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This chapter is from the book

Creating Customer Value

Why do you need an accurate understanding of how your customers define value? First, customers make purchase decisions based on the value they expect to obtain. The question in the mind of decision makers is, “Does the value justify the cost?” Second, customers employ similar criteria to evaluate supplier performance as they used to select suppliers in the first place. If your quest is to drive revenue growth—that is, obtain and retain customers—you need to deeply understand what customers value.

Economists often discuss value in terms of utilities. As Peter Drucker noted, utility is what a “product or service does” for the customer. Four core utilities are often discussed:

  • Form utility is the primary responsibility of purchasing and operations managers who acquire inputs and transform them into products or services of greater customer value.
  • Possession utility falls within marketing’s domain and consists of efforts to communicate (i.e., promote) a product’s value and then facilitate the exchange process.
  • Time utility emerges from effective management of all value-added processes that influence when a product is available for purchase. Logistics managers make the inventory and transportation decisions that ultimately determine availability’s time dimension.
  • Place utility is primarily the charge of supply chain managers who ensure that products and services are where customers expect to find them—when they are needed.7

A correct understanding of economic utilities informs the design of a company’s supply network and value-added processes; however, form, possession, time, and place utilities are seldom explicitly discussed by decision makers in the supplier selection and evaluation processes.

To gain direct insight into how your customers define value, you might want to gather supplier scorecards from a sample of your customers. You will find five criteria are common across the majority of the scorecards: cost, quality, delivery, responsiveness (also known as flexibility), and innovation (see Figure 1-2). Indeed, scholars have long argued that these value dimensions are the key to meeting customers’ real needs.8 To win tomorrow’s competitive battles, you must grasp the nature of these value dimensions and build the systems to create and deliver them.

Figure 1-2

Figure 1-2 Dimensions of value creation

Cost

Companies are under constant cost pressure. One result: The supply chain functions of logistics, production, and supply management are managed as cost centers. You can thus expect your customers’ purchasing professionals to be unrelenting in their efforts to reduce costs. Globalization has emboldened them by increasing factor mobility and market access, which gives them alternative sourcing options—options that often possess low-cost labor advantages.

To reduce costs, companies pursue a combination of four strategies:

  • Productivity enhancement—The key to improving productivity is to promote learning.9 Companies are thus minimizing work rules and increasing training (including cross-training). The goal is to empower workers to find and implement better ways to do things.
  • Automation—Technology is making process redesign a perpetual initiative.10 Many tasks that have been performed manually can now be automated. Others, especially those that can be digitized, can be relocated to lower-cost locations. New technologies such as additive manufacturing (also known as print manufacturing) will continue to enable process redesign.11
  • Global network design—Improved logistics have reduced the total landed costs of products made in distant lands.12 Companies are taking advantage of this by locating facilities in far-flung countries with low-cost inputs.13
  • Outsourcing—Sometimes companies discover that they can no longer perform certain value-added activities as well as other members of the supply chain. When this happens, they move from make to buy. Outsourcing enables companies to do what they do best, relying on supply partners for complementary value creation.14

Carefully considering these four strategies reveals that a true cost capability cuts across value-added processes, requiring intra- and interorganizational collaboration. Processes across the entire supply chain from raw materials to end consumer must be designed for efficiency. One manager in the CPG industry emphasized that the real measure of cost performance is “total landed cost to the customer’s trunk.”15 Effective cost reduction can initiate a powerful cycle of competitiveness. As they expand market share, companies can improve scale economies and raise profitability. The added funds can then be reinvested in future capabilities.

Quality

Quality is often defined as conformance to specs. A customer focus, however, means that quality is nothing more or less than meeting customer expectations. David Garvin, a Harvard professor, identified eight factors that customers use to assess quality:16

  • Performance—A product’s operating characteristics
  • Features—The unique characteristics that distinguish a product from rivals’ products
  • Reliability—The user’s ability to count on the product not to fail
  • Conformance—How well a product conforms to design specifications
  • Durability—A product’s life expectancy (also, mean time between failure)
  • Serviceability—The speed and ease of repair when problems occur
  • Aesthetics—The perceptions of fit and finish (also, artistic value)
  • Perceived quality—A product or brand’s quality reputation

As for managing quality, Six Sigma (6σ) is the gold standard in quality philosophy and practice. Motorola launched Six Sigma in 1985. The goal was simple—eliminate defects. Motorola chose to call its quality program Six Sigma for two reasons. First, statistically speaking, a process that achieves 6σ quality produces only 3.4 defects per million parts made. Second, managers wanted to avoid the stigma attached to total quality management (TQM) programs. Six Sigma follows the DMAIC methodology—Define, Measure, Analyze, Improve, and Control—and applies statistical tools to identify and remove the causes of defects in value-added processes. As process variability is eliminated, quality improves. Jeffrey Immelts, CEO at General Electric (the company that made 6σ popular), calls Six Sigma the common language at GE. Everyone from the loading dock to the C-suite is expected to speak the language of Six Sigma. At GE, quality is important everywhere.

You may wonder where quality ranks among the five value dimensions in importance. For many decision makers, quality is more vital in deciding purchase decisions than cost. Quality has been called the most vital factor in long-term success. W. Edwards Deming went so far as to say, “You are not obliged to manage quality. You can also choose to go out of business.”17

Delivery

Managers’ penchant for lean, just-in-time operations has made a delivery capability an increasingly important source of differentiation. Companies frequently operate with minimal inventory—sometimes as little as two to four hours of supply. They rely on suppliers’ ability to deliver to promise. They may even specify a delivery time window so that they can better plan their own operations and improve facility utilization. Thus, delivery is more than just “doing things fast.” It is also the ability to do those things consistently. Fast, reliable delivery requires short order cycles and reduced variability.

If your company wants to use delivery as a competitive weapon, you must focus on building speed across a variety of processes. For example, in a classic example, Motorola became a world leader in pager manufacturing by reducing production cycles from 30 days to less than 30 minutes. National Semiconductor, by contrast, redesigned its global distribution network to reduce order fulfillment lead times by 47 percent. A 34 percent increase in sales resulted.18 Customers value speed. Fast, reliable cycles improve forecast reliability and reduce the need to carry inventories. Sony de Mexico, for instance, reduced its overall order cycles by 75 percent, enabling its customers to cut their inventories by 50 percent.19

These examples illustrate the cross-functional nature of a delivery capability. Any activity that negatively impacts the time or variability of the order cycle diminishes a firm’s ability to deliver on time. A late supplier delivery, a machine malfunction, a parts shortage, an incorrect order entry, or a transportation delay reduces delivery performance and drives costs up. For instance, an electronics manufacturer operating in the Dominican Republic experienced persistent production delays. To compensate, logistics managers resorted to airfreight to meet promised delivery schedules on 70 percent of orders—at a cost 600 percent higher than ocean shipping.20 Research has shown that firms that experience supply chain delivery glitches report on average 6.92 percent lower sales growth, 10.66 percent higher growth in cost, and 13.88 percent higher growth in inventories.21

Responsiveness

Change is the only constant in today’s business world. The ability to act quickly—that is, to adapt or respond—as customers make special requests, competitive requirements change, or the unexpected happens conveys a vital advantage.22 Disasters such as the 2011 earthquake off the coast of Japan—and 2011 flooding in Thailand—have brought new attention to the need to build a responsive supply chain. Being responsive enables a company to deal with the risk inherent in lean, global operations. Responsive companies recover from the unexpected more quickly and resume operations faster than the competition. Sun Tzu summarized the power of responsiveness as follows, “Every minute ahead of the enemy is an advantage.”23

Responsiveness, like the other value dimensions, is a cross-functional capability that relies on effective information systems, well-designed processes, and the adaptability of the firm’s people.24 The following steps are critical to creating a responsive culture:

  • Make responsiveness a priority throughout the firm and across supply chain relationships.
  • Map processes to make them visible and to identify responsiveness enabling activities or decisions. Use mapping to initiate risk-mitigation discussions and identify operating alternatives.
  • Use information systems to monitor operations, link to customers, promote proactive environmental scanning, and share information on a real-time basis across the network.
  • Cross-train workers and organize work in multifunctional teams.
  • Design performance measures to value responsiveness.
  • Build learning loops into every process throughout the organization.

Toyota has built a highly responsive supply chain. Suppliers are required to locate near Toyota’s production facilities for fast, reliable, and flexible delivery. Within Toyota’s factories, information and logistics systems synchronize materials flow to incoming orders—enabling custom assembly. Further, Toyota can build multiple models—for example, the Camry sedan, Sienna minivan, Highlander SUV, and Lexus RX 330—using the same platform and on the same production line, helping it mix and match production to market demand. If Toyota does not properly anticipate market needs, it can quickly adapt to them.

Innovation

To avoid “one-hit-wonder” status, companies need to be able to innovate consistently. In most industries, the time between new product introduction and product “obsolescence” has shrunk dramatically. Rivals can copy and introduce their own “new and improved” version of products within six to nine months, making first-mover advantage fleeting. Apple’s iPad illustrates the innovation dilemma. Pushed by rivals like Amazon, Google, Samsung, and Sony, Apple has brought a new iPad to market every year since it introduced the original iPad in April 2010. The gap between the iPad 3 (March 2012) and the iPad 4 (November 2012) was a scant eight months. Research has long shown that bringing products quickly to market is the key to financial success.25 In one instance, products introduced six months late, but within budget, realized a 33 percent decrease in expected profits over the first five years. Products introduced on time, but 50 percent over budget, realized only a 4 percent reduction in profit.26

Process innovation—often overshadowed by the quest for new products—can also deliver unique competitive strengths. Into the early 2000s, much of Dell’s success resulted from patents, not for its products, but for various aspects of its manufacturing processes. By 2003, Dell had earned more than 550 business-method patents. Michael Dell’s mantra was “Celebrate for a nanosecond, then move on.” Industry analyst Erik Brynjolfsson noted, “They’re inventing business processes. It’s an asset that Dell has that its competitors don’t.”27 Dell’s eventual undoing was a failure to bring the right new products to market quickly. When asked about what surprised him about the computer industry, Erik answered, “I didn’t see [tablets] coming.”28

Walmart is another company that has emphasized “inventing” processes as a competitive lever. Persistent improvement of cross-docking methods over a 20-year time period ensures high levels of on-shelf availability at everyday low prices. Walmart continues to work with suppliers to improve the efficiency of its back-office operations (focusing on details like palletization and radio-frequency identification [RFID] tags) even as it strives to find ways to involve customers to reduce checkout times and improve the service experience. The key to process innovation is to cultivate a culture of experimentation and learning within the four walls of a company as well as across the supply chain. The benefits of these efforts include greater efficiency, enhanced quality, and faster cycles. One additional, overlooked benefit: Process innovation tends to be much more difficult to copy than product innovation.

Total Order Performance—A Synergistic Approach

As you read about the dimensions of customer value, you may have thought, “Based on my personal experience, not all value dimensions are equally important in every purchase decision.” If so, you would be correct. Just as individual consumers weight each factor differently, companies likewise have distinct priorities. Even for the same entity, unique purchases are handled differently, depending on the importance or type of buy. Terry Hill, professor at London Business School, expressed these ideas using the language of order qualifiers and order winners.29 To help you prioritize decisions regarding value creation, you will want to remember three rules:

  • Get into the game—Across most purchase decisions, cost and quality are the critical value dimensions. If you want to be taken seriously as a potential supplier, you have to perform well in these areas. However, because they are universally important, high levels of parity often exist in these areas. Cost and quality thus tend to be order qualifiers.
  • Differentiate yourself—Harvard’s Michael Porter made a vital observation: Sustained success requires you to differentiate your company’s value proposition in the mind of customers.30 If your cost and quality positions are good enough to get you consideration as a supplier, you need to differentiate yourself along the lines of one of the other dimensions. That is, customers must view your delivery, responsiveness, and/or innovation as an order winner.
  • Avoid disqualification—You must meet minimum requirements across all five value dimensions. Even if you rate well on cost, quality, and a differentiating characteristic, you could still disqualify yourself via unacceptable performance elsewhere. Your customers are keeping score. You earn points along each dimension. Having an order disqualifier will make it impossible to earn enough points to win (or keep) a customer’s business.

You may also have noticed that efforts to create value in one area influence the other value dimensions. Many interactions exist within and among them. For instance, focusing strictly on quality, efforts to add cutting-edge features may hinder reliability. By contrast, efforts to design in serviceability may improve reliability and durability. Your challenge is to make the interactions more visible so that tradeoffs can be accurately assessed and good decisions made.

Importantly, until recently, managers believed it was impossible to concurrently pursue improvements across all value dimensions (see Figure 1-3). Managers viewed high quality as inherently expensive. They perceived consistent delivery to conflict with responsiveness. Leading companies have shown, however, that the relationships are more nuanced—and often synergistic. Better process visibility, information exchange, and workforce flexibility promote higher levels of performance across all value dimensions. For instance, the term hidden plant was coined to describe the fact that 15 percent to 40 percent of a firm’s capacity is used to find and fix poor-quality work.31 In many settings, better quality reduces costs. The ability to do things fast often can improve forecast accuracy and offer more decision gates. The result: Responsiveness improves and costs go down. A more holistic approach can enable the value dimensions to work together like the spokes of a wheel to advance the company to a more competitive market position.

Figure 1-3

Figure 1-3 Interactions among value dimensions

Finally, you may have observed that logistics contributes differently to each value dimension. Table 1-1 summarizes logistics’ value-creation role. Logistics is a core contributor to delivery and responsiveness capabilities. Indeed, logistics process and network design can enable a company to compete on speed and to mitigate the negative consequences of unexpected events. Such capabilities are hard for rivals to replicate. By contrast, logistics provides only tangential support to a quality advantage. However, poor logistics can become a quality disqualifier. As for costs, careful logistics management can make a direct contribution to a cost advantage, but other functions—especially purchasing—represent a much higher percentage of cost of goods sold (COGS). Thus, logistics can enable a cost advantage but not secure one. Finally, logistics innovation can help a company develop distinctive processes, improving delivery, responsiveness, cost, and quality performance. Logistics is a vital value creator.

Table 1-1 Logistics’ Contribution to Value Dimensions

Value Dimension

Definition

Logistics' Contribution

Cost

The ability to achieve lower cost levels than rivals

Logistics costs often represent 8 percent of a company's COGS. By reducing total logistics costs, a company can lower total landed costs and be more competitive in expanded geographic markets.

Quality

The ability to deliver products and services that customers view as better than those offered by rivals

Logistics' main contribution is to avoid damaging product during shipment. However, unique or tailored services can improve customers'perceptions of quality service.

Delivery

The ability to deliver with consistently short cycles

Logistics is a core contributor to a delivery capability. Effective order cycle design and management reduces cycle times and ensures dependability. Inventory, transportation, and network design decisions can provide a delivery advantage.

Responsiveness

The ability to quickly respond to unexpected events

Logistics is a core contributor to a responsiveness capability. Process design augments inventory, transportation, and network design to help provide the adaptability and flexibility needed to respond to the unexpected.

Innovation

The ability to bring new products to market quickly or to improve processes consistently

Logistics seldom contributes meaningfully to product innovation. However, incremental and/or radical innovation in processes can provide distinctive advantage—typically in the areas of delivery and responsiveness.

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