Wednesday, May 13, 2009
Strategic Planning Analogy #256: Thin is In?
Suppose that you had to choose your future spouse from three who are behind a curtain so that you cannot see them. The only thing you know about them is their weight.
Let’s say there are three men behind the curtain—one is of average weight and two have above average weight. At first, you might be hesitant about picking one of the men who has above average weight for fear of choosing an ugly, fat man. However, the man could also be overweight because he is a hunky, muscular guy who could be quite appealing.
Both extra muscles and extra fat can create above average weight. By just hearing what the weight is, there is no way of knowing if it is fat or muscle. The best and the worst choice could have the same weight.
Now, suppose there are three women behind the curtain—one is of average weight and two are below average. At first, you might be inclined to choose one of the women with below average weight, thinking she could have a beautiful fashion model appearance. On the other hand, below average weight can be caused by being sickly and bedridden—near death.
Just knowing the weight will not let you know if the lower weight causes the woman to look like a fashion model or a sickly person. Again, the best and the worst choice could have the same weight.
By only knowing the one attribute (weight), it is very hard to make a proper choice.
In strategic planning, one often has to make choices—how to position the brand, who to target, what the appeal is, and so forth. For example, in creating a sales strategy, it is common to try to target specific types of customers to go after.
A problem arises if you define your target by just one variable. As we saw in the story, if all you know is one variable (weight), you may be placing both your best and your worst choice in the same target group (higher weight for men, lower weight for women).
For example, let’s say you want to target heavy spenders. As we will see in this blog, a single variable like “heavy spending” can cause problems, because both some of your best customers and some of your worst customers can be heavy spenders. This makes the target ineffective.
The principle here is to avoid targeting based on only one variable. To illustrate this point, we will look at the flaws in targeting “heavy users,” based only on the single variable of sales volume with your firm.
At first, this might seem like a logical metric to target for sales. After all, people who spend a lot with you probably like you (or your products), and it shows they have the financial means to buy a lot from you. People who like you and have money to spend sound like a good target for getting additional sales, right?
Maybe yes and maybe no. As in the story, that single attribute can be deceiving. Just as an overweight man can be ugly with fat or handsome with muscle, a customer currently spending a lot with you can either be a desirable target for increased sales or an undesirable target. A best and worst target choice could have the same sales volume with you.
Here are some examples of high volume customers who would make poor targets for additional sales.
1. Those Who Know How to “Game” the System
There are many reasons why someone might buy a lot of product from you. One reason could be because they know how to “game” your system. By this, I mean that they know how to cherry-pick your offerings in a way that makes them extremely unprofitable to serve.
Perhaps they only buy your loss leaders. Perhaps they only buy when you clear items out below cost. Perhaps they are heavy users of your added services, making lots of costly demands that wipe out the profitability of their purchases.
Sure they love you. They love you because they know how to take advantage of you and get a better deal than you can afford.
I used to work with a company that was one of the largest purchasers of consumables in the United States. Just by looking at sales volume, you might think that this was a good target for getting additional sales. However, this company was an expert at gaming the system. They almost never paid anything near full price to the manufacturers of mass consumables. Additional business from them would not necessarily be profitable.
There’s the old joke about the salesman who goes to his boss and says, “I’ve got good news and bad news. The good news is that I just got Wal-Mart to purchase from us. The bad news is that I just got Wal-Mart to purchase from us.” The point is that even though selling to Wal-Mart may create high sales, the demands Wal-Mart makes for pricing and services could make that business undesirable.
If most businesses were to plot sales by customer against profits by customer, they would see that high volume customers are often among their most profitable and most unprofitable. Like in the story, the best and the worst choices can look identical on a single variable.
Therefore, when targeting customers, perhaps add some variable which help you to know how profitable they are. Profitability is more important than mere volume.
2. Those Whom You’ve “Tapped Out”
One reason why a customer could be spending a lot of money with you is because they are already buying 100% of their need for that product from you. Once you get 100% share of a customer’s business, there is virtually no potential to increase sales with them. You already have all that they are going to buy.
Therefore, if you offer these types of people all sorts of sales incentives and discounts to purchase from you, the volume of business from that customer will stay about the same. What will change is the profitability of that business. They will be buying the same amount (100% of their need), but now they will be buying it and getting your incentives and discounts. All you have succeeded in doing is lower the profit on business that was already yours in the first place.
So instead of looking at just one variable (sales volume), it probably makes sense to also look at your share of their spending in the category (share of wallet). If you already have near 100% share of their wallet, trying to get more sales out of them would most likely be unproductive. Instead, you should be looking to target customers who like you enough to spend quite a bit with you, but still are spending some of their money on your competitors. Then you can target additional sales from them by getting them to shift a higher percentage of their business with you. You will not be able to separate out this more profitable target if you only look at the single variable of sales volume.
3. Those Who Buy Differently
Not everyone is motivated in the same way. A tactic which increases sales with one type of customer may have no appeal to another. Some may appreciate price discounts. Others may prefer value-added services. By lumping all heavy users together, you are classifying them by similar end behavior (purchase volume). However, this group can have all sorts of dis-similarities when it comes to why they purchase and what motivates additional sales (intermediary behavior).
If you try to use the same sales-boosting strategy on this segment, it will probably be effective on some and not on others, depending upon whether that type of strategy appeals to them.
It would be better if you added motivational factors in your definition of segments. Then you could target the most appropriate motivational tactic separately to each segment. That way, everyone would be spoken to in the most appropriate language.
Setting customer sales targets based on a single variable, like sales volume, can be a mistake, because both good and bad targets can have similar sales volume. Other factors to consider include customer profitability, share of wallet, and motivation variables.
Niche businesses can often provide a better return on investment than businesses targeted at the great masses in the middle. As a result, even the strategic goal of trying to increase sales a lot may be a mistake if it destroys your success with the niche. Narrow sales targets (based on multiple variables) may at first look limiting, but it may help reinforce your success within your niche.