Unfortunately, all too often managers become preoccupied with costs to the detriment of value to customers. With a cost orientation, managers pay minimal attention to customer value (Exhibit 1.8). According to Boyd Beasley, the senior director of customer support at Electronic Arts, the successful producer of video games, “In years past, we [EA] were very much a cost center operation and our vision was to come in on budget...We are turning the ship to be significantly more customer centric” by providing more services to customers and bringing them into the product development process earlier.22
Exhibit 1.8 Orientations
Reprinted with permission from “How Marketing Affects Shareholder Value,” The Arrow Group, Ltd.®, New York, NY, 2008.
There are at least two problems with a single-minded cost orientation:
- Cost reduction programs may lower value to the customer more than they lower costs.
- Cost preoccupation is often, but not necessarily, associated with low pricing strategies.
If lowering costs leads to an even greater lowering of perceived value, CVA® is being decreased, and the organization is contributing less to society and will, therefore, have a lower level of financial performance. Decreasing CVA® when lowering costs represents the hollowing out of a brand.23
During a hollowing-out process, because CVA® depends on the perceptions of customers, there may be a time lag between the lowering of costs and the lowering of perceived value. There is inertia in perceptions—customers may be forgiving at the first signs of lowered product or service value.
An example of how easy it is for managers to begin the hollowing out of a brand: Typically the author travels to China two or three times a year with a major US airline. In the past, they provided sandwiches in the middle of the trip—the time in the air is 14 to 15 hours so the sandwiches were welcome. Recently, the airline decided to eliminate the sandwiches, cutting back on their value to customers. Notice the price of a round-trip business class ticket is in the vicinity of $10,000; the cost of providing a sandwich perhaps a dollar or two. By cutting back on costs, they risk losing the entire fare because there are other carriers flying the same route that are not cutting back on the small comforts that make a trip bearable. Truly, the airline is following a policy of “penny wise, pound foolish.”
When the author mentioned the loss of sandwiches to a flight attendant, she said, “Yes, they are just getting very chintzy—and I am tired of reporting the negative passenger reactions. The managers don’t understand.” Perhaps it would be helpful if the cost-cutters were asked to experience a 15-hour flight sometime and learn how the world looks from a passenger’s point of view.
Incidentally, whenever the author sees one of this airline’s expensive print ads, he immediately thinks, “How many sandwiches is that ad worth?” Glossy advertising does not offset perceived product or service deficiencies—as eventually the top managers of this airline might learn. In fact, glossy advertising makes customers more sensitive to perceived value deficiencies.
One can see hollowing out actions all the time and everywhere. When a local bank promises wonderful service and a customer does not receive that level of service, perceived value falls even faster than any cost savings. When a chemical produces lags in their delivery, perceived value may decrease more than any shipping costs saved.
The time lag between when a cost is cut and when customer value falls can tempt a senior manager to cut costs because they can appear to be successful with a cost-cutting program as long as customers have not yet noticed the decline in customer value. Their successor will discover later that the cost decreases have eroded the customer value and brand reputation of the organization, compromising the brand’s power to generate revenue, profits, and cash flow, sometimes irretrievably.24
All cost reduction programs should be calibrated against the impact on customer value as perceived by the customer—value engineering from the customer’s point of view. Unfortunately, many organizations are cost-oriented because they do not know the perceived value associated with their product or service and, therefore, are unable to discover the impact of cost changes on value as perceived by their customers.
An infamous example of failing to consider CVA® is the Schlitz beer story. In the 1970’s, Schlitz was the number two brewer in the US. Concerned with their stock price, top management cut costs by using less expensive hops and reducing the time to age the beer. In the short run, profits increased and so did the stock price, but then customers started to realize that the Schlitz taste had deteriorated and they stopped buying the beer. Schlitz was never able to climb back to their number two position. It was a classic case of deliberately decreasing CVA® for short-term gain and consequently hollowing out a once strong brand.25
Organizations focused on costs often seem to focus on price-cutting strategies. As a result, they risk training their customers to be concerned about price to the exclusion of value and often incite price wars. The airline, telecommunications, and automotive industries include competitors that seem to have adopted this approach.26
There is usually only one winner of a price war: the customer. Of the companies involved in the price war, the lowest-cost producer may do the best; but their financial results may or may not be attractive. As demonstrated in Chapter 5, as prices are lowered, unit volume must increase substantially simply to maintain contribution.
Meanwhile, in such an industry, many customers become price-shoppers instead of value-shoppers. That simply intensifies the pressure to lower prices and accelerates the vicious spiral of price cuts. Price wars not only erode profits, but also train customers to expect the same prices and to assume that all products and services perform the same—even if that is not true.
A preoccupation chiefly with costs can keep one from achieving an optimal strategy for all the reasons above. But the situation is even worse. As discussed in Chapter 5, many organizations do not even know their appropriate costs and, instead, use some form of average full-costing, which compounds the errors associated with a cost orientation.