Learning Customers’ Needs
Needs of Potential Customers
Discussion Points
Customer Development Process
Relative Effectiveness

The most critical component of incremental business strategy is to understand customer’s needs. In the “Learning Customers’ Needs” figure the common forms of gathering needs are shown. In contrast to this list are the “Needs of Potential Customers” shown in the following figure. Note that in-person interactions at trade shows jump the top of the list when looking for new business. That said, looking at the form of discussions with customers most companies focus heavily on current customers’ problem areas as shown in the “Discussion Points” and “Customer Development Process” figures. The critical importance here is that the relative effectiveness of these approaches with respect to long-term success is poor as shown in the “Relative Effectiveness” Figure. Thus it is critical to utilize processes outside of customer engagement if good next-generation or breakthrough strategic direction is desired. But for incremental strategic direction is desired, the next step is to prioritize what is heard from different customers.

The best way to prioritize what direction a strategic plan for incremental growth takes is rank order a customer list by those that usually have the highest volume or highest profitability for a corporation. The problem comes when customers low on the list ask for an increase in the product line items to meet their needs. An important distinction to make is to understand that these customers make two types of requests. The first type is when the request reflects a true market need. Helping these customers service their needs builds growth for everybody. The other type of request comes from a customer that has misjudged their customer’s true need. Servicing a customer request for such a misguided a new feature creates more product line items with limited volume and profitability.

These concepts came to light in the late 1980s and early 1990s when reengineering efforts throughout corporations became prevalent. The work was made more popular in the early 2000’s with a book, Angel Customers & Demon Customers, written by Larry Selden and Geoffrey Colvin. The “Economic Profit per Customer Example” figure shows the distribution of wealth that the good and bad customers create for corporations. They used a form of EVA (economic value added) to assess each customer’s contribution, that is a spread (or return) on invested capital minus the cost of capital.

ROI –Cost of Capital Differences Between Companies
Economic Profit per Customer Example

Important in the “ROI –Cost of Capital Differences Between Companies” figure is to note that it is a normal distribution pattern that is typical of many companies’ customers. Another way to look at the same data as shown in the “Economic Profit per Customer Example” figure. Here the ETA per customer is shown and the normal distribution now shows us the positive and negative EVA being contributed by each decile of customers.

Customer Segmentation Matrix

Diving still further into the EVA per customer, the “Customer Segmentation Matrix” figure shows that for any customer there are product lines that are profitable and those that are not. When customers request unique and distinctive features in a product one drifts away from the sweet spot of this graph into unprofitable areas.

From an innovation management standpoint a company will have many ideas from customers. The way to go about strategic planning in the incremental area is to quickly put customer requests on a chart which shows the contribution by customer by product line. One can quickly determine which are going to generate profits for a company and which ones should be sent back to the salesperson declining the opportunity. This is hard to do, but good methods are described by Larry and Geoffrey in their book on ways to deal with customers appropriately. From an innovation management standpoint and business planning it’s a matter of taking the top 20% of the needs described by “A” list customers, focusing on those with a “just do it” attitude and discard the rest pending a review by the sales organization.

Factor and Sub-Factor Ratings for New Product Strategies (1)
Factor and Sub-Factor Ratings for New Product Strategies (2)

The “Factor and Sub-Factor Ratings for New Product Strategies” figure provides many of the relevant considerations for screening of new product strategies. This is one of three often used screening tools. The other two are Breakeven Analysis and Preliminary Financial Return Analysis. The one illustrated in the figure is a Product Profile Analysis conducted by knowledgeable managers and experts. When scores between competing strategies vary widely this provides a quick assessment of which strategy to choose. When the numerical scores are close however, in-person discussion and deliberation among the experts is necessary.

Elements of a Business Model

Before moving on from the segmentation matrix of the “Customer Segmentation Matrix” figure, notice that there is a box for high profitability where the homogeneity of the need is low. Ideas in this box represent excellent business opportunities requiring further review. Looking at organic or incremental growth in this box, as well as perhaps a little and translational or next-generation growth is the specialty of long-established industry specific consulting firms. Strategic planning for growth in this box is usually done by segmenting according to the elements of a business model. Often they involve six typical steps. These relate to the value chain, business segmentation, business scope, technology, competitive advantages, and value proposition. These are shown in the “Elements of a Business Model” figure.

The Laws of Marketing Physics

In “Jump Start Your Business Brain: Win More, Lose Less, and Make More Money” Doug Hall describes the way to look at business strategies in simple terms. He focuses on three drivers. They are the “Overt Benefit”, the “Reason to Believe”, and the “Distinctive Difference” of one company to another, as shown in the “The Laws of Marketing Physics” figure. When setting business strategy, these elements of your company’s business model need very careful consideration. Contrasting the “Customer Segmentation Matrix” figure with the “The Laws of Marketing Physics” figure, Doug’s Overt Benefit is hidden in elements 1 and 3, the Reason To Believe in elements 2 and 4, and the Distinctive Difference is in elements 5 and 6.

Understanding a company through these perspectives enables creation of business strategic plans for incremental and some next-generation growth. The purpose of each element in the Business Plan follows (in outline form):

Define all key elements of the business including:

  • How value is delivered to its customer base.
  • Sources of competitive advantage to be built or sustained.
  • The product or service bundle and how it will vary by customer segment.
  • The role of technology in value creation and resourcing levels.
  • The overall scope of the business — the value chain position.
  • The drivers of business value and overall economics.

Key elements of the model should include:

  • Value chain positioning.
  • Business scope (products and services).
  • Technology position.
  • Customer and market segmentation.
  • Business value drivers and Company’s competitive position.
  • Customer value proposition.
Example of a Business Model for Surfactants Industry

Getting a little bit more specific the “Example of a Business Model for Surfactants Industry” figure shows the examples of a business model for a company in the surfactants industry. This picture is laid out along a value chain of raw materials, intermediates, surfactants, and end users and customers. It answers the questions of what are typical products, the size of the market, the market’s growth rate, the concentration of industry players, value drivers, the typical margins, and where specific companies are working along the value chain.

In the example shown, the typical margins along the value chain are relatively equal, although one can see that the intermediates market and the end-use consumer portions of the value chain are generating much higher returns than for instance those parts of the chain dealing with the surfactants themselves. One can also see at a glance which companies are participating in the high-growth areas and to some insight what the value drivers might be that a company would have to take advantage of when innovating new products and services in order to take share in these portions of the value chain. It is again worth reiterating that this planning methodology works best in established industries were market size, growth rates, participants and margins are known.

Segmenting an Industry to Look for Where the Leverage Is

Stepping back a moment and looking at this Chapter’s contents, from a business strategic planning standpoint we are making progress, but we are still not to the point of understanding what our strategy should be. Oftentimes the next step is to segment the industry in a particular manner to look where leverage exists. This is exemplified in the “Segmenting an Industry to Look for Where the Leverage Is” figure.

In this representation we see that it’s important to consider segmenting the market along the products and services offered, the markets and applications that are served, type of customers, and the geographic region in the world to focus on. Notice that the table is a matrix so that the markets, customers, and competitors show up as columns as well. This forces us to think about how the product variability changes as a function of market, customers, and competitors. It also highlights show how markets and applications vary by customers and competitors, and finally how geography affects markets, customers, and competition. Filling in this table allows us to determine where the sweet spot might be. It covers segments that have the largest size and growth rates and within those segments, the market, customer, or competitors that we should focus our business strategy on to gain maximum leverage.

Example of Segmentation by Markets

The “Example of Segmentation by Markets” figure shows for the different business segments the sales, growth rate and most importantly the descriptors. It gives us a sense for which segments are the ones that are likely to be the most profitable and subject to our application of strategic resources.

Example of Value Propositions That Will Drive Business Strategy

Taken from this picture we see in the “Example of Value Propositions That Will Drive Business Strategy” figure an example of value propositions that are going to be able to drive our business strategy. In this listing is a column titled nature of the value proposition. It is in fact the attributes that we’re going to use for driving innovation in specific areas. Another good column to add (not shown), is one that addresses Doug Hall’s Overt Benefit, Real Reason to Believe, and Distinctive Difference.

Solid innovation management in areas where incremental and some next-generation growth is needed is best done by a very clear understanding of the value proposition. Targeting innovation appropriately to take head-on the value proposition in a way that attracts customers away from competition is key to success. It also lays the groundwork for our intellectual property strategy because it outlines the nature of the claims that we wish to achieve when our innovation efforts are successful. As we’ll see later in the innovation strategy area it’s not enough to claim how you do it but one that also claims intellectual property around the “choke point” or value proposition description. Understanding this concept at the outset is key to productive integration of business strategy with intellectual property management.

Remembering that we’re focused on incremental innovation for known markets allows us to utilize market research that is readily available. The “Services Example of Business Scope Where Further Segmentation Shows Areas of Most Value” figure shows there are four service offerings placed in a hierarchy.

Services Example of Business Scope Where Further Segmentation Shows Areas of Most Value

These service offerings range from low value services up through to the ultimate selling of a customer on a solution. Because of the incremental nature of the new product or service to be created, the future costs and the revenues can be relatively reliably forecast when innovating along this hierarchy. Again it’s important to remember that for incremental innovation the selection criteria for which project to do is going to be done on an ROI or customer class priority listing. Projects with the lowest risks and the highest organizational capability to deliver are the ones that are going to be selected by such a selection strategy. Thus, understanding completely the elements of cost incurred and returns received from incremental innovation isn’t as critical as for next-generation projects.

When strategies are put together in the manner of the “Services Example of Business Scope Where Further Segmentation Shows Areas of Most Value” figure it is easy to see which of the four types of innovation might be best employed to deliver value to a corporation. It could be the first type of innovation that is product or service innovation involving a physical product or service or enhancement. Alternatively the second type of innovation involving a process for improving efficiency or effectiveness might be appropriate. The third kind of innovation which involves a new marketing concept or action can be determined from such segmentation matrices. Lastly, and sometimes overlooked, is a management innovation, the fourth type. This innovation talks about a new way of managing or constructing a completely different business model. It was the dot-com boom of the late 1990s that showed this type of innovation could lead to very high investor returns. Specific forms of differentiation are:

  • Differentiate products using unique features.
  • Differentiate products based on increased customer benefits.
  • Differentiate products based on improved productivity.
  • Differentiate products based on protecting the customers’ investment.
  • Differentiate products by lowering the cost of product failure.
  • Differentiate products with high performance.
  • Differentiate products based on unique fundamental capabilities.
  • Differentiate products through design.
  • Differentiate products as total solutions.
  • Differentiate products based on total cost of ownership to the customer.
  • Differentiate products based on brand-name or service.

William Hall and Michael Porter studied carefully such business level strategies. Their research showed that strategies at the business level can often times be reduced to a two-dimensional figure. This is shown in the “Survival Strategies in a Hostile Environment” figure.

Survival Strategies in a Hostile Environment

This figure is a variation of the standard relative cost versus relative performance graph used in the 1970s and 1980s by Bain consulting firm. The distinction is on the vertical axis one looks at relative differentiation as the element of segmentation, versus relative performance as done earlier. In either matrix it is high relative differentiation or higher relative performance at low relative delivered cost that generates all the value. The converse of low differentiation and high costs “the valley of death” is unfortunately where some innovation projects get funded. In the book “Innovate or Evaporate” by James M. Higgins, the product innovation strategies associated with various well-known companies are positioned on this matrix. He has talks about product innovation at three levels. The first level being kaizen or continuous improvement. The second level is what he calls leaping or what I call next-generation new product development. And finally the third level of innovation Higgins calls Big Bang innovation (equivalent to Breakthrough or Horizon 3).

Value Map

From a business strategy standpoint it’s important to know where a project is placed on this graph as well as on the more traditional graphic developed by Bain Corporation as shown in “Value Map” figure. It is this graph which does the best job of showing integrated business, technical and intellectual property management.

If one is conducting innovation at the upper left-hand quadrant of the graph one wants to protect the technical innovation with every form of intellectual property possible. If one is operating as a corporation in the upper right quadrant one wants to protect those new products with intellectual property, but judiciously thinking about in which countries of the world should IP be obtained to best thwart competition. Also, for a corporation operating in the upper right quadrant a new product or technology located in the lower left quadrant should not be resourced but if it is created within the company, hopefully by accident, would be put out for licensing. That is because it would be incongruent with the company’s ability to market, sell and distribute such products. A business ROI would best be gained by licensing to competitions who were branded and known for working in that lower left area of the market. Historically companies well known for working in the upper right hand quadrant were Hewlett-Packard, Intel, and 3M. Historically companies known for working in the lower left quadrant are companies like Wal-Mart and Hyundai.

Example of an Experience Curve

In order to get a sense of how fast dots (products) will migrate across the “Value Map” figure, experience curves can be created which represent the cost per unit as a function of the total accumulated volume or units. This is shown is the “Example of an Experience Curve” figure. This log-log linear relationship has been found to be generally applicable across almost all industries. Note that although time increases with experience, the curve is plotted against units produced and may be quite irregular with respect to time. That said, the rate of migration across the value map can be estimated and used for strategic planning purposes. The rate of migration for performance on the y-axis is much more irregular and not as easily ascertained for planning purposes.

EVA of Divisions in a Large Corporation
CFIRR of Divisions in a Large Corporation

In a large Corporation there is always the question as to which business units should receive the bulk of the corporation’s innovation resources’ attention. To answer this question two financial measures of divisional performance are helpful. These are the Economic Value Added (EVA) of Divisions in a Large Corporation and the Cash Flow Internal Rate of Return (CFIRR) of Divisions in a Large Corporation. Both are shown in the respective figures. For business strategic planning, offensive next-generation innovation should be applied to those divisions with a high EVA and high CFIRR. Incremental customer focused innovation can be applied to those divisions in the upper half of the EVA spectrum and who have an adequate return above the real cost of capital. For those divisions that do not meet this threshold and have inadequate or negative returns the only option from a strategic standpoint is to invest in radical or breakthrough business models or technical innovation if the underlying marketplace trends warrant such an effort. This is not often the case and thus innovation resources should be withheld from such divisions. From a business strategy standpoint sale of such divisions to a competitor, or acquisition of a start-up company with a breakthrough business model are two acceptable strategies.

Patterns of Product-Model Evolution

For incremental business strategies, several other generic forms are available. These include price-based strategies (either offense or defensive), time-based product strategies (based on superior product development process cycle times), product family strategies (“Patterns of Product-Model Evolution” figure), global product strategies (by leveraging a regional product into new regions or develop customized global products by region, i.e. Flavored beverages) and cannibalization strategies.

Relative Rates of Disruption

In deciding between incremental and disruptive business strategies, teams need to take into account the amount of change both ongoing in the environment and that the Company’s strategy itself will unleash. In today’s environment of Moore’s law, with its relentless journey into the realm of the smaller, cheaper, and faster, acceleration of new technology introductions will increase. As it does that Metcalfe’s network effects law is to spread them around. In “Unleashing the Killer App” it was argued that combination of Moore’s Law and Metcalfe’s law becomes the Law of Disruption. This law can simply be stated as follows: social, political and economic systems change incrementally, whereas technology changes exponentially as shown in the “Relative Rates of Disruption” figure. This is particularly true with respect to cyberspace. It is not about computers anymore, it’s about living.

Partnership Options

Business strategies also have to take into account this increased rate of technology change. To create new products and services in this environment, the range of partnerships that must be considered is shown in the “Partnership Options” figure. The high technology environment moves to options to the far right of the curve. As covered in the “When and How to Access External Technology” chapter, good partnerships make for an excellent business strategy, or on the other hand, poor partnership management can just as easily be an organization’s undoing.