For any executive, it’s nothing new that markets are becoming more complex in every dimension that we care to mention: technology, consumption patterns, demographic changes, competition, and government regulations, among other things. In this environment of complexity and under the umbrella of growth strategies, executives take action to launch new products or to go after the conquest of new customer segments, or both, in organic and non-organic ways. In many cases they fail to achieve the intended purpose: creating value through profitable growth.
An investigation on growth and profitability carried out by Sintec, including 152 leading companies of Latin America, shows that less than 30% are able to grow profitably.
The reason that both products and additional customers generate greater complexity is because they tend to have different behaviors from those which the company already faces, both in the nature of demand as well as in supply. In some cases this complexity is unnecessary because it does not create value. In other cases companies do not have the available capabilities along the value chain to handle this complexity, in both cases value is lost.
The company’s profitable growth is not based solely on its business strategy which defines which markets and which products are involved. It is also imperative to design and implement a customer and operations strategy, by focusing on certain market segments, competitive value propositions, commercial activities, and the supply of products and services. These strategies lead the company to focus on customers and products/ services, and build the capabilities required to succeed. By capabilities we mean the ability of a company to execute key business processes, for instance Product Development, Branding, Distribution, Manufacturing, Commercialization, which are based on practices, organization and information technology. In this way, the company does not get involved with creating complexity and develops the skills needed to be successful.
Let’s first see why growth generates greater complexity and how it can destroy value on the way.
GROWTH AND COMPLEXITY THE COMPLEXITY OF CUSTOMERS
In the process of growth, businesses seek more customers to sell to. This leads them to participate in different segments and channels that have
very different behaviors in their demands, as well as in terms of care requirements and products. This dynamic can lead to a result as shown
in Figure 1, which shows the accumulated value generated by customers in the vertical axis and in the horizontal axis the number of customers, ordered from largest contribution to lowest contribution.
In other words, what this curve tells us first is that not all customers contribute equally to the profitability of the company, and second that with some clients the company even loses money. Hence, the total cost of serving the customer is greater than the variable contribution of its sales, if the company ceases to have those customers and eliminates the resources involved, it could earn more money. Is that what you should do? Not necessarily, but that’s what happens.
This situation occurs for two reasons: The first is that the customer is not profitable, no matter what the company does; it is unlikely that the
customer will be profitable. This happens because the company is looking for new clients, without asking itself what kind of customers their vendors should look for and how to address them. Vendors simply take to the streets to sell, guided by their volume incentive, without having a client type to look for. The assumption is that additional customers will bring an additional profit, which is not necessarily true. The other reason is that the proposed customer value in terms of products, business conditions, schemes of service and attention, is not what the customer requires and leads to unprofitability.
Whichever of the two cases, the curve of Figure 1 is commonly found among companies.
THE COMPLEXITY OF PRODUCTS
Just as companies seek more customers in order to grow, they also develop more products with the same purpose. One consequence of this is behaviors such as those seen in Figure 2.
The vertical axis shows the percentage contribution of a number of products to variables such as sales and inventory. What this chart tells us is that there is a significant percentage of products that contribute to sales in a very small way, but consume a significant portion of the inventory, and could be arguably obsolete products. What this graph demonstrates is that for a supply chain to add an additional product, especially if it is a low sales item, is not a marginal cost. The problem is compounded when we want to bring all products to all customers.
In virtually any industry we observe a behavior of increased proliferation of products. This is due to, as mentioned, the efforts of companies to differentiate
and target specific customer segments. However, this proliferation is not accompanied by a similar increase in volume. In other words, you can double the number of products, but you’re not going to double sales. This applies not only to products themselves, but also services such as health, financial,
educational and telecommunications, among others.
COMPLEXITY IN THE VALUE CHAIN
The addition of new segments of customers, greater product variety and competitive dynamics, have resulted in more complex value chains in operations, with more difficulties in their integration and implementation, and therefore more difficulty in their administration. The main mistake is to assume that in the value chain, from vendors to suppliers, it is marginal to add new customers and products. As if this were not difficult enough, there is a competitive pressure to reduce costs and increase productivity for both expenditures and assets.
When a company launches a new product and/or conquers a new customer, it triggers a series of activities back through the whole chain. To the extent that these products and customers are different from the current behavior, they demand different activities in the chain, different ways of buying, selling, producing, storing, transporting, even registration.
Ultimately, this results in the creation of different value chains that coexist in the same company. That is the source of the complexity, and all companies don’t necessarily face it in an effective manner. For example, inventories are managed the same way regardless of whether the products have different natures in their demand. Resources are managed without understanding the role they play in the chain or the cost or total investment. Products are added to vendors assuming they can be sold, but without fully understanding the role played by the customer and what is required for the vendor to be effective.
High quality requirement products are added for industrial customers with products of low quality requirements for distributors who have very different behaviors not only in their demand, but also throughout the supply chain. Or in consumer products, when dry products are integrated with chilled, which have very different storage and distribution conditions. In short, customers and products are added without understanding the impact this has on the whole chain and the actions that should be taken to be effective in service and generate profitability for the company. At the end of the day, this creates service problems in addition to incurring unanticipated expenses and investments that affect profitability.
The most effective way to address this complexity is through a strategy that focuses the efforts of the company in certain market segments/ products and with different proposals, aligning the entire chain and building capacity to be successful in doing so. This is what we call Customer and Operations Strategy.
CUSTOMER AND OPERATIONS STRATEGY
In addition to considering customer and product decisions, in order to have the ability to be profitable in an environment of new customer segments and product categories, companies must have an integrated strategy for clients and operations, with abilities that allow you to grow and be profitable in an environment of greater complexity. Customer and Operations Strategy is comprised of five elements shown in Figure 3. Let’s analyze each of them.
UNDERSTANDING THE MARKET
Understanding the market is something commonly talked about in business. However, few actually take it seriously; those that do are good at it. This encompasses understanding customer segments, their needs, future developments, the connections between needs and how they are covered with the products and services, profitability by segment, and unmet and unexpressed latent needs. These companies know how to read and understand a point of sale, and the buyer, they are in constant contact with market information and feedback through their own sales force about what happens in the market, know how to react quickly and assertively with information and even an educated insight into this dynamic market environment.
Ultimately, the big game is segmentation: Understanding segments, needs, potential returns, the position of competitors and selecting segments to compete in, is one of the core competencies that a company must have.
Segmentation means being able to answer questions like: which segments to get involved with, why, what it takes to be successful and which ones not to participate in. And to do it not once, but constantly.
Companies that do this better than their competitors really have an advantage for two reasons. First, they understand the game they are playing, where to participate and where not to. Second, they understand better than the rest what it takes to be successful in this participation.
VALUE PROPOSITION
A value proposition is the positioning of the company through a combination of products, business conditions and service experience to provide by segment. In this process, companies face a major challenge. A solution which is not clear could have significant consequences if not resolved in the right way. In the majority of industries having a unique value proposition for all market segments is a mistake, companies need to have segmented offerings.
However, the two extremes are equally damaging. In most industries there is a single offer, understood to be for certain segments and not suitable for other segments vs. a unique offering for each customer, which is totally inoperable because of its complexity and cost.
From the point of view of value, this continuum from a single offer to a unique offer, would behave as shown in Figure 1. Faced with segmented markets,
very little differentiation in supply has little value; very high differentiation also adds little value. In other words, very little complexity (variety) does not lead to taking advantage of market opportunities, increased complexity (variety) more than necessary causes its own problems and entails higher costs than the benefits they seek to gain – value is lost by unnecessary complexity.
So the question is: how many segments and value offers should exist? The reality is that it would be very difficult to find an exact answer. And if we found it would be temporary due to the very dynamism of the market. What needs to exist are robust processes and analyses of the sources of complexity, in
this case, market segments and value propositions as well as the responses that the company should make and the validation of the results that this complexity is causing.
COMMERCIAL STRATEGY AND EXECUTION
This aspect involves the design and implementation of platforms to capture the demand, delivering the products and services offered. In a commercial
platform there are three key elements:
- Commercial Business Development: is related to specific products,prices, promotions and services to each segment, subsegment, up the client level.
- Go-to-market Models: they include the various schemes of face-to face sales and non-contact sales (internet, mobile, telephone) under which the company serves its customers.
- Commercial Execution, Management and Control: refers to activities to carry out business transactions with clients.
These elements are interdependent and therefore must be coordinated with each other to be effective. Coordinations are given by indicators, management
and processes.
Furthermore, these elements must work in an environment of market segments with segmented propositions, so it should have its own segmentation. For example, an industrial company that serves customers with higher product specification requirements and midsize customers and distributors, or a consumer products company serving clients in the modern channel, traditional channel and wholesalers; or a Telecommunications company that serves residential, business and government clients. And what about a retail chain that has different formats? The list goes on and on, in each of these cases the way in which they organize and coordinate these three functions is essential in order to be effective.
OPERATIONS STRATEGY AND EXECUTION
The purpose of the whole chain of a company’s operating activities is to offer quality products or services in a timely manner and be cost competitive. This ability is related to strategy, planning and execution.
The operations strategy covers the following areas: being clear about what skills are required throughout the supply chain to deliver the value proposition
effectively, what resources in the chain must be optimized and which should have excess capacity, where to locate plants and distribution centers, what resources they should own and what should be outsourced, what production strategies for new products, what kind of relationships they should have with suppliers, strategically or transaction-based.
Planning refers to integrating supply and demand in the mid term, 3 to 12 months. These processes are critical because they are based on the conduct
of the company in the mid term. Synchronizing forces for new releases and promotions and ensuring the supply of products, anticipating problems that may occur in the supply, making decisions that are need to be made, making visible the available capacity in the supply chain and informing, in advance,
if said capacity can be sold. These processes allow the company to align the level of business planning and supply activity, identify potential problems and take preventative measures before they happen.
Execution refers to the processes that integrate activities along the chain to capture and deliver an order, whether products or services, or both, from distribution, manufacturing, warehousing and purchasing. These activities should be synchronized through processes.
ORGANIZATION AND INFORMATION TECHNOLOGY
In his book, Strategy and Structure; Chapters in the History of the Industrial Enterprise, Alfred P. Chandler made the phrase “structure follows strategy” immortal in the corporate world. Chandler’s conclusion has two important implications for those who direct the destinies of a firm: first, that the organizational structure of a business is an enabler of its strategy, and second, that there is no single best structure in and of itself, or organizational structures that are more effective than others, it all depends on the strategy of the company.
However, in light of the evolution of business, we would be stopping quite short to say only that structure follows strategy. First, because it’s not only the structure but what we can understand by organization, including: structure, strictly functional and hierarchical division of labor, people skills, their skills and knowledge covering management decisions about performance indicators, leadership and culture that embraces the values, but, above all the behaviors of leaders and people.
In addition to Organization, Information Technology has also become an enabler of business strategy. This is not for itself alone, but to the degree that
it enables the management practices and the interaction between members of the business and even business partners and action.
PROFITABLE GROWTH
Considering all the previous elements, through an effective customer and operations strategy, any firm can have a better chance of entering the upper right quadrant of the matrix shown in Figure 4, which is where all executives wish their companies were. The three reasons this happens are: focus, alignment and capabilities.
Focus refers to dedicating efforts to selected market segments, not all the segments. Moreover, it refers to the design of specific offers rather than
the shotgun approach. This definitely allows you to concentrate efforts and resources where the greatest opportunities for growth and profitability are.
Alignment involves synchronizing the efforts, intentions and business resources with those of operations. Avoid having Commercial and Marketing areas walk on one side and Operations areas walk on the other. This lack of coordination wastes resources and destroys value.
Capabilities refers to the development of processes, organization and technology that enable the organization to be effective in its execution, whether in operation, management and/or in planning. These capabilities allow the company to be effective in serving customers and in the use of
resources.
CONCLUSIONS
All top executives, without exception, seek profitable growth for their business. With this in mind, they launch initiatives for new products and add new customer segments that do not always yield the desired result and sometimes even end up with the completely opposite results of those planned. The reasons for this are twofold, on the one hand they are initiatives that generate more complexity and will not yield a value, on the other hand the initiatives that are launched could be good, but the organization does not have the skills to handle more complexity because it does not have an adequate strategy for customers and operations. The difference between a successful company and another, between a successful executive and others, is not in the purposes they seek, but in how they seek them.
Oscar Lozano Gonzalez, Sintec
About Sintec
Sintec is the leading consulting firm focused on generating profitable growth and developing competitive advantages through the design and execution of holistic and innovative Customer and Operations Strategies. Sintec provides a thorough and unique methodology for the development of organizational competencies, based on three key elements: Organization, Processes and IT. Furthermore, Sintec has successfully carried out more than 300 projects on Commercial Strategies, Operations and IT issues with more than 100 companies in 14 countries throughout Latin America. Our track record of more than 25 years makes Sintec the most experienced consulting firm in this area of expertise in the region.
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