Monday, November 12, 2007

Strategic Planning Analogy #128: Talk Your Ear Off

Well, I’m back from my vacation. I spent a week in rural northern Ontario. The locals told me that my wife and I were up there during the off-season—after the warm weather activities and before the snow-related activities.

There were many ways to tell it was the off season. First, the resort was nearly empty. Second, about half of the tourist attractions were closed. Third, about five times when we went to a restaurant to eat, we were the only patrons in the restaurant. At first that seemed kind of creepy, but we got used to it.

Initially, we thought this would make it hard to fill up the days. However, we soon found out that it didn’t take much to fill the day. Everywhere we went we would run into locals who would want to talk to us as long as we were willing to listen. Sometimes, they could talk on for hours at a time. If we hadn’t walked away a couple of times, we’d probably still be talking to some of these people.

The funny thing was that these locals would tell us they liked living up in the rural areas because they didn’t like being around a lot of people. They said they liked the solitude. Yet, whenever someone showed up (local or otherwise), they would end up talking up a storm to each other. One guy told us he took walks on trails that weren’t near his home, because if he went on a trail close by he would end up seeing someone he knew on the trail and spend his time talking rather than exercising.

Then I thought about all the people I know who love the hustle and bustle of the big cities with all the people. These urban folks don’t mind all the people, yet they rarely strike up a conversation with people they meet on the street. So the people who craved solitude seemed more willing to break that solitude with conversation than the ones who like to be surrounded by people.

It seems a bit ironic that even though these people preferred the solitude, the fewer the people in the area, the more likely they wanted to break the solitude by talking to anyone—even strangers. Yet those more comfortable being around lots of people seemed less likely to talk to them.

Apparently, we tend to place more value on the things that are the most rare. If people are rare, we value their company more. If people are plentiful, we tend to value each individual less.

Business seems to work in the same way. Value is not necessarily based on the intrinsic worth of the item. Instead, it is based on the relationship of the worth to its supply. Even if it is not worth all that much under normal circumstances, if the item becomes extremely rare, then its value suddenly increases. Therefore, when developing strategies, one must not evaluate items in isolation, but rather in relation to their supply in the marketplace.

The principle here is “supply and demand.” The more supply relative to demand, the less the value. The less the supply relative to demand, the higher the value. At first, this would seem to be a simple principle. Nothing new here…we’ve heard this before. However, how many times have we failed to include supply and demand in our strategic toolkit of actions?

On October 31, 2007 the Wall Street Journal wrote an article about GM. They explained a new strategy taking place at GM. In the past, whenever GM had a hot-selling car, they would ramp up production. Their logic was that they should manufacture more of the items that were selling well.

Unfortunately, it is difficult to fine-tune production rates to demand in a timely manner. Inevitably what would happen was that GM’s rate of production would eventually outstrip demand, causing a glut in supply for the car in demand. To sell down the glut, they would have to discount the price heavily. This would take all the profit out of the hot-selling vehicle. This is what happened to the GM HHR vehicle.

By contrast, the latest hot vehicle at GM is the Buick Enclave. However this time GM did not ramp up the production much on the Enclave. Instead they intentionally kept the supply of the vehicle small.

This had two positive impacts. First, by not flooding the market with Enclaves, people did not tire of the vehicle through over exposure. The difficulty in getting the Enclave helped to make the car even hotter to own. There is more status in owning that which is difficult to attain. Second, by not building so many, GM was able to sell the Enclave at full sticker price, which increased the profitability on each unit sold.

The strategy used by GM regarding supply had a direct impact on profitability—to hurt the profits of the HHR and help the profits of the Enclave. Even though they didn’t change the vehicles themselves, GM changed supply—and that changed the profits.

Just as the limited supply made people more important in rural Ontario to locals (even though the locals claimed to not liking to be around lots of people), the Enclave’s value was heightened based on limited supply.

This principle is also very important in the fashion industry. When production is limited so that only the elite few can get it, the fashion stays hot. Once supply is opened up and “everyone” can have one, the fashion allure is lost and the entire fashion brand suffers. It is a fine line that many of the high end fashion brands are now walking in trying to increase the breadth of demand for their brands. If they go too far, the brand will lose its cache and will be abandoned by its core customer.

Remember, the goal of most strategies is not to maximize sales, but to maximize profits over the long haul. Many times, the relentless pursuit of additional incremental sales can actually reduce total profitability, because of some combination of the following:

1) Too much margin needs to be given up to create the additional sales. This margin loss may not only impact the incremental items sold, but reduce profits on other units which could have sold at a higher price if fewer were made.

2) The brand image/status is destroyed through over exposure and future brand efforts fail as a result.

3) To get the additional sales, additional investments needed for production capacity or marketing create a negative return in investment on these sales.

4) Due to the efforts of getting new customers, the more loyal and more profitable customer base could receive less attention, causing them to leave and take their business where they feel more important.

Fewer sales can actually be more profitable, because it keeps supply and demand in a more profitable balance.

Studies have shown that, regardless of industry, most of a company’s profits come from about 15-25% of the customers and that about a half of one’s customers are currently unprofitable to serve. Perhaps if one quits trying to get all of those extra customers and spends more time trying to satisfy the 15-25% best customers they already own, one may be better off.

Therefore, when designing your strategy, don’t let the lure of sales cause you to make strategic decisions which destroy profitability. Sales are nice, but profits are better.

Value is often influenced greatly by the laws of supply and demand. Supply and demand is something your company can have some influence over, if incorporated into the strategy. Therefore, controlling supply and demand should be a part of the strategic goals.

Just because the people in rural Ontario wanted to talk more did not mean that they were more gifted in the art of conversation. The conversations weren’t special or the words more exciting. The length had more to do with the desire to talk (based on the rarity of people to talk to) rather than the value of the words spoken. The same was true with the Buick Enclave. GM didn’t raise the value by improving the vehicle. It was not made more special. It was the same vehicle it was before. They just increase the desire through controlling supply.

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