Friday, June 20, 2008

Analogy #187: A Cup's Worth of Value

In Lemonland, most of the children tried to make a little money by running lemonade stands. All the children got their lemons for the same Lemonland lemon groves. They also all used the same official Lemonland Lemonade Recipe. As a result, the lemonade at all the lemonade stands tasted pretty much the same.

With all of these children on every street corner trying to sell the same product, it was hard for any one child to get an advantage. There were just too many lemonade stands relative to demand and all the lemonade tasted the same.

As a result, some of the children started cutting the price of the lemonade. At first, this created an advantage, but eventually all the other children dropped their prices to match, eliminating the advantage. So then, some of the children started dropping the price even more.

These cycles of price dropping and price matching went on for quite awhile, until there was little revenue left for making a profit. As a result, the children started doing whatever they could to cut their costs. Again, as soon as one child got a cost advantage, the others would copy it, eliminating the advantage.

There was one child, however, who refused to follow this trend. She charged more than any other child. Yet, at the same time, she sold more lemonade than anyone else.

I went to see her to find out what her secret was. When I asked her how she could sell more of the same identical lemonade than anyone else, even though she charged more than anyone else, she responded, “I’m the only one left who still offers the lemonade in a cup.”

Sure, everyone was selling the same identical lemonade. However, lemonade without a cup is not very valuable. It’s not like you can pour some in your pocket to drink later. And if you pour it into the palm of your hands, it will just run through your fingers and make your hands all sticky. Without a container to put your lemonade in, there is little desire to purchase it.

So even though the lemonade was a commodity, the user experience could vary considerably, based on something as simple as a little paper cup.

In the business world, a large number of items appear to be commodities, just like that lemonade. And like those children, there is a temptation to cut prices and cut costs in order to get a temporary advantage in the market.

However, as the story illustrates, if you focus just on the commodity, you can miss out on the bigger picture—the entire experience. People don’t just buy an item (like 8 liquid ounces of lemonade). Instead, they buy a “purchase experience”, which includes convenience, service and maybe a little paper cup to hold the purchase. The item may be a commodity, but the purchase experience doesn’t have to be.

The principle here is that the way one develops their strategy depends a lot on how one defines their business. For example, if you take a narrow product-centric approach to define your business (like “I sell lemonade”), you may take one approach (like cutting prices and costs to the point where you no longer offer a cup).

However, if you define yourself more broadly, as playing a roll in the entire consumption experience, you could develop a much different strategy. In the case of the lemonade stand, a broader definition could be something like this: “I provide convenient, on the spot, liquid refreshment to hot, thirsty customers.” With this type of definition, you would never consider a strategy which eliminates the cup. You might even add ice to the lemonade to make it more refreshing.

Just because you sell the same identical product as someone else does not mean that you have to provide the same identical experience. When you define yourself as an “experience provider” rather than a seller of a particular product, it can open your thinking to more strategic alternatives.

I was recently reading a story about a company called Granite Rock (courtesy of Granite Rock sells granite, which is a commodity product. If Granite Rock had defined themselves narrowly as just a seller of commodity granite, they probably would have created a strategy of minimal investment and lowest prices, just like most of the other companies in the field.

Instead, however, they looked at the entire value chain and defined themselves as a company which improves the value process for purchasers of granite. With that type of definition, the strategic focus turned from “pushing granite” to “helping customers”. What they discovered was that for granite purchasers, time is money. Granite Rock determined that each wasted minute for its customer’s truckers cost them $1.20.

As a result, Granite Rock invested considerable sums of money to make their transaction process faster. They developed a system called “Granite Express” that automatically loads trucks like an ATM machine. The driver swipes a card, pulls in his truck, and lets the machine do the loading. This process cut the loading time from 24 minutes to 7 minutes, saving the purchaser over $20. Better yet, because the machine was automatic, it is open and available 24 hours a day. Just think of how much money could be saved by not having to wait all night for the granite loader to open up for business.

Thanks to these kiHow to Brand Sandnds of added services, Granite Rock is doing well, in spite of charging about 6% more than its competitors.

Back in 1998, the Booz Allen Hamilton consultants (now called Booz & Co.) wrote an article called “How to Brand Sand.” The point of the article was that nothing—not even sand—is a true commodity, if you look at the bigger picture. This article resonated with me because in college I worked for a company which sold sand. Unfortunately, the sand company I worked for thought narrowly about their business, so they cut out virtually all the costs and sold primarily based on price (and eventually had to shut down the business).

In the Booz article, they listed the variety of strategic options which open up if you define yourself more broadly within “commodity” industries. They defined the strategic process to find these options as follows:

1) First, carve up the market from every angle—profits, needs, behaviors—to identify those customers who are responsive to differentiation.

2) Second, differentiate your offering in one or more of the six "generic" dimensions of differentiation.
a) Quality Control
b) Supply Reliability
c) Product Customization
d) Applications Knowledge
e) Convenient Packaging
f) Services which make Process More Convenient for the Customer

3) Third, bundle several differentiations into a brand, and then communicate that brand consistently and strongly.

4) Finally, align your business capabilities to reinforce and defend the brand and the underlying sources of differentiation.

If you follow a process similar to this, you can have a far richer strategy development process—both richer in terms of strategic variety and richer in terms of profitability.

Before starting the process of choosing one’s strategy, first take some time to make sure you have properly defined the business you are creating that strategy for. If you define yourself too narrowly (product-centric), you may end up feeling trapped in a commodity free-fall, where your only strategic option is to keep cutting costs and prices to get an edge.

However, if you define yourself more broadly as a provider of consumption experience solutions, you may find many, more desirable strategic options. This does not just apply to fast moving consumer products. It can also be applied to seemingly mundane industrial products like granite and sand.

When I was a child, a buddy and I opened up a lemonade stand. Business was awful. Adults didn’t take the time to stop. They just drove buy. The only people to hang around the stand were other children.

We soon discovered that the other kids were more interested in toys than in lemonade. As a result, we went and got some of our old toys we no longer wanted and started selling them to the other children. Suddenly, we were making money.

If we had stuck to a narrow, product oriented business definition (selling lemonade), we would have been a dismal failure. However, by taking a broader business definition (making people who hang around on the sidewalk happy), we were able to modify the strategy to create a success.

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