in terms of “today’s” situation, the “could be” or theoretical state and finally the “should be” or practical condition. Understanding the size and shape of the value cube in Figure 2 is often one of the most revealing aspects of the Customer Value Analysis approach.

Figure 1: Outside In Approach Customer Value Analysis Customer Value Analysis is driven by an Outside-In approach. The principle behind the Outside-In approach is that companies must understand how value is created and captured with their customers in order to position themselves for profitable growth. As shown in Figure 1, the Outside-In approach defines value from the customer’s perspective, rather than the biased perspective of the supplying company. Dr. Daniel Kahneman recently won the Nobel Prize in Economics for his work in showing that people are overconfident and anchored in their own thinking. The Outside-In approach acknowledges that the answers developed within the company are likely anchored around the current product and service offerings and may or may not translate into value from the customer’s perspective.

Direction of Growth Understanding the shape of the value cube and the firm’s relative position is key to focusing the organization on maximizing value. Once the shape and size of the value cube is understood, then the company can choose the axis that provides the most opportunity for profitable growth. A simple example of how to process the company’s position in the value cube is shown in Figure 3. Choosing this axis needs to be integrated with the companies overall strategy. There are times when the value space available does not support the company’s stated strategy, at which time the strategy needs to be evaluated.

Dimensions of Growth The value that exists between a company and its clients is not linear but rather exists on a number of differing, but related, value planes. Customer Value Analysis typically considers value along three dimensions, which form a value cube as shown in Figure 2: •

Customer Profitability: Measures the overall profit an organization drives from its customers. Customer Profitability is measured at the customer level, segment level, and at the enterprise level.

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Share of Wallet: Measures the revenue derived from a customer for a company’s products and services in relation to the total spend on the overall category. Share of Wallet is also measured at the customer, segment and enterprise levels.

© 2006 Charter Consulting

Figure 2: Customer Value Analysis; Value Cube

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POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth

Customer Facing Operational Excellence Once the context for profitable growth is set, the company needs to position its business processes to deliver optimal value to the customers. Aligning business processes is the key change agent in support of executing against the growth horizon. Organizations that focus their resources on understanding the economics of customer behavior and align their business processes for execution will grow profitably. Industrial companies that have developed competency around Six-Sigma, TQM, Lean Manufacturing and so on have a head start toward achieving Operational Excellence in customer facing processes. Each of these organizational practices has at its core a common framework from which to drive activity and change through the organization. The challenge for most companies is that the efforts have been focused on quality and cost. In order to raise these concepts up to the level of business philosophy, the concepts of revenue, growth, and customer must be incorporated.

Figure 3: Defining the Direction of Growth Customer Economics The key to quantifying the value cube is understanding the economics of the demand value chain or “customer economics.” The focus of customer economics is in defining how each customer along the demand value chain accrues economic benefits that manifest themselves on a financial statement. These economic benefits can be impacted through either cost or revenue drivers along the demand value chain. In order to describe these value drivers, a map of the demand value chain and its associated value transformation processes must be created in collaboration with the customer. Most often companies talk about features and functions but fall well short of being able to describe their product or service’s real economic benefit. Only after the company develops an understanding of the customer’s economics will it be able to influence how that value is created and exchanged along the demand value chain.

The opportunity is to repurpose the basic scientific problem solving methodologies that are currently being used for quality and cost reduction, populate them with new, relevant tools and deploy them against the customer oriented profitable growth challenges. A few examples of the change in tools are listed in Figure 4:

Summarizing Customer Value Analysis Customer Value Analysis uses an Outside-In approach to establish the context for making investments which will enable profitable growth. Although many companies believe they understand how their customers view value, recent Nobel Prize winning work suggests that we are too over-confident and anchored around our current situation. By taking an Outside-In approach, as shown in Figure 1, these biases are broken yielding a more effective approach to making investments in profit-driving growth opportunities.

Inside-Out Mindset

Outside-In Mindset

ƒ Supply Chain ƒ My Economics ƒ Process Variation ƒ Product Innovation Process ƒ Price ƒ House of Quality ƒ Pareto Analysis ƒ Portfolio of Projects ƒ Cost of Quality

ƒ Demand Value Chain ƒ Customer Economics ƒ Scenario Planning ƒ Customer Innovation Process ƒ Value ƒ House of Value ƒ Multi-Dimensional Scaling ƒ Portfolio of Investments

Figure 4: Outside-In Mindset

© 2006 Charter Consulting

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POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth nies collect credit histories and demographic information. This ultimately creates the data playground on which consumer marketers thrive. On the industrial side, data is not as forthcoming but is more transparent via the internet than at any time in history. Through use of data mining via the internet combined with primary research, industrial companies can access information that enables them to take a much more quantitative approach to market. That said, all too many companies continue to rely on traditional qualitative insights gained through Customer Satisfaction Surveys.

Many if not all of these customer facing tools have been enabled by technology and most have some established process. What’s missing are the people who can assemble these tools together using a rigorous approach to profitable growth similar to the approach companies have employed toward cost and quality improvement … Six-Sigma for profitable growth if you will. This point has brought to light the need for companies to create a competency around industrial marketing. Industrial marketers are those individuals who can bring the process skills of a SixSigma expert together with the business acumen of an investment banker to design and build customer facing processes that will create solution value.

For these reasons and more, the skills required of the industrial marketer are not going to be filled by consumer marketers, sales professionals, or engineers. Industrial marketing skills need to be built, which constitutes both the challenge and the opportunity for competitive advantage.

Although many industrial companies recognize the need for improved marketing, the area remains a bit of an enigma for the majority. Charter has found that in order to drive continuous profitable growth in industrial markets firms must come to grips with the need to raise the competence level of their marketing skills to that of their consumer counterparts. Here are a few reasons why:

Summary of Customer Facing Operational Excellence: To achieve a more reliable and sustainable growth platform companies need to be more rigorous in understanding then managing those customer facing processes which will drive profitable growth.

1. Complex Demand Chain: Industrial companies typically deal with a complex demand chain that involves many different parties working together to ultimately define an end use product. Understanding the economic dynamics of this demand value chain is very different than predicting the behavior or trade-offs that a group of consumers will make during their shopping experience.

Customer Value Creation—Case Study: Fortune 200 Manufacturer of Communication Materials Situation Like most companies in today’s economy our client had spent the last few years aggressively reducing costs. Recently the company started to reconsider investments that would drive future growth. The company chose Charter’s proprietary Customer Value Creation approach due to its focus on the economics of the customer interaction and its emphasis on achieving Operational Excellence on customer facing processes.

2. Decision Process: In the Industrial market space decisions about which solution offers the maximum value are made in days-weeksmonths. In the consumer world, the decision process is often made in seconds. 3. Switching Costs: Due to process entanglement, relationships in industrial markets often span years. Convincing industrial customers to switch requires hard hitting and sustainable economic benefits.

Discussion of Approach 1. Assess the Current State [Inside-Out Perspective]: This element of the process focused on developing an understanding of how the firm delivered and captured value in “today’s” state. This was an Inside-Out perspective that captured the firm’s beliefs regarding the value

4. Data: For the consumer marketer data is more readily available. Companies such as Neilson and IRI collect “Point of Sale” information which in turn allows deep statistical insights to be gained about consumer behavior. Other compa-

© 2006 Charter Consulting

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POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth Customer economics included defining the participants, value drivers, and improvement opportunities for each step along the demand value chain. This activity focused heavily on interviews and collaboration with customer and non-customer executives. These interviews significantly relied on the perspective of profit & loss leaders since they were in a position to see above the transactional fray and provide guidance on mutual gain sharing agendas. In the end, this research yielded a view of the value chain that quantified value for each step and allowed economic valuation of the demand value chain. Just as importantly, the process identified oppor-

dimensions of customer profitability, number of customers and share of wallet. As previously mentioned, duration was also considered to provide a perspective on change in value over time. During this phase the firms strategy and marketing plans were reviewed to determine what areas the firm intended to drive growth in the future. They include: increase customers, increase share and increase profitability. The outcome of this phase was an internal perspective of “today’s” value cube and how the firm planned to change the cube’s shape. As shown in Figure 5, the client felt their share of wallet and number of customers were high, with the overall profit contribution representing the value enhancing dimension of focus. As a result the company was focused on cost reduction and elimination of lower profit contributing customers.

Figure 6: Demand Value Chain

Figure 5: Value Cube Defined from an Inside-Out Perspective

tunities along the value chain for investment defined through collaboration with customers.

2. Determine “Could be” Potential [Outside-In Perspective]: In this phase, the objective was to understand value from the customer perspective and determine how the firm was positioned in the overall demand value chain. The first step was to define the value chain itself. Initially, the client had a narrow perspective of the demand value chain. Their view was anchored around participation in a print value chain rather than a chain of value that existed to drive retail store traffic. By simply defining the purpose and steps of the demand value chain the client started to ask and consider questions from a completely different perspective… Outside-In. A sanitized version of the demand value chain is shown in Figure 6. Having constructed the demand value chain the client was then prepared to develop a more detailed understanding of their customer’s economics.

© 2006 Charter Consulting

Figure 7 represents the outcome of the process to establish theoretical value from an Outside-In perspective. This view of value is a much different view than the Inside-Out view in Figure 5.

Customer Profitability

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“Could Be”

Today

Share of Wallet

Figure 7: Value Chain Defined from an Outside-In Perspective 5.

POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth In this case, the Outside-In perspective revealed the dominant opportunity for profitable growth existed on the “Share of Wallet”dimension of the value cube. Armed with this information the firm decided that it was better off creating services around its base product that ultimately delivered solutions rather than focusing on a significant effort to change the profitability of the product itself.

Customer Profitability

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3. Determine “Should Be” State: Having established the context for profitable growth on the “Share of Wallet” axis the client then decided upon projects to pursue. This task was accomplished by developing cost-benefit cases for each of the opportunities that were identified throughout the value chain. As shown in Figure 8, these cost-benefit cases were evaluated on a number of criteria using a balanced customer innovation portfolio approach.

“Should Be”

Share of Wallet

Figure 9: Value Cube Defined From a “Should Be” Perspective the Customer.” The Office of the Customer was given two significant charters: • To program manage the profitable growth initiatives. • To achieve Operational Excellence in customer facing processes by taking a continuous improvement approach to industrial marketing. Using the learnings from successful Six-Sigma and TQM deployments, the Office of the Customer was sponsored by the CEO. By having top executive sponsorship, clear expectations were established on the priority of profitable growth initiatives. Results The project set the context for profitable growth by identifying value added revenue opportunities of well over $500 million, focused on increasing share of wallet with current customers. This outcome represented a much different path than the originally held plan of improving profitability through cost reduction and elimination of lower profit contributing customers. By defining the direction and magnitude of the growth opportunity the client was now much better positioned to choose projects that were relevant to the business opportunity. Additionally, capital and human resources were focused on improvement opportunities that were aligned with the Outside-In interests of the customer.

Figure 8: Balanced Customer Improvement Portfolio Concepts were ultimately selected based on the companies risk/reward profile and its desire to penetrate particular portions of the overall demand value chain and layered into a “should be” model that is shown in Figure 9. Define Road Map to CVC Having set the context for profitable growth and identified specific customer driven improvement initiatives the company established an organizational framework to transition the effort from interesting learnings to bottom line profits. This was done through the creation of the “Office of

© 2006 Charter Consulting

Today

“Could Be”

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POINT OF VIEW Customer Value Creation: A Platform for Profitable Growth Summary of Customer Value Creation In order to achieve profitable growth, companies must take an Outside-In approach and strive for Operational Excellence in customer facing processes. The Outside-In approach focuses on setting the context for growth and investment through understanding the business through the eyes of the customer. Operational Excellence focuses on deploying rigorous methodologies and analytics to ensure profitable growth is achieved. A Call to Action Capturing profitable growth ahead of competitors is more challenging for most companies than staying in the cost cutting race. Although capturing profitable growth should always be a priority, it is a necessity during times of economic expansion. By most measures the expansion has begun.

About the Authors Gary A. Plaster is a Senior Vice President with Charter Consulting. Mr. Plaster has over 20 years of industry and consulting experience. Mr. Plaster can be contacted at [email protected]. Jerry D. Alderman is a Vice President with Charter Consulting. He has more than 19 years of industry and consulting experience. Mr. Alderman can be contacted at [email protected]

55 East Monroe St. Suite 2600 Chicago, Illinois 60603 (312) 228-4500 Phone (312) 228-4501 Fax www.charterconsult.com [email protected] A division of Technology Solutions Company

© 2006 Charter Consulting

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