Excerpt from Get Your Price!: Value-Based Strategy for Capital Equipment Companies
You’re motivated to implement a value-based strategy. You want more customers at higher prices and the ensuing commercial success. But have you thought about how a value-based strategy actually makes that happen or why it’s so powerful?
Wonder no more. Here are the four primary reasons that you need a value-based strategy:
- You’ll avoid the commodity trap.
- It will lower your costs.
- It will provide the best leverage on your profitability.
- You have the potential for near-instant results.
Let’s take a closer look at each of these.
Avoid the Commodity Trap
When the buyer sees no difference between you and your competitor except price, you have fallen into the commodity trap.
It’s easier than you might think to end up here. The road to the commodity trap surprisingly often starts with the hubris of success. Your company or business unit may have been built around a great product idea that the market loved. There’s a good chance that you’ve been playing out that idea for a while. This can go on for years. Competition may have emerged, but you have combated it with
- Specification leapfrog,
- New product features, and
- Lower manufacturing costs.
Yet you are still likely to end up in the commodity trap. You see your product solved a problem. For that, you were rewarded handsomely. Competitors saw you making a mint solving that problem, so they jumped in. Eventually, you and your competitors will have solved that problem to a degree that the customer no longer requires more capability to solve it. Decisions between alternatives become largely based on price. At that moment, you are in the commodity trap.
The root cause of the commodity trap is a product-oriented pursuit of competitive advantage where the customer problem is treated as static. Over time, the value differential between competitors solving this problem shrinks to the point where the customer sees no differential—that is, except for price. See Figure 4.
Figure 4: Product-focused strategy leads to the commodity trap.
In value-based strategy, this can be avoided. The difference is that a value-based strategy always starts with the customer’s goals and the problems he needs to solve to achieve those goals. These goals and problems are always evolving as legacy problems are solved. The supplier pursuing a value-based strategy puts as much focus on discovering new, hard, valuable problems to solve for its target customers as it does trying to create superior products. These suppliers avoid the commodity trap by constantly redefining the problem that they are solving. Doing so reconstructs market boundaries and creates uncontested market space. See Figure 5.
Figure 5: Value-based strategy leads to uncontested space.
By way of a hypothetical example, let’s consider gravel. That’s right, gravel—bits of crushed stone. It seems to be a product all but destined for the commodity trap. In fact, gravel—along with oil, corn, and wheat—is often referred to as a commodity.
Land developers need gravel to create stable building surfaces. To compete, the product-oriented gravel supplier would focus on the gravel. He would
- Offer a full range of gravel types typically required to meet land developers’ various applications, and
- Streamline the process for producing it to lower his production costs.
The customer-value-oriented producer would also do these things. But the value-oriented producer knows that several suppliers eventually will have the application space covered and that any cost advantages will evaporate. The value-oriented producer knows that he needs to discover the next important customer problem to solve.
For the sake of our example, let’s say that our value-oriented supplier discovers that one of the biggest land-developer problems is the amount of time his drivers and equipment are tied up waiting in line for their turn to pick up their load. If you’ve ever gone by a gravel yard, you’ve probably witnessed the dusty entrances with long lines of idling dump trucks. It probably never occurred to you the amount of time and money being wasted in the gravel queue. It’s a real profit killer.
Voila, the value-oriented gravel-yard operator discovers an opportunity to create uncontested market space. Instead of trying to improve the gravel, as the other suppliers do, the value-oriented supplier can consider offering
- Gravel-delivery services, or
- Online pickup scheduling with guaranteed pickup times.
Suddenly, the value-oriented gravel producer finds himself in uncontested market space. No amount of gravel optimization is going to commoditize his offering. Sure, eventually, the other players will catch on and start developing solutions to compete in this new space. But by the time they get up to speed and become a threat, the value-oriented producer is already working on the next customer problem.
Lower Costs
When you think about value-based strategy, your first thought is probably:
“Better pricing.”
That’s understandable. Value-based strategy’s headline promise is that customers will pay prices that are tethered to the value that they derive from the products that they buy. In fact, value-based strategy is often thought of only in terms of pricing strategy.
But it is so much more. It will also lower your costs.
When your understanding of your target customers’ needs is vague, you compensate by casting a wide net. You bloat the product with the capability to cover a broad application and performance space. You hope that casting a wide net will improve your chances of catching a customer.
Hope is not a strategy. And wide nets are expensive. Wide-net products have high manufacturing and development costs.
An equally flawed alternative to a wide-net approach is to take your direction from the competition. When you let your competitors drive your roadmap, you’re assuming that they know your target customers better than you do. What if they are following a wide-net strategy? Following them will just create an even wider, higher-cost net for you.
A value-based strategy is built on a foundation of customer intimacy. You must understand your target customers’ business, problems, and needs as well as you understand your own.
Put as much effort into developing this understanding as you do designing your products. Test and retest your assumptions. Once you know exactly what your target customers need, take measure of the competition. You’re not interested in the full scope of their capability. You care only about how they stack up on the key value drivers. Do this until you know the following with great precision:
- The problem your target customers seek to solve
- The environment in which they need to solve it
- The financial value created once it’s solved
- The criteria customers will use to make purchase decisions
- The product’s value-driver performance levels required to win their business
Equipped with this knowledge, you won’t have to rely on a wide-net approach to capture your target market. You no longer need to toss extra capability and features into your product to hedge your bets. You know exactly what the customers need. You know exactly what the customers’ critical value drivers are. You set these and only these to be superior to the competition. The rest you set to be just good enough. You leave features that are irrelevant to customer value off the bill of material.
The result is a lean, winning product.
Best Leverage on Profitability
You essentially have three options to improve profitability:
- Lower product costs.
- Lower operating expenses.
- Increase revenue.
Most often, a profitability-improvement program will focus on the first two. This tendency is fueled by the comfort that the company executives feel when they work on things that they believe they can control. Increasing revenue requires a favorable response to your effort from customers and competitors. Therefore, this option doesn’t provide the same sense of control as the first two.
However, lowering product costs and operating expenses have much lower leverage on profitability than increasing revenue. Let’s look at an example.
Suppose that an $800M equipment company was looking to improve its profitability. The management team at this company decided to analyze the impact that making a 10% improvement in each of the three options would have. The results of this analysis are shown in Table 2.
Table 2: Value-based strategy impact on profitability
| Improvement Options | ||||||
| (Millions of dollars) | Plan of Record | 10% COGS | 10% OpEx | 10% Revenue | ||
| Revenue | 800 | 800 | 800 | 880 | ||
| Cost of goods | 400 | 360 | 400 | 400 | ||
| Gross margin | 400 | 440 | 400 | 480 | ||
| Operating expense | 300 | 300 | 270 | 300 | ||
| Profit | 100 | 140 | 130 | 180 | ||
| Change | N/A | 40 | 30 | 80 | ||
You can see that increasing revenue has double the profit impact of a cost-of-goods-sold reduction effort and nearly triple that of an operating-expense reduction.
Yes, this simple profit-and-loss arithmetic borders on stating the obvious. However, this obvious option for improving profitability is often dismissed.
That changes when you’re fully equipped with value-based strategy competency. The questions of how to provide customers with more value or how to extend your value advantage over the competition are no longer intimidating.
Potential for Near-Instant Results
You want higher prices. You get it that a value-based strategy can deliver.
Your team has brought you up to speed on what it really takes to adopt a value-based strategy. You know it will have a broad impact on how you define, create, and market products. Everything you do will need to be oriented to create unique customer value.
It’ll be a significant undertaking. But what if you need results now?
A value-based strategy requires you to embark on a journey through the four-step framework shown below in Figure 6.
Figure 6: The value-based strategy process
And there you see the problem. It’s in the second step. You actually have to create valuable products before they can be sold. It’s the “Create Value” part that can take so long and frustrates the need-results-now crowd.
Don’t give up. Near-instant results are still possible by taking a shortcut.
You haven’t been operating in a vacuum. You engage customers, battle competitors, and develop products every day. Your strategy is well informed, even if a value-based framework hasn’t guided it. It’s possible that your existing portfolio contains untapped value.
To find out if it does, you first have to complete the “Define Value” step. This step develops an economic-value model for the products in your portfolio. You’ll need two inputs:
- The added economic value that your customer gets from your product when compared with your competitor’s product
- Your competitor’s reference price
The market value of your product is simply the reference price for your competitor’s product plus your added value. See Figure 7.
Figure 7: Value-pricing model
This is immediately useful. Use this definition of market value to “value audit” your existing product portfolio. This will produce one of three outcomes for each product:
- You’ve priced it correctly.
- You expect a price higher than its actual market value.
- You’ve underpriced it.
A discovery that you’ve underpriced a product is like found gold. When you find one, immediately take a shortcut from “Define Value” directly to “Market Value.” See Figure 8.
Figure 8: Value-based strategy shortcut
When you get there,
- Increase the product’s price to reflect its value,
- Update your marketing materials and strategy to substantiate your revised value proposition, and
- Train sales to defend your new value-based price.
Then get ready to enjoy near-instant value-based strategy results.
The motivation to “go find instant results” is often a low-margin product. The hope is that a value-based approach will boost its price. It might help, but the odds are against you. When a product is under price pressure, the market is already signaling the maximum that they will pay for it. There’s probably not much juice left in that orange.
You are far more likely to find an underpriced product among your best performers. These are the products that routinely achieve target profitability. Management doesn’t complain about the price they’re getting. Customers don’t complain about the price that they’re paying. Price tension is low. This is where underpriced products usually hide.
Near-instant results are possible by taking the value-based strategy shortcut described here. Everybody should try it. Just don’t forget this shortcut is just that, a shortcut. It’s a retrospective portfolio assessment. Value-based strategy is “deliberate.” Discovering unexpected value in products that were developed without a value-based approach isn’t deliberate; it’s lucky.
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