Sunday, May 17, 2009

Strategic Planning Analogy #258: Just Add Milk

When my children were small, they were very fussy eaters. One of the few things they liked to eat was macaroni and cheese from a box. We tried pretty much every brand available in order to find the type of macaroni and cheese they would like the most.

To me, all the brands looked about the same. The boxes were the same size. The macaroni inside was about the same size and the same amount. The powdered cheese packets were the same size and looked about the same. From my perspective, the only difference between the brands was the picture on the outside of the box.

However, there was one brand that was a little bit creamier and a little bit tastier. I wanted to know why. As it turns out, on every other brand, the instructions called for adding one-quarter cup milk to the powder. However, on the brand that tasted a little bit creamier, the instructions called for one-third cup of milk.

In other words, the only reason why that one brand was creamier was because I added more milk to it. I was the one making it creamier, not the manufacturer. After that, I bought whichever brand was on sale and just added extra milk. That made my children happy, so I was happy.

Just as I was trying to make my children happy, businesses try to make their customers happy. And sometimes, those customers can be rather fussy, just as my children were.

To win over a fussy customer, one has to devise a strategy which provides a superior overall product versus the competition.

There are lots of ways to add value to your offering. Unfortunately, it usually costs a company more to provide that extra value, thereby lowering profits. However, what was fascinating to me about the macaroni and cheese was that the one brand found a way to provide superior taste without increasing its costs or its prices. Instead, it indirectly increased the costs of me, the customer, who had to add additional milk (at my expense).

It wasn’t a big extra cost to me (one-twelfth of a cup of milk), so I didn’t mind. But it allowed their brand to claim a superior attribute on “creamy” and appear to be the superior brand even though their contribution to the meal was essentially identical to the competition.

When devising a strategy, then, consider the example of this macaroni and cheese brand, which created superiority by getting someone else to add the extra value.


The Importance of Trade-offs
Michael Porter, one of the foremost authorities on business strategy, likes to talk about how important trade-offs are to strategy. In fact, he believes that determining your trade-offs is one of the most critical strategic decisions one has to make.

The idea is that a company typically does not have enough internal resources to be the best at everything. Therefore they have to make a choice as to what narrower area they can be best at. Then, to create superiority in that area, you pile up your resources in that area, putting far less somewhere else. The big decision is the trade-off—where will you trade away strength, so that you can be even stronger somewhere else.

Even if you do have a lot of resources, there are constraints which can make it difficult to attain superiority in all areas. For example, it is pretty much impossible to create a bicycle that is simultaneously the fastest, the sturdiest and the cheapest. Fast bicycles tend to cut back on sturdiness in order to reduce weight. Or, if you want to get both light and sturdy, one has to use very expensive metal alloys which prevent one from being the cheapest.

Therefore, if you try for all three attributes in the same bicycle (fast, sturdy, cheap), you will probably not be the best in the market on any of them. It is better to focus on one of the three and then make trade-offs on the other two. That way, you are at least superior in something and can target your bicycle to the people who value that tradeoff the most.

Trade-offs Do Not Necessarily Have to Be Entirely Internal
The principle of this blog, however, is that these trade-offs do not necessarily have to be entirely internal. Sometimes, one can get others to make the trade-off on your behalf.

As we saw in the story, the macaroni and cheese brand got me, the customer, to make the trade-off for them. I sacrificed more milk in order to make their product creamier. This was great for the manufacturer, because they got a superior product without adding costs to their product. I was the one who added the value at my expense.

There are lots of ways to get your customer to make the trade-offs and add the value for you. For example, Home Depot knows that not everyone drives a vehicle that has the capacity to haul all those big and bulky products home. Therefore, Home Depot offers the use of a Home Depot pickup truck in order to get your products home. This is an added value that the little hardware store cannot offer. The trick is that they get you, the customer, to pay for that value. You have to rent the truck.

What a deal for Home Depot! They get to add value by adding a beneficial service (the pickup truck). But at the same time, they get you to pay for the value (another profit center for Home Depot). Better yet, now that you can haul more stuff home, you are more likely to buy more stuff, thereby increasing sales. Added value and added profits for Home Depot without Home Depot having to trade away anything.

Or how about those warehouse clubs, like Costco. These firms add value by having the lowest prices. How are they able to achieve the value of the lowest prices? It is by charging the customers annual membership fees. About three-fourths of a club’s profits come from those membership fees. In other words, the clubs get the members to make the sacrifice for the trade-off which creates the lower prices by having them pay the membership fee.

Better yet, Costco gets the profits up front, by charging the membership fee in advance. And the profits are guaranteed, and are not dependent upon how much the customer later purchases. And finally, since the member wants to get the most benefit from that membership fee, they feel obligated to spend more at Costco throughout the year, creating even more profits. That’s a pretty good deal for Costco, considering that the customer made the sacrifice trade-off for them.

In the first half of the 20th century, grocers would have all of the product behind a counter. Customers would go up to the counter and tell the grocer what they wanted and the grocer would collect it for them. Then, a fellow named Cullen got the idea for the supermarket, which offered prices a whole lot cheaper than the grocer. Part of the trade-off to get there was to give the customers shopping carts and to have them do the labor of selecting the products off the shelf themselves. Again, the customer took on some of the trade-off to fund the lower prices.

Don’t Forget the Others
Customers are not the only ones you can use to absorb some of your trade-off. The auto industry has shown us that sometimes you can get your suppliers to pay the price for your trade-offs through all sorts of concessions (although we have lately seen there are limits to how much they can bear). The airlines industry in the past has achieved trade-offs at the expense of their employees, by having pilots take a big pay cut. In the dot-com world, advertisers are often used to bear trade-off expenses so that a greater value can be given to the customer.

If you get creative, you can probably find lots of ways to adjust your strategy so that the burden of trade-offs are shared with others in the supply chain.

Although trade-offs are an essential part of strategy, it is not a foregone conclusion that your firm has to carry the full burden of those trade-offs on its own. Sometimes you can get external partners, like customers, suppliers and employees to pick up some of the burden. By passing off some of the burden, you can afford to provide a superior value with less pressure on profit margins.

Perhaps, instead of calling it a “trade-off,” we should refer to it as a “trade-to.” In other words, instead of always looking at what we can eliminate, we should look to who we can pass the burden off to.

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