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How Great Managers Capture Profit Pools -- and Anticipate or Precipitate Shifts
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As a general manager, your job is to devise a strategy for performance improvement. There are a number of valuable analytical tools that will help you turn up data and insights about all the sources of profit-pool shifts.
Excerpt from the book
The Breakthrough Imperative: How the Best Managers Get Outstanding Results
by Mark Gottfredson and Steve Schaubert
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As a general manager, your job is to devise a strategy for performance improvement. Insight into your customers’ preferences and behaviors, and into how those preferences and behaviors might change over time, is essential. It can help you take full advantage of your competitive position. It may even give you the ability to counteract the advantages of leaders who are farther down the experience curve and thus move up (or over) the ROA/RMS band. There are a number of valuable analytical tools that will help you turn up data and insights about all the sources of profit-pool shifts.
(article continued below ...)
What to Do About Changes in Customer Preferences and Behavior
An important source of shifts in profit pools, we said, is everyday
changes in the preferences and behaviors of customers. Most of the tools we
will discuss here are designed to help you anticipate and respond to such
changes.
Customer segmentation
Segment Needs and Performance (SNAP) charts
Customer ethnographic research
The revenue sieve
Loyalty and retention
Customer segmentation
Customer segmentation is an indispensable tool for
performance improvement, because it answers fundamental questions any
company must face. Are we selling to the right customers? Which segments
should be the primary target of our product-development efforts, and of our
sales and marketing activities? In which regions and countries should we be
competing? In which markets can we create differential value? How should we
differentially allocate our sales and marketing resources to various
segments? To answer such questions, a management team must understand which
customer segments are most attractive in terms of size, profitability, and
growth. They must also make an honest assessment of their company’s
capabilities to meet each segment’s needs relative to the competition. Some
segments “fit” a company better than others -- that is, the company has
greater ability to serve these segments in a way that is differentiated from
competitors. Some segments are more profitable, either because they generate
higher revenues, because they can be served at lower cost, or both. And some
segments are growing faster. Segments with high growth, high profitability,
and sufficiently large revenue potential are a company’s natural focus. But
the company may also be able to adjust its value proposition to serve
high-growth customers that are not currently very profitable.
Remember FitEquipCo’s profit-pool map, mentioned earlier in the chapter?
The analysis revealed that the company’s share of revenue was less than its
share of units sold, and its share of profits was less than its share of
revenue. So FitEquipCo’s management team concluded they needed to refocus
the company on winning more customers in higher-spending segments. To do
this, they worked to gain a deeper understanding of those customers’ needs
and how they differed from the needs of other segments. They then invested
in product development, sales resources, and service approaches designed to
meet those needs better than the competition.
Effective segmentation can also reveal underexploited opportunities
within your customer base. By “de-averaging” your customers and prospects,
you can often find hidden pools of profit that could be more fully
exploited. A great starting point for this sort of analysis is to identify
segments that are willing to choose your product over others, or that are
willing to pay more for the bundle of needs and wants that your product
represents. Have you fully penetrated all the customers in the market who
have similar characteristics? Among those you have penetrated, have you
earned and captured 100 percent of their purchases?
We discussed a simple scheme that divided customers into three camps:
those who buy primarily on price, those who are looking for some combination
of quality and service, and those who are looking for some form of prestige
through buying a particular brand. Of course, much more complicated
segmentation schemes can be developed, but this simple one can be powerful.
Dow Corning is a good example. Dow Corning makes silicone-based products
that are used as a raw material in many different industries, from cosmetics
to electronics to food and beverages. In 2001, the company was facing a
series of challenges. Its revenue growth had been flat for several years,
and its profits were below expectations.
Of course, many of the company’s customers wanted and needed technical
support or other services. So Dow Corning began offering these services à la
carte, at prices that would cover its costs. This two-brand strategy enabled
the company to be clearer internally about the needs of its customers, both
the “price-seekers” group and the “custom-solution” group. Both groups
turned out to be more satisfied with what they received from the company.
The results were remarkable. By 2006, Dow Corning had grown by more than 60
percent and multiplied its profits. In 2005 the research firm Frost &
Sullivan named Dow Corning the specialty chemicals company of the year.
Segment Needs and Performance (SNAP) charts
Different customer segments
will have different wants and needs. If you compare your offerings for
particular segments with those of your competitors and substitute products
as they are viewed by these customers, you are likely to glimpse what will
happen to your profit pools and relative market shares down the road.
How to assess the needs of different segments over time? One simple tool
-- we call it a “SNAP chart” -- can often get you 80 percent of the answer.
First, you define the specific attributes of the products or services you
offer that might be important to the customer segments you want to target.
Second, you conduct research aimed at determining how important each of
these actually is to these customers. A bank, for instance, might study
everything from its hours of business or its loan rates to the quality of
the advice it offers and the ease of access to its ATMs. Third, you assess
your performance on each attribute as viewed by the customers and where each
of your competitors performs on these dimensions as well.
The resulting chart shows how you measure up to the competition in the
eyes of your key customer segments. You can use it to identify which gaps
are most important to close (if you’re behind) or widen (if you’re ahead).
You can also see where you might be overshooting the mark. The company
exceeds customers’ requirements on innovation and assortment, two attributes
that rank number four and number six in importance to the customer. It is
thus incurring costs that may not earn a return in the marketplace.
Meanwhile, it is slightly underperforming competitors on quality, which is
number one in importance, and significantly underperforming on customer
service, which is number three. It probably needs to take action to close
those gaps.
SNAP charts, incidentally, underscore the importance of an effective
segmentation strategy. To oversimplify only a little: if you have only one
undifferentiated offering, you are unlikely to meet the needs of your
customers as well as competitors that have offerings tailored to each
significant segment. You will also probably incur unnecessary costs in
over-serving needs that are not highly valued by some customers.
Customer ethnographic research
Traditional quantitative and qualitative
research techniques can help identify and size customer segments and
characterize their needs. But in fast-changing markets, or in situations
where innovation is required, customers often have trouble articulating or
even recognizing their own needs. Consumer-products and technology companies
have pioneered the use of a tool known as customer ethnographic research to
address this kind of situation. It’s a way of identifying unmet needs that
customers might not be wholly aware of. Researchers spend time with
customers in their homes, backyards, or cars. They watch what customers do
-- the frustrations they encounter, the jury-rigged devices they come up
with to solve their problems. That helps the companies develop products that
customers wouldn’t necessarily have been able to describe.
The revenue sieve
Once you know more about your customers, you need to
figure out the appropriate actions. One tool that can help you capture more
value from your segmentation is known as the “revenue sieve.”
The revenue sieve starts by asking the question: what customers represent
100 percent of the market we could serve, and why do we not have all of it?
This technique breaks down the difference between the full addressable
market and a company’s current sales. The concept can best be illustrated
through the story of Grainger, the industrial-goods distributor.
At this point, the company took a fresh and detailed look at the
addressable market and applied the revenue sieve. It first noticed that MRO
products were being purchased by a far broader range of customers than just
contractors. Manufacturers, wholesalers, and institutional and commercial
organizations all bought MRO supplies, though Grainger had not been
targeting these customers. In fact, the total market for the products
Grainger distributed was $40 billion, eight times the size of the market
that the company had traditionally addressed. Starting with that $40 billion
total market, Grainger could identify the points of leakage between that and
its current sales.
As Grainger managers analyzed the full-potential set of customers and
their buying patterns, they discovered that the various customer segments
had different needs. But all had one thing in common: a lot of unplanned
purchases. They would suddenly discover they needed something, and would
then look for the most convenient location to buy the products. The
distances customers were willing to drive, however, was generally limited.
So Grainger took a number of actions to address the full-potential
market. It dramatically increased the number of branches, so that more were
within a thirty-minute drive from concentrations of customers. It refocused
its product lines onto the convenience items that were most often the object
of unplanned purchases. It restructured the salesforce and applied best
practices for each type of customer. It improved customer service and
streamlined its ordering procedures.
The result was a rekindling of growth: through the 1990s, Grainger was
able to grow at an average annual rate of more than 7 percent a year, or
about twice the underlying industry growth rate for Grainger’s basic
products. By understanding the leakage between full potential and current
sales, the company could take concrete actions to grow when the conventional
wisdom suggested it was doing as well as it could.
Loyalty and retention
Our colleague Fred Reichheld is well known for
showing that customer retention and loyalty can be enormous boons to growth
and profitability. Think about how rapidly your company grew last year. How
much of the growth came from new customers, and how much did you lose from
customers who left you for a competitor? Most companies’ revenues are like a
leaky bucket. As you add revenue in the top, you lose it out the bottom.
This happens for a variety of reasons. Some of your customers have bad
experiences and move to someone else. Some enter a new phase in their life
cycle and now find your offerings less attractive than those of a
competitor. Others experiment with the innovations offered by competitors.
In many industries, increasing customer retention can be the biggest single
driver of profitability. In credit cards and some other financial-services
businesses, for example, increasing retention by as little as 5 percent can
double profits.
An obvious starting point, of course, is to measure accurately how well
you retain your customers and what share of their purchases you have earned.
Understanding customer retention in each segment of customers, and mapping
the differences in retention rates among customers acquired through
different channels, on different products, pricing or service plans, and
with different customer experiences can help locate “hot spots” for focus.
But while this is an important technique for figuring out what has happened
in the past, managers have long struggled to find a way to anticipate future
issues. Traditional measures of customer satisfaction have failed to gain
the trust of management teams for a variety of reasons. The measures often
rely on complicated, hard-to-understand indices. They are often based on
small samples of customers, and they may become available only after a long
lag time because they require months of data collection and analysis. The
measures may also fail to explain and predict variations in customer
behavior and profitability.
In recent years Reichheld and others developed a metric and approach
known as Net Promoter® Score (NPS), which measures loyalty and can help
predict customer retention and share of wallet. One of the simplest, most
practical, and most powerful approaches to customer metrics, NPS is derived
from asking your customers just one question: how likely they would be (on a
zero-to-ten scale) to recommend your company, product, or service to a
friend or colleague. Typically, companies using the NPS approach follow up
with only one to five additional questions. That keeps the survey short and
respectful of a customer’s time. Speeding up the feedback enables the metric
to become an embedded operational process rather than remaining an isolated
piece of research. Used wisely and in the right circumstances, NPS can
supplement or even replace some of the more complicated customer-feedback
approaches companies have traditionally used.
Looking at your Net Promoter Score over time is the best way we have
found to assess and predict customer loyalty, and greater loyalty is the
best way of plugging the leaky bucket. You can calculate your NPS by
customer segment, and you can compare your scores with those of your
competitors simply by surveying customers of all the relevant companies.
Average scores naturally vary by industry, but the leading companies in many
industries are likely to have an NPS greater than 50 to 60 percent. If you
are ten percentage points below the best competitor in your industry, you
may have an opportunity to improve performance through a strategy designed
to increase customer loyalty.
If you find that your NPS is declining over time, additional research
into your customers’ experience may reveal the reasons and may help show how
to improve things. In businesses with many customer touch points this can be
challenging, but the reward is worth it. St. George Bank in Australia, for
instance, discovered that its promoters -- those who said they would
definitely recommend it to a friend or colleague -- were twice as profitable
as an average customer: they used more of the bank’s products, on average,
and gave it a greater share of wallet. But the bank’s retention rates for
promoters were not as high as they should have been. Root-cause analysis
showed that poor service was the major cause of defection. So managers
attacked service issues aggressively, focusing on touch points likely to
have the greatest effect. They used best-practice examples to set goals and
develop initiatives. They developed detailed implementation plans, including
training and recognition-and-rewards programs. They created a dashboard of
measures so that they could monitor their progress. Three years later the
bank’s NPS had risen, and its stock price had outperformed a peer index by a
factor of 1.4.
In all such cases, the key to success is identifying the factors that are
most important to the customer. Analyzing why customers defect can be an
effective way to learn exactly what is most important. Customer satisfaction
is usually a combination of many complex factors that are difficult for a
customer to articulate and prioritize -- but when customers decide to leave
you, they can usually tell you exactly why. So focusing on identifying and
eliminating the root causes of defection is a powerful tool.
You can supplement your NPS analysis with a host of diagnostic tools
related to loyalty: share-of-wallet analysis, analysis of the lifetime value
of a customer, customer migration analysis, and so on. There are also many
other sophisticated tools for learning about your customers these days --
tools such as the S curve, cluster analysis, perceptual mapping, CHAID
(chi-squared automatic interaction detection, a method of answering
questions such as which factors best explain the behavior of a given
variable), and discrete choice. Depending on your situation, you will want
to use a variety of tools to understand your customers in depth. It’s a key
to both diagnosing your current performance and evaluating opportunities for
the future.
Segmentation and retention efforts are at the ends of a six-link chain of
activity that enables a company to earn more profits per customer than its
competitors, and then to out invest the competitors to generate greater
growth. The first links are 1. to identify the most attractive target
segments and 2. to design the best value propositions to meet their needs.
The next steps are 3. to acquire more of the target segment and 4. to
deliver a superior customer experience. That enables the company 5. to grow
its share of wallet, and finally 6. to drive loyalty and retention, with
more promoters and fewer detractors.
The following is an excerpt from the book
The Breakthrough Imperative
by Mark Gottfredson and Steve Schaubert
Published by Collins; March 2008;
$26.95US/$28.95CAN;
978-0-06-135814-2
Copyright © 2009 Mark Gottfredson and Steve Schaubert
Author Mark Gottfredson is a partner in Bain & Company's Dallas, Texas,
office, which he founded in 1990. Currently global head of Bain's
performance improvement practice, he has advised clients in a wide range of
industries and is a leader in the firm's business strategy, airline,
manufacturing, and retailing practices. In 2005, Consulting Magazine named
him one of the world's top twenty-five consultants. He has written
extensively for publications such as Harvard Business Review, Wall Street
Journal, Singapore Business Times, The Edge (Malaysia), South China Morning
Post, London Business School's Business Strategy Review, and World Business
Review. He is fluent in Japanese and has worked extensively in Japan. Mark
graduated magna cum laude from Brigham Young University and received his MBA
from Harvard Business School with high distinction in 1983. He lives in
Dallas.
Steve Schaubert is a partner in Bain & Company's Boston, Massachusetts,
office. He joined the firm in 1979 and became a partner in the following
year. Currently Bain's chief investment officer, he has worked with clients
in numerous industries including steel, textiles, automotive, health care,
consumer products, distribution businesses, and financial services. Prior to
joining Bain, he held several senior general management positions in the
health care industry. A summa cum laude graduate of Yale, Schaubert earned
his MBA from Harvard Business School with high distinction, and an MS in
engineering management from Northeastern University. He lives in Boston.
For more information, please visit
www.thebreakthroughimperative.com .
June 2008
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