In B2B markets, when market demand is high our plants are full. We stand firm on price. Our average costs are in line with plans. Profitability is impressive. Everyone looks like a rock star.
When, markets turn as part of the normal business cycle, or we hit an unexpected event like the current Coronavirus pandemic, our customers see lower demand for their products and reduce their orders with us. With their plants below capacity, their average costs swell squeezing their profit margins. Recognizing the access capacity in the market, purchasing managers ask for discounts from us and our equally volume-deprived competitors.
In downturns, we face tremendous pressure to retain volume so we often match our competitors’ price reductions. Our margins get hit on both sides – higher average product cost from lower production volume and lower average prices from acquiescing to customers’ discount requests. It’s a vicious, downward spiral.
It doesn’t have to be this way. Differentiated products with higher quantified value to for customers, have less pressure on prices. A key antidote to survive the downturn is to measure and communicate the quantified value your products/services provide to your customers.
Defend prices. Customers decide between two suppliers by assessing if the differential value is greater than the price difference. In other words, if your customers don’t believe your offering creates more value than your competitors, then you are going to be stuck following your competition’s discounts down.
A medical device manufacturer made an instrument to test for bacteria in a patient’s blood. Due to anti-trust requirements, they licensed their technology to a competitor. As a result, the two competing instruments had the same testing accuracy. One device was easier-to-use, but customers were unwilling to pay extra for it. Customers were not aware that “ease of use” improved their profitability. After conducting customer value research and building a customer value model, the manufacturer learned that “easier-to-use” really meant a less skilled technician could run the device. A less skilled operator enabled 24-hour operation in even the smallest hospitals – resulting in a substantial cost savings to the hospital. The manufacturer overtook the market share leader while also charging a price premium.
If your sales people rely on vague statements of value like “easy-to-do business with,” “complete end-to-end solution” or “high quality” (usually similar to your competitor’s value claims), then your sales team will struggle to maintain prices.
Smarter cost reductions. In downturns, managing costs is critical. The most successful managers cut costs that have the least impact on the value delivered to customers. Overhead costs are easy to identify as easy cost reduction targets, but we’re unlikely to get all cost savings there. However, this cost cutting may significantly impact the value of our product/service to the customer and could lower profitability in the future. Here again, customer value models inform better decisions.
Having a value calculator to quantify and prove the value to customers is a requirement for a market launch among customer value leading companies. At one such company, the value calculator uncovered bad news before the market launch. Very few customers would see a bottom-line improvement from adopting the new product. In fact, the value calculator proved that the performance on one dimension caused most customers to lose money on the purchase. The management pulled the launch, saving over $1/2 million of marketing spend and even more valuable sales rep time. They also set a minimum performance level on the lagging dimension for the next generation of the product.
Smart managers focus cost cutting where the resulting performance differences have the smallest impact on customer value. With a customer value model for a product or service, managers can perform sensitivity analysis to identify where small performance changes create disproportionately large impacts on the value delivered to customers. Cutting costs that impact these high leverage value drivers starts a death spiral. Value to the customer diminishes so win rates and/or average realized prices erode.
The good news is that other performance dimensions may have little to no impact on the value our customers experience. Surprisingly, some changes may seem like a negative to users, but they actually create value. For example, a manufacturer made a product that had been commoditized. Competing primarily on price, they redesigned the manufacturing process to save 10% of the costs. A 10% cost advantage in commodity market is a significant advantage. The only problem was that the redesign made the product harder to open. The manufacturer worried that users would find this inconvenient. The supplier conducted customer value research and learned that the more difficult to open lid prevented contamination. The cost savings from less contamination was worth over 60% of the price of the product. Not only were they able to reduce costs in a smart way, but they also raised price while maintaining volume.
New sources of revenue. With volume declining, smart managers also look for new earning opportunities. Identifying supplementary programs and support services is a fertile area. The challenge is getting the customer to pay for it.
A tier 1 supplier to the automotive industry had its core product under severe price pressure. Past attempts to charge for add-on services had been unsuccessful. Nevertheless, management believed that one add-on service had particular promise despite the initial negative reaction from customers.
This supplier developed a customer value model to estimate and prove the bottom-line impact (quantified value) of the new service for the customer. This service reduced customer total costs by minimizing the cleaning and maintenance of equipment used to apply the core product in the manufacturing line. In addition, the line would perform at the “optimum level” with reduced product usage/waste and greater control over process emissions.
By building a business case for the customer to adopt the new service, the customer agreed to pay 3 times the price that they had previously turned down. This supplier ultimately built a highly profitable $100 million service business during a market downturn.
Customer value quantification addresses both your revenue and cost challenges in a downturn. Customer value models bolster pricing by proving quantified value to both your customers and your sales team. They also identify smarter cost cutting by limiting the impact on your value proposition. Now more than ever, can you afford not to measure your customer value?
Eric Berggren is an Adjunct Lecturer at Northwestern University Kellogg School of Management and Managing Director of CVET LLC, a firm devoted to developing cutting tools grow and profit from customer value. He can be contacted at firstname.lastname@example.org
Ashesh Desai is a director at Value Transformed Inc. A company which helps Fortune 500 organizations improve their agile operating models to grow customer profitability in disruptive marketplaces. He can be contacted at email@example.com