Tuesday, June 17, 2008

Analogy #185: The Goodness of Grain

Here are some stories about three retailers. The first retailer sold shirts. She decided to do a survey to find out what size shirts she should sell. The survey results said that the average person in the area wore a medium-sized shirt, so she loaded up her store with lots of medium-sized shirts.

The store owner didn’t sell a single medium-sized shirt, although she did quickly sell out of the few smalls and larges she carried. Frustrated, the store owner went to the person who did the survey and complained. “How can the average person in this market be a medium, yet I could not sell a single medium shirt?”

The surveyor said, “Well, according to the survey, half of the market wears small shirts and half of the market wears large shirts. Therefore, the average size is a medium.”

A paint retailer wanted to start selling barn paint, so he conducted a survey to see what colors people used on their barns. The survey result said that the average barn color was orange, so the retailer stocked up on orange barn paint. He didn’t sell any orange paint. When he complained to the survey reseacher, the man replied, “Well, half the barns were red and half the barns were yellow, so the average color—halfway between red and yellow—is orange, even though there was not a single orange barn in the market.”

A third retailer sold swimming suits and wanted to find out what kinds of swimming suits to sell, so he did a survey of the market. By now, the survey researcher was hesitant to tell the retailer what he found, since the last two retailers complained so much about his research. Therefore, when the retailer asked him what the results were, he reluctantly said the following:

“Well, I did the research you asked and found out that half the market is men and half the market is women. Therefore, I’m not sure if the average customer has two sexes or no sexes. I really don’t know what type of swimming suit is appropriate for that type of average person.”

Just because the average shirt size was medium, the average barn color was orange, and the average person had two and/or no sexes, does not mean that the market is full of medium-sized, orange barn owners with two/no sex. The averages masked the reality that in fact there was not a single person fitting this profile. It was just a midpoint within a diverse mix of people.

Even though medium shirts are the closest average to the whole population does not make it the best choice for particular individuals who are either small or large. Similarly, although orange is halfway between red and yellow does not make it the best color for individuals who want red or yellow barns—even if it is the closest color to the average for the whole market.

Averages may describe the overall market, but transactions take place at the individual level. If you have a diverse market (and most markets are), then averages can steer your decision-making in the wrong direction, as it did in these stories.

So, no matter what your business may be, don’t fall into the trap of these retailers and look only at the averages.

The principle here is about granularity. The idea is that if you dig down deeper to a more granular level, you will tend to make better decisions than if you just try to appeal to broad market averages.

The shirt retailer would have been better off getting granular, to find out that she should not have catered to an average “medium” person, a person who—in fact—did not exist. By becoming more granular, she would have seen that a better approach would have been to carry lots of smalls and larges, with very little medium. Either that, or she could have specialized in either only large or only small, to get a strong position with half the market.

This sounds like a pretty basic concept. However, just because a principle is simple and basic does not mean that it is necessarily in widespread usage.

I was reading a new study today by the folks at McKinsey & Company. They were doing research on companies who operate in growth industries. They found that just being in a high growth industry does not guarantee that your company will automatically be a high growth company. In fact, many of these companies are slow growing.

Based on their research, the McKinsey folks found three major causes for slow growth companies in a fast growing industry. One of the top causes was firms who operate in a high growth industry, but have a product portfolio which excludes the highest growing part of the industry.

In other words, they operate their business sort of like the retailers in my story. They see that on average, the industry is growing, so they enter the industry. However, they do not get granular enough to find out which parts of the industry are causing the growth, so they make the wrong choices.

This would be like someone wanting to participate in the growth in the automotive industry, so they decide to start building gas-guzzling SUVs. Then, they will be confused when their growth is much less than the average of the auto industry. Had they done a more granular analysis, they would have seen that all the growth is in small cars and hybrids, while the SUV sector is declining.

Again, it sounds simple, but according to research, it is often not put into practice.

We have talked about granularity for determining product mix. As we saw in the story, you can also use granularity to determine your targeted customers. Not all customers are created equal. Study after study has shown that most of a company’s profits come from a small minority of their customers and that a large sector of the customer base is actually unprofitable to serve. To optimize profitability in such a mix, it helps to get granular and treat different customers differently.

This concept is popular in the banking industry, where the profitable customers often get all kinds of special personal service while the unprofitable customers are pushed towards a lower cost interaction on the internet. If you had treated all of these customers with average service, the most profitable would flee to a competitor who treats them better, and the other customers would become even more unprofitable to serve.

Going granular and owning a small niche can often be more profitable than compromising your distinction in order to capture the entire “average” market with a bland mass product produced in huge quantities. We talked about something similar to this in a previous blog (see “Talk Your Ear Off”).

In a diversified marketplace, where people are accustomed to having their distinctions catered to, a bland product placed in the middle of “average” rarely does well. In fact, knowledge of the average customer in the market can actually be a disadvantage, because it provides a false sense of confidence that you understand who the customer is. However, as we have seen, the average person may not provide any real insight into the diverse mix in the marketplace. If the market is half male and half female, it may make more sense to choose one segment and specialize in it, rather than try to design clothing that works well for the average half-man/half-woman. Get granular enough to find the real, solid customer opportunities

The same principle applies to industries. If you want to grow in a growing industry, spend time getting granular enough to find out which part of the industry is truly fueling that growth.

Buried treasure is rarely just sitting on the surface. That’s why the treasure is said to be “buried.” If you want to find it, you have to dig through the granular sand. If you want to find the treasure in your industry, get granular and dig around to find the best customers and the best product segments. Then target them in a specific manner, rather than relying on average appeals.

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