Divergence or Convergence

OOOPS!
Back in the June 18, 2007 edition of Advertising Age magazine, marketing guru Al Ries made a prediction. Apple was about to launch the first version of the iPhone. Al Ries predicted that the iPhone would be a major disappointment.

Well, looking back, it would appear that Al Ries was wrong. By just about any measure one can think of, the iPhone has been a HUGE success. For example, the recent launch of iPhone 4 sold 1.7 million units in the first three days.

WHAT WENT WRONG?
Since I think that Al Ries is one of the smartest human beings on the planet (at least when it comes to business and marketing), it shakes my confidence to see him appear to have been so wrong in his prediction. But then I realized that he was wrong for all the right reasons.

Ries predicted that iPhone would disappoint, because he saw it as a convergence device. Convergence devices try to be multi-functional by combining the functions of other single-purpose devices. Rather than creating a new solution, they merely take old solutions and cram them into a single device. In this case, he saw the iPhone as being a multi-function device combining the functions of a phone, a computer, a camera, a media player, and so on. As Ries so convincingly put it in his article, when consumers view your product as a convergence device it usually fails to catch on (think of all the failed combination computer/TVs that have been introduced over the years).

The problem is that when you are seen as combining a bunch of stuff into one device, you are not viewed as an expert at any single function. Why buy a complicated, sorta-good, multi-function device when you can buy the best single-function products from experts in that field?

Instead, Ries says success typically goes to the divergence device. A divergence device takes a current product offering and narrows the scope by becoming more specialized or more narrowly targeted than its predecessors. It goes narrow to create a more specialized solution for a more narrowly defined problem. To quote the Advertising Age article, “The first computer was a mainframe computer, followed by the minicomputer, the desktop computer, the laptop computer, the handheld computer, the server and other specialty computers. The computer didn’t converge with another device. It diverged.”

Therefore, since he saw the iPhone as a convergence device rather than a divergence device, Ries predicted disappointing results.

The theory was right. What was wrong was Ries’ prediction of how the iPhone would be perceived in the marketplace. Apple never marketed the iPhone as a convergence device and consumers never thought of it as a convergence device.

Instead, Apple created a unique, new business ecosystem centered around “apps.” First, there were the thousands upon thousands of apps developed, doing things never done that way before. Then there was the App Store, a place to purchase all of these unique Apps. And then there was the iPhone, a device to make the apps come to life.

The iPhone was not seen as the combination phone/computer/camera/ media player Ries feared it would be. Instead, the iPhone was viewed as a specialized divergence device—the first App Machine. Apple became the undisputed leader in the world of apps…they owned that space because they built an integrated system. Therefore its iPhone—the App Machine—became a huge success. Others are having trouble copying this success, not because they cannot mimic the device, but because they have an inferior offering of apps (making them inferior app machines).

CHANGING FUNCTIONS
In the last few blogs, we’ve been looking at ways to create innovative new growth opportunities by tweaking elements of the business model. We’ve seen how you can innovate by changing ownership, changing location, and changing who pays. Today, we are looking at changing the amount of functionality. The iPhone was a huge success, because it created a new way to look at how a phone functions (as an Apps machine, where talking is seen as just one of many apps—and not necessarily the most important one).

When it comes to functionality, you have several options:

1. Function Target: General Solution (broadening the target) or Niche/Specialty Solution (narrowing the target)

2. Function Bundle: Single Function Solution (unbundled) or Multi-Function Solution (bundled).

When you put this together, you get a 2x2 grid.


Let’s apply this grid to the way Procter and Gamble (P&G) approaches the laundry business. In the single function/general solution box you have Tide. Tide is positioned as the best working laundry detergent for the general public (one function for the masses—the upper left-hand box). But Tide did not stop there. They also have multi-function versions of Tide:

1. Tide with Bleach
2. Tide with Dawn Stain Scrubbers
3. Tide with Febreze Freshness
4. Tide with a Touch of Downy Softener



These multi-function products still target the masses, but do more than just regular detergent (placing them in the lower left-hand box).

And then there is Dryel, P&G’s system for doing dry cleaning in your home dryer. It is specialized, in that it was designed to only provide a solution for “dry clean only” clothing. But it is multi-functional, in that is claims to clean, freshen and unwrinkle those specialty fabrics. This places it in the lower right hand box.

Finally, there is the new brand from P&G, called Swash. Swash is targeted at a very special niche: Young adults who are too busy or too lazy to do laundry, yet still want to look nice when they go out socializing. There are four single-function products under the Swash brand:

1. Swash Fresh It Up – Spray your clothes and 5 minutes later they smell like they were just laundered. You can tell this product is targeted at young, socializing adults, because one of the fragrances is called “Posse,” a young adult term applied to one’s inner circle of friends/companions.
2. Swash Get It Out – Just rub the pen over the stain and it goes away.
3. Swash Smooth It Out – Just spray the clothes and smooth them out with your hands while it is still wet. When it dries in a few minutes, most of the wrinkles will have gone away.
4. Swash Steam It Out – Just put the sheet into the dryer for a few minutes with the worn clothes and they will come up almost like newly washed.

The beauty of this approach is that P&G has created all sorts of laundering innovations without having to create all sorts of new inventions. It’s multi-function versions of Tide are combining Tide with products/inventions already in the P&G portfolio—Dawn, Febreze, and Downy. Swash uses a lot of existing P&G technology, only packaged and modified a bit, such as the technology behind the Febreze freshener, the Dryel steaming sheet, and the Tide To Go stain pen.

The innovation behind Swash is not so much about inventing new technology as it is about taking old technology and reinventing the business model as it relates to functionality. They took generalized functionality and repackaged it as a solution for a niche audience/need. Suddenly you have a whole new laundry category.

BUT WHAT ABOUT THE CONVERGENCE ISSUE?
But what about Al Ries’ concern over the high failure rate for convergence products? Doesn’t that make adding multiple functions a bad move? The problem is not whether or not you add functionality. The problem is how you position the result.

The iPhone added a lot of new functions to the mobile phone, but it was not positioned as a mobile phone pus other functions. It was positioned as a single function device—the apps machine. Similarly, Dryel was not positioned as a freshener plus cleaner plus unwrinkler of specialty garments. It was positioned as the first system for doing dry cleaning at home (a new single function).

But what about things like Tide with Bleach? Well, the positioning there is that there is a single function to be done (cleaning your clothes). Rather than using two products during that single function (adding detergent AND adding bleach), you just add one product, giving you the benefit of one product/one step convenience plus the assurance of compatibility.

So, if you are going to change the business model to increase the number of functions, either position it as resulting in a brand new single-function category (Apps Machine or Dry Cleaning at Home), OR position it as a superior way to tackle a single problem (like doing laundry).

Don’t position it as a way to multi-task, a way to do multiple functions with a single product. This is where Al Ries says you get into trouble.

SUMMARY
One way to innovate is by changing the functionality of the product. This includes the idea of either broadening or narrowing the target of the function (mass vs. niche) or broadening or narrowing the number of functions done (single vs. multi function). The trick is that if you want to broaden the number of functions, you need to position the result as a superior one-function product, even if that means inventing a new category.

FINAL THOUGHTS
In the blog, we talked about how P&G took mass oriented products and created a whole new industry when they applied them to a narrow solution with Swash. It can also work the other way. There have been lots of narrow solutions, like the coating to protect spacecraft re-entering the earth’s atmosphere, which created new industries when applied to mass solutions (Teflon coating for non-stick cookware). The idea here is to look at which box on grid a technology is currently located (regardless of where it is) and see if you can create innovation by putting that technology into a different box on the grid.

Strategic Planning Analogy #335: Free Lunch?

THE STORY
Back when I was getting my college degree, the economy was bad and jobs were practically non-existent. I needed to find a job to help pay for my education and was not having much luck finding one. I was desperate.

Eventually, I found a job working at a telephone call center. My job was to call people up on the telephone and tell them they had won some “free” magazine subscriptions. After they had accepted the “free” gift, I was to tell them about a small handling charge for setting up the subscriptions. As it turns out, that “small handling charge” was equivalent to paying for a magazine subscription.

Once people heard how much those “free” magazines would cost them, they cancelled the subscriptions.

After doing this job for two days, my conscience told me that selling “free” subscriptions to unsuspecting people is wrong. The lies and deceptions were more than I could take. So after two days, I quit. As it turns out, I was not that desperate for a job.

THE ANALOGY
If you want your business to survive long-term, eventually you have to generate income. And the income needs to exceed costs. Giving everything away for free forever to everyone is usually not a path to long-term prosperity. Somebody, somewhere has got to put money in your pocket.

At the call center, I was telling people they were getting the magazines for free. In reality, that was a lie. These people were really paying for these magazines. All we had done was change the name of what they were paying for, from “subscription fee” to “handling fee.” Call it what you want, but they were still paying for the magazines. I’m sure the call center was also getting money from the magazine publishers who wanted to increase their subscriber base in order to charge more to the magazine advertisers.

So in the end, those magazines weren’t free. The subscribers were paying for them in “handling fees” and the advertisers were paying for them in “advertising fees.” And that was how this call center put money in its pocket even though it was supposedly giving away magazines for free.

There are lots of creative ways to put money in your pocket. There can be sources for your income that have nothing to do with the user of the product (like the magazine advertisers). Because there are lots of ways fund an income stream (from a variety of potential sources), creative revenue sourcing can become a key strategic differentiator and a source of innovation.


THE PRINCIPLE
This is another in a series of blogs on innovative business models. In the last two blogs, we looked at innovation via changing who owns the product/service and where the product/service is offered. In this blog, we will look at innovation based on how a product/service is funded.

One’s initial thought may be that the person who uses the product/service should be the one that pays for it. After all, they are the one getting the benefit. However, as we will see below, that is only one option. There are many other ways to fund a business’ revenues. If you are creative enough in sourcing your revenues, you may open up a whole new business model that creates new growth opportunities. Listed below are a few ways to derive income from people other than by just charging everyone who uses a product/service.

1) Only Special Users Pay Model
Instead of having everyone who uses a product or service pay for it, you can have only certain class of people pay for it—the rest getting it for free. This is often referred to in the online space as the “Freemium Model.” Most people get the basic version of the software/internet service for free, but if you want extra features, you pay for the premium model. A perfect example is LinkedIn. The vast majority of the people using this job-related social networking site are using the free version. However, because free pricing created a large pool of people in the LinkedIn database, the data became extremely valuable to people like job recruiters, who pay money to get a premium version with extra features to access this data.

A similar example is Adobe PDF. They give away the Adobe Reader files for free to establish PDF as the standard way to read protected documents. Then, Adobe charges money for the premium version which allows people to not just read the files, but also write files in PDF. Without the large base of free readers, there wouldn’t be much incentive to write files in the format (where the real money is).

This is not just a digital model. Think about night clubs that have a “Ladies Night,” where women get in free. The reason is similar to Adobe PDF or LinkedIn. If you have a lot of women at the night club, you make the night club more valuable to single men who are willing to pay a premium to be at a place with a greater abundance of single women.

Perhaps there is a way you can segregate your customers, whereby if you give some a free ride, you will create more value for others who will pay a premium for a version of that product/service.

2) The Advertising Subsidy Model
Anyone who has watched a NASCAR race understands the advertising subsidy model. The cars and the drivers are completely covered with advertising logos. Advertisers pay a bundle of money to get those logos on the cars and drivers. Why? They know that a lot of eyeballs are watching the race and they want to take advantage of those eyeballs to get them to like their product.

A large proportion of internet sites use this model. The sites are free to users, but they are covered with advertising. A lot of the traditional media also rely on advertising as a primary source of income (as we saw with the magazines in the story). They are all trying to exploit the eyeballs looking at the media and make a pitch to them to purchase something else unrelated to the media.

When you purchase a new computer, the initial screen can be full of free trial versions of software (from which they eventually want you to buy full versions). This is referred to as “Spamware.” Software companies are so willing to spend money to be on that initial computer screen that both the manufacturers and retailers of computers are fighting to get that money. Some retailers will wipe off the spamware installed by the manufacturer and put their own spamware on the computer before selling it.

Perhaps there are ways to put advertising into your business model in ways that have not been done before.

3) The Bundling Subsidy Model
When you bundle items together, you can sell one piece of the bundle for virtually free, because you are making sufficient profit on the rest of the bundle. For example, some stores sell computers at a loss, because they know that if they can bundle enough other goodies with the computer (like extended warranties, printers, ink, cables, software, etc.) the net bundle is profitable.

Mobile phone carriers often bundle in a free cell phone, provided you sign up for a long contract (long enough to pay off that cell phone in the monthly fees). Movie theaters keep ticket prices low by charging a small fortune for popcorn and soda (and make a profit on the whole bundle).

In these cases, the user ends up paying for everything by overpaying for one piece in order to underpay for something else. However, you may find strategic partners who want to become a part of your bundle and will put in part of the subsidy in order to get into your bundle (because they know they will sell more as part of your bundle than on their own). You can have different vendors bid against each other to get into your bundle (or pay to participate).

Of course, it can also work the other way. You can create a new model by unbundling. Some phone carriers do not subsidize the mobile phone. As a result they can charge a lower price for monthly service. Just because the industry does it one way does not mean you cannot do it the other way. We talked more about the bundling model in another blog.

4) Greater Good Subsidy Model
Sometimes you can get someone other than the user to pay because they see a greater good in subsidizing the purchase. For example, governments pay for all sorts of things used by customers because it is seen as a public good to do so (like health insurance). I see all sorts of commercials on TV selling motorized chairs for people with disabilities. The commercials brag that the chairs are free to the user, because they get the government and insurance companies to pay for them.

Charities (via the people who donate to them) also pay for a lot of items which are then given away for free (often to the poor who cannot afford them) because it is a good thing to do.

Employers will often provide on-site daycare, health care facilities, and cafeterias at a subsidized rate because they see the greater good in employee hiring, employee retention, getting employees to work longer hours, or in reducing health care costs.

Perhaps you can find a way to get money from employers, charities or the government instead of from the customer, because you can prove “a greater good” will come of it.

5) The Insurance Model
In the insurance model, people do not pay for their individual use of a product and service. Instead, they pool their money with others. When they need the service, the money is paid out of the pool. The customer hopes that they will put less into the pool than they take out in services.

Insurance is common for things like health and life and automobile accidents. But why stop there? Now you can get insurance on your pet’s health, insurance against identity theft, insurance for auto repair, and legal assistance insurance. What other things could you convert to an insurance model?

6) Bad Person Punishment Model
Sometimes, you can paint someone else as “the bad guy” and force them to pay for your costs as a form of punishment. This is common in the legal profession, where lawyers will take on your case for free and get paid via the damages paid by the “bad guy” you are suing. By why stop there?

In Canada, there is a 21 cent surcharge placed on every blank recordable CD sold. Why? Because blank recordable CDs are portrayed as the bad guys since they encourage the illegal downloading of digital content. This surcharge is then distributed amongst “the victims” of illegal downloading.

Many are clamoring to do the same to food companies that sell products with too much fat or salt. They want a bad health tax put on them to help pay for the health consequences of poor eating. They’ve already done it in a way with cigarette manufacturers, getting them to pay for their unhealthy product. Some are pushing to tax news content on the internet to subsidize print media.

Maybe you can find someone to paint as the Bad Guy (and paint yourself as a victim) and get the bad guy to pay your costs for you.

SUMMARY
Don’t automatically assume that your income has to come from all the people who use your product/service. There are lots of other options, including premium customers, advertisers, bundle partners, government, employers, charities, insurance pools, and bad guys. If you think creatively about your business model, you may find a way to revolutionize your industry by funding it in a new way.

FINAL THOUGHTS
There’s an old saying that there is no such thing as a free lunch. Well, if you are creative in your funding model, you can create a free lunch for some, just so long as you find someone else to pay the bill.

Strategic Planning Analogy #334: Where It’s At

THE STORY
Shortly after the fall of the USSR, the company I worked for started working with Russian partners to bring western-style supermarkets to Russia. It was a very difficult project, in part due to the Russian infrastructure.

In general, it is easier to transport processed food than un-processed food, since processed food is already packaged in a way that reduces spoilage. That is why, in most western countries, the food processing factories are located near where the food is grown. That way, the food can be processed shortly after being picked—reducing wastage and rot.

In Russia, however, we found that the food processing factories tended to be located closer to the big cities. The problem was that due to the poor transportation network in Russia, a lot of the food became spoiled and damaged before it reached the factories. The quality of the processed food suffered as well.

As a result, most of the food in our Russian supermarkets had to be imported from outside Russia. It made the products more expensive, but the customers appreciated the higher quality.

THE ANALOGY
A simple little concept—where to put the food processing factory—made a big difference in the Russian food chain. Russians needed to import food—not because they couldn’t grow it, but because so much of it spoiled before it could get consumed. Had they only located the factories closer to the growing fields, there would have been fewer food shortages.

Every product or service needs to be located somewhere, be it food processing or business consulting or whatever. Just as poor location choices had a detrimental impact on the Russian food chain, poor strategic choices of location in your business could have disastrous results. Conversely, if you are clever in your locational decisions, you may create exciting new business opportunities.

Therefore, when creating your business strategy, it may be wise to ponder new locational alternatives. It might revolutionize your industry.

THE PRINCIPLE
This is another in a series of blogs on innovative business models. In the last blog, we looked at innovation via changing who owns the product/service. In this blog, we will look at innovation base on where the product/service is created/sold.

Although we can often think of location as a given, there actually is quite a bit of variability in where one can provide a good or service, if you think creatively. If you decide to make location decisions differently from conventional wisdom, you may create an exciting new growth opportunity.

1) Locate Where the Customer Is
Often, people must travel to the store or service shop in order to get a good or service. But what if you brought the store or service shop to the customer? Take cars, for example. There are firms that will drive their service operations to the location of your car rather than you having to drive your car to the service shop. This includes a variety of services, such as windshield replacement, cleaning, and even mobile oil change trucks.

Enterprise rent a car came up with an ingenious locational idea. Their great insight? If you need to rent a car, then there is a good chance that you do not have transportation to drive to the car rental location. Therefore, Enterprise will drive the rental car to where you are located.

And how about shopping? Firms like Tupperware, Avon, Amway and Mary Kay do the selling right at your house…no need to go to the store. And of course there are all the etail options where you can buy from your laptop.

Firms like SnapOn Tools and Mac Tools drive their inventory of tools to the worksite to sell right where the work gets done. Lunch Wagons will drive the restaurant right to the work site as well. Consultants or other contract workers can be located at their place or your place…whatever works best.

You can get grooming services (for you or your pet) to come to where you are. And if your computer isn’t working right, the Geek Squad will drive to your home or work location and fix it right there…or they might do it remotely through the internet. No need to lug your computer to a shop.

Perhaps you can think of a business typically done remotely which can be revolutionized by moving it closer to the customer.

2) Locate Away From The Customer
The opposite can work as well—taking jobs usually done on customer’s site and move it somewhere else. For example, homes are traditionally built at the site where the home will be lived in. Howevever, that is not the only way it can be done. Pre-manufactured homes can be built in a factory and merely assembled on site.

“Home-Cooked” meals are traditionally made at home—hence the term “home-cooked.” However, there are a number of firms like Dream Dinners which provide an off-site kitchen, where groups of customers come in and cook a week’s worth of meals at the same time—then take them home to freeze for later.

Modern technology and internet connections are making remote diagnostics posssible, so that problems can be repaired without visiting the home. We already talked about this with computers. But now there are home devices which can monitor health (and are remotely connected to medical providers). Similarly, if some business equipment (like copiers) fail, they can sometimes be repaired remotely through the internet. You can check up on your home remotely, to see if there are any burglars, or to change the lighting or heat settings.

There are people looking to do the same thing for home appliances. Why have a repairman drive out to the home if you can fix it with a software patch sent to the appliance over the internet? In fact, if the appliance starts feeling “sick,” it may remotely contact the repairman on its own.

Perhaps you can think of a business typically done near the customer which can be revolutionized by moving it somewhere remote.

3) Upstream Considerations
Not only can you make innovative changes by changing the locational orientation with the customer. You can also change the locational orientation with suppliers. We saw in the story how building food processing factories closer to the farms can be beneficial. This same principle can apply to other supplier issues.

For example, breweries consume a lot of water. It makes sense to locate breweries near cheap, high quality water. Otherwise, you would go broke trying to import water to the brewery

Sometimes the economies of scale are such that it makes sense to centralize production. Other times, distribution costs may be for of a factor than production, so it could be better to spread production closer to your customers.

Labor costs vary by area. If you have a high labor process, perhaps it makes more sense to locate closer to cheaper labor. Then again, if you get creative, you might be able to reinvent an industry by bucking that conventional wisdom.

Take, for example Zara, the fast fashion retailer owned by Inditex. Where most clothing retailers source their apparel from cheap labor markets in Asia, Zara gets much of its inventory from higher-cost nearby Italy. Zara found that by avoiding Asia and using nearby Italy, they increased their flexibility and speed to market tremendously. Then, they designed a business model for Zara which exploited this speed and flexibility. It has been fabulously successful. The higher labor costs are more than compensated for by the competitive advantage in speed and flexibility due to the different location choice.

SUMMARY
Location decisions do not have to be “automatic.” Although conventional wisdom may cause everyone to locate their business or service in the same way, it doesn’t mean that it is the only way it can be done. By creatively changing the traditional location where goods and services are produced or sold, you may create an innovative new industry with plenty of growth potential.

FINAL THOUGHTS
In retailing, they say that the three most important factors for success are “location, location, and location.” If you get clever, perhaps location can be the key to your success.

Strategic Planning Analogy #333: Ownership

THE STORY
Back when I was getting my MBA, one of the things I was taught was how to do the classic “Rent versus Buy” analysis. The idea is to track the costs over the lifetime of an asset to see if it is cheaper to rent the asset or buy it.

I was so excited about learning this new tool that I immediately wanted to apply this knowledge to the company I was working for part-time while getting my MBA. I did a quick analysis of whether this company should rent or buy its trucks. I was eager to share my results with company management.

Unfortunately, company management was not as excited about by the analysis as I was. Apparently, they had already been doing an analysis of their own, called “Reinvest versus Liquidate.” They had come to the conclusion that they were going to wind down the business instead of reinvesting in it. Thus, an analysis about renting versus buying future trucks was worthless, since they were not going to be needing any additional trucks in a wind down.

This taught me an important lesson: If you don’t have a great long-term strategy, a lot of the day to day decisions lose their importance. Maybe that’s why I’ve spent most of my career trying to help firms find that long-term strategy instead of helping them with “Rent versus Buy” decisions.

THE ANALOGY
Most of the time, we see the “Rent versus Buy” decision as a minor tactic. It is usually not the key to our core business model. Instead, it is just a tool to find the cheapest way accomplish our business model. If the business model is failing, like in my story, “Rent versus Buy” is not seen as powerful enough to stop the failing business model.

However, what if we elevated “Rent versus Buy” to become the core differentiation in our business model? Would it be possible to create a new, more powerful business model based upon assumptions around ownership? Could a creative new approach to ownership create a business model so innovative that a whole new industry is born? Could this help save companies from liquidation?

I think so.

THE PRINCIPLE
This is another blog in my occasional series on innovative business models. In the past, we’ve looked at innovation by adding or taking out intermediaries, in bundling/unbundling, changing access, and in changing how a problem gets solved. In this blog, we will look at innovation by changing ownership.

Everything has to be owned by somebody (or somebodies). For many items, ownership transfers to the buyer at the point of the transaction. For example, if I go to a car dealership and purchase a car, the ownership of that car transfers to me.

For other items, ownership does not transfer at the point of the transaction. Instead, the “purchaser” is only leasing use of the property. For example, an owner of an apartment building maintains ownership of the property and makes money by renting out the apartments.

Other times, a third party takes ownership. For example, a manufacturer may sell an item to a third party finance company who then leases the property to a user.

The point here is that you get a different business model depending on whether ownership is located with the product/service provider, the product/service user, or a third party. If you want to create a new business model innovation, consider shifting from a traditional ownership model to a different one.

1) Shifting From Traditionally Rented to Owned
Let’s look at a few industries that have traditionally used a lease business (provider-owner) model to see what happens when you shift to a user-owner model. For example, apartment buildings were traditionally a provider-owner business. The owner of the building remained the owner. The users of the building rented their space from the owner (never took ownership). But what if the users did take ownership? When this happened, a whole new exciting industry was created, called “condominiums.”

And how about vacations? Traditionally, when you went to a vacation spot, you rented your accommodations from a Hotel, Inn, Bed & Breakfast, or other such facility. But what if you could own that accommodation? Some entrepreneurs tried that and created a new business model, the “timeshare” vacation, where you own a week’s worth of a vacation property, which can be traded for vacation spots all over the world.

This timeshare model has spread to other industries where other business models had previously been dominant, such as commercial jets (NetJets) and boats. Either you went from renting to partial owning, or from full owning to partial owning.

Before the breakup of the telephone utility in the United States, every telephone in the country was owned by the telephone utilities. Customers rented them as part of their monthly utility bill. Now, customers own their own phones. This revolutionized the telephone manufacturing business.

When movie studios first started allowing customers to view video tapes of their movies in people’s homes, a rental model was chosen, spawning firms like Blockbuster. Then the studios lowered the price, so that consumers started buying and owning the movies, benefitting firms like Wal-Mart. Now, in the age of digital streaming of movies, we’re moving back to a rental model.

The point is that you may be able to revolutionize an industry by finding something which is traditionally rented and find a way to transfer ownership to the user.

2) Shifting From Traditionally Owned to Rented
This same principle also works in reverse, where something typically owned by the user is shifted to a rental model. For example, instead of owning your furniture and appliances, you can rent them. Firms like Cort will gladly rent you whatever furniture you need, for home or office. Other firms, like Aarons or Rent-A-Center, use a hybrid rent-to-own model for furniture and appliances.

What about clothing? There are a number of firms specializing in renting out designer clothing and accessories via the internet, including firms such as Wear Today Gone Tomorrow, Rent Me a Handbag, and From Bags to Riches. In New York City, there are designer clothing rental shops, such as Albright and Ilus.

People may have been comfortable renting cars for a short period when away from home, but tended to want long-term ownership or a long-term lease on a car for home-town use. Now, however, there are firms such as ZipCar which will rent you a car for a few hours or a day right in your own home town in a very convenient manner. This is causing many urbanites to abandon car ownership, just renting cars for those occasions when mass transit is inappropriate. Customers claim to save money and help the environment. A new industry is born!

Again, look at industries where users traditionally own the product and consider how you could reinvent the industry by converting to a rental model. You may create the next ZipCar.

3) Other Interesting Ownership Changes
Governments have traditionally been responsible for providing its citizens with a number of services, such a prisons and highways. However, even though the government is responsible for providing the service does not mean they have to own the service. Lots of government services, like toll roads and prisons are now owned or operated by non-government third parties. There may be many other government responsibilities that can be done by independent third parties.

Outsourcing can be applied to a lot of areas. This shifts ownership to others, rather than to yourself. Are there new frontiers in outsourcing yet to be developed?

And what about cooperatives? Group ownership of property may be better than owning it all by yourself.

And maybe you can split a single transaction into two. For example, one business model being considered in the electric car industry is one where you would buy the car, but rent the very expensive battery inside the car.

SUMMARY
One component of a business model is who retains ownership. It could be the provider (who rents), the user (who buys), or a third party (who facilitates). One can invent exciting new business innovations by merely changing the traditional ownership pattern in an industry business model. Maybe such an opportunity exists in your business.

FINAL THOUGHTS
My initial excitement about “Rent versus Buy” was quickly deflated in the story. However, if you look at ownership issues as the opportunity to potentially reinvent an industry, there is plenty of reason to get excited again.

Strategic Planning Analogy #332: Why?

THE STORY
There’s a comedian who goes by the name of Professor Irwin Corey. Although still alive and sometimes performing (he’s in his 90s), his prime comedy years were in the 1960s and 1970s.

Professor Irwin Corey always dressed in a frumpy, wrinkled suit with tennis shoes. One time, back in his prime, Irwin Corey was appearing on a TV talk show. The host of the show asked Prof. Irwin Corey, “Why do you wear tennis shoes?”

Prof. Irwin Corey replied, “Actually, that is two questions. The first is ‘Why?’ This is a question that philosophers have been pondering for centuries. As for the second question, ‘Do you wear tennis shoes,’ the answer is yes.”

It’s hard to argue with logic like that.

THE ANALOGY
Professor Irwin Corey was hesitant to answer the question “Why?” After all, the great thinkers and philosophers since the beginning of time were unable to answer such a question. Why then, would one think that Irwin Corey could answer the question?

Instead, he stuck to simple questions, like “Do you wear tennis shoes?” Yes, easy to answer, but not very insightful.

I think a lot of business people are like Irwin Corey. They avoid the tough question of “Why” and focus on the easy to answer questions which provide very little strategic insight.

In reality, the best place is in the middle, asking a more focused series of “why” questions, like “Why do you wear tennis shoes?”—easier to answer than “why” and more insightful than “Do you wear tennis shoes?”

THE PRINCIPLE
The principle here is that merely observing surface behavior (like whether or not you are wearing tennis shoes) will not lead to great strategic insight. If you want to influence customer behavior to your advantage, you need to look deeper into the motivations behind that behavior. You need to ask why.

The traditional technique for doing this is called “The 5 Whys.” The idea is that you ask a person why they do something. Then you take their answer and ask why they said that. If you continue doing this five times, you will have dug down to the true motivation behind the behavior.

It takes multiple layers of asking why to get to the truth, because often consumers themselves do not truly understand their deeper motivations. They cannot truthfully tell you their deepest motivations at the first, because they do not know the truth. You have to dig deeper, one level at a time, because that is all the customer can handle. You are helping them with their own sense of self-discovery on why they do things.

If you stop the process too soon, you will only get a surface response which does not get to the real heart of the matter. As a result, you will miss the true strategic insight.

Discount Store Example
For example, one time I was working on a project to find out why people shop particular discount stores. When customers were asked why they shopped discount stores, nearly all of them said “To save money”, regardless of which store they shopped. Well, that didn’t provide much insight. Worse yet, it gave me no clue as to why some customers preferred saving money at discount store “A” while others preferred saving money at discount store “B”.

Had I stopped there, I would have concluded that everyone sees discount shopping the same and that all discount stores are about the same—places where you can save money. But that would have been the wrong conclusion.

I used the 5 Why approach to dig deeper. What I discovered was that people had different reasons for why they wanted to save money. And, depending on their reason for saving money, people preferred a different discount store.

For example, one group wanted to save money in order to feel like they were doing more to take care of the needs of their family. This group tended to shop discount store “A”. Another group liked to save money because they loved to shop—the more they saved, the more things they could buy. This group seemed to prefer discount store “B”. A third group loved to buy expensive status items. However, they knew that the only way they could afford to buy the status brands at the status stores was by saving money on things that were less important to them at discount stores. This group tended to prefer discount store “C”.

Now I had meaningful information around which one could design a strategy. I could segment customers based on this deeper motivation and take actions to strengthen the value on the deeper dimensions associated with the chosen segment. I would have never discovered this insight if I had stopped at the first level of observation.

The Concept of Self Worth
After having done enough of these 5 Why studies over the years, I have noticed a pattern in the types of deep motivations you discover. In general, people like to feel good about themselves as individuals. Rarely do people take pride in being a bad person. Instead, they want to see themselves in a favorable light. Therefore, if given a choice, people tend to act in ways that will make them feel better about whom they are as a person.

I call this the concept of Self Worth. The idea is that if you know what makes a person feel better about their worth as person, then you can predict how they will act—in a direction which increases that self worth. Then you can increase your profits by helping them achieve that self worth.

What makes all of this really interesting is the fact that there are a variety of ways in which people define self worth. Therefore, you can strategically segment a market based on self worth. You can choose a self worth segment and build an offering which is the best at reinforcing the self worth of a particular segment.

Most self-worth segments seem to fall into one of three broad categories, which I call “The Internal Compass,” “The External Status Seeker,” or “The Accomplisher.”

The Internal Compass people tend to be driven primarily by an internal sense of what is morally right and wrong. They feel better about their self worth when they are doing the things they define as being morally right. This is the internal compass directing their actions. People like this tend to be more religious or are more concerned about large societal issues, like preserving the planet.

To win over these people, you need to convince them that patronizing your business reinforces those moral issues they believe in. For example, people buy Tom’s shoes because they know that for every shoe they buy, Tom’s donates a pair of shoes to a poor person. Their moral compass says that helping the poor is right and those that help the poor are better people. Therefore, buying Tom’s shoes makes you a better person.

The External Status Seekers use more of an external compass. They tend to feel best about their sense of self worth when they think that people in their peer group find them more acceptable. In other words, this group lets others define their worth. They more THEY like you, the more you like yourself. This is about fitting into society. Even more so, it is about having special status within your peer group—being one of the more highly esteemed within the peer group. This is the primary segment for teens and is also very important for a large percentage of adults.

External status seekers learn what the rules are for status in their group and then act to attain them. It could be by owning the right status brands. It could be by belonging to the right social groups. It could be by being seen in the right places with the right people. To win this group, you need to understand the rules of that portion of society and then help them achieve status with their peers via playing those rules. For example, if you convince this group that your brand of automobile is the highest level of status among their peer group, then that group will buy more of your brand of automobile.

The third group is The Accomplisher. These people measure their sense of self worth based on how much they have personally accomplished in their life. The more activities they have done, the more they like themselves as a person. It’s almost like a check list. The more things that are checked off, the higher their self worth. The key here is to find out what types of activities they find meaningful and then help them accomplish them.

By using the 5 Why approach, you can figure out which self worth sub-groups are most relevant. Then you can develop the appropriate strategy.

THE SUMMARY
Observing surface behavior is usually not going to lead to great strategic insight. Insight comes from understanding the motivations behind that behavior. If you understand the motivation, then you can increase the behavior in a direction which is more mutually beneficial. A way to get at the deeper motivation is through the 5 Why approach. This will usually help you to see what creates a sense of self worth in people. Then you can build a strategy which reinforces that sense of self worth.

FINAL THOUGHTS
Don’t be like Professor Irwin Corey, who avoids the tough questions. Take the time to learn the deeper motivations.

Also, this was another blog based on a suggestion of a reader. If you have any topics you'd like me to tackle, let me know.

Strategic Planning Analogy #331: Heal Thyself

THE STORY
I have a large number of friends who have left the big corporate world and set up small consulting businesses. I know it can be difficult for a small start-up to get established. After all, there are a ton of small business consulting firms. The joke is that “small consulting firm” = “unemployed executive between jobs.”

Therefore, I’m curious to see how these friends of mine position their business to succeed. I go to their web pages to see how they present themselves to the world. Quite often (but not always), these web sites are a real mess.

Many of these web sites are bland and generic. From reading the site, I cannot discern their consulting point of view or style. Others are so packed with jargon that I have no idea what they are talking about or what services they provide. Rather than being customer-centric, they tend to be consultant-centric. Worse yet, they do not convince me why anyone should prefer hiring them over the competition.

Other than the page that shows a picture of the actual consultant, you could pretty much swop pages between sites and not be able to tell the difference.

So here’s my question: Why should I write a big check to a consultant who claims they can make my company a huge success (better positioned, bigger, stronger, more professional) if the consultant’s own business looks like a bland, unpositioned, unprofessional mess?

Physician, heal thyself.

THE ANALOGY
Although there are some advantages to being a small firm (more flexibility, less overhead so you can charge less), there are also quite a few disadvantages. The bigger firms have bigger promotional budgets, economies of scale, well-known reputations, and other such benefits.

On top of that, there is typically more personal risk for an executive to recommend to his boss to hire the services of a small firm. As the old saying used to go back in the heyday of mainframe computing, “nobody ever lost their job because they recommended that their company use IBM.” IBM was the “safe” choice, because they were big and well-established leaders in the field. If the deal later turned out to be bad, rarely would you be in deep trouble for recommending the safe choice. However, if you had recommended a small firm and the deal went bad, you could easily lose your job for making such a poor recommendation.

Therefore, if you are a small business and want to succeed, you need to work extra hard at building a winning reputation. Unfortunately, it seems like many of my friends wanted to skip this step when setting up their consulting businesses. Many of these friends were so focused on being able to “do the work” that they did not spend sufficient time creating a compelling reason why they deserve to “get the work”. They had not branded their business.

THE PRINCIPLE
The principle here is that small businesses are not immune to strategic planning. They need a plan to win as much as the big companies—maybe even more so. And since most small businesses are predominantly in service industries, what you are selling is not an isolated product, but rather a relationship between the service provider and the customer. Therefore, it is essential to take the time to brand your business, the entity you want your customers to form and keep a relationship with.

A business brand should answer the following questions:

1) Why should someone do business with me?
2) Why am I a superior choice over the competition?
3) What is my area of specialty…what do I provide better than the big guys?
4) If you had to describe your benefit in the marketplace in one or two words, what would those words be?
5) Who am I targeting for business? What problem am I trying to solve for that customer? How is my solution superior for that customer? If it is not superior, should I change my business model or change my targeted customer?
6) How do I present myself and sell myself to my customers so that they can quickly understand my brand and why it is the best solution for their problem?

Trying to be all things to all people is hard enough if you are a large firm. If you are a small firm, that is next to impossible. Even if it were possible, your potential customers would not believe such a claim—you would be seen as too small to have that capability to offer so much with any degree of quality.

Therefore, you have to make choices and tradeoffs. You need to focus on being better at doing less. The trick is deciding what and who to focus on (and what not to focus on), and how to create a business model which exploits that niche. This focus becomes the nucleus of your brand.

Some small businesses resist the idea of spending time to brand their company. I will look at two common points of resistance and show the weakness in their argument.

1) I Have Connections (The full silo fallacy)
A lot of times, people who leave the world of big corporations to start a small business think that those connections to the big business world are all they need. They claim that their Rolodex is full and their old contacts and clients love them. Therefore, there is no need to brand and sell their business—all they have to do is get their old contacts to follow them to their new, small business.

There is some truth to that line of reasoning. I had a friend who left a big corporation and took several of that corporation’s key clients with him to his new, small business. That worked quite well…for a short period of time. The problem was that after a couple of years, he had successfully met most of their needs. Suddenly, the business from those old clients stopped. Because he had not spent time branding his business and selling that brand, no new business was coming in. So when the old business stopped, he had no business at all, so he had to shut down his small firm and go back to being an employee in the big business world.

I call this the “full silo fallacy.” It would be like a farmer saying, “I have a large silo full of grain, so I can stop farming.” The problem is that eventually, either the farmer will use up all the grain in the silo or the grain in the silo will go bad. Either way, if the farmer stops farming, eventually he will run out of resources and go broke. Just as a farmer needs to keep farming to replenish the silo, a small business needs to brand itself and sell that brand in order to keep replenishing its sales.

A silo full of great connections from the big business world will not provide business forever. Here are some of the factors that can deplete that silo faster than you think. First, some of those friends who seemed to love you when you worked for that big company in reality may have only spent time with you as a way to get closer to that large company. Once you leave that big company, you become less valuable to them and they de-friend you. I saw this very thing happen to another friend of mine. A lot of his so-called friends were less likely to return his phone calls after he left the big firm. They only liked him for his connection to the big firm. Many did not follow him to his small firm.

Second, just as we saw before, it can be personally risky for an executive to recommend a small firm. Even if these contacts love you and want you to have the business, they may not feel they can take the personal risk. And even if they want to take the risk, they may not be able to convince their bosses to take the risk (even if they did not mind working with you when you were at the large company). And if you have not developed a strong brand to counteract this risk, you are even less likely to get this business.

Third, contacts don’t sit still. Many of them retire, switch industries, leave your area, or in other ways are no longer in a position to help you. If you have not developed any branding to transcend that personal friendship, you business with that company can evaporate when the contact leaves.

Fourth, many large businesses make their employees sign contracts preventing them from taking away clients when they leave. So even if the contacts want to move with you, you may be prevented from taking them by contract. And even if there is not a contract, the old company is going to fight back to keep those clients. They have a lot of resources at their disposal to keep a client from switching.

Finally, as we saw earlier, some relationships have natural endings. Your type of services may no longer be needed because: a) you finished the project; or b) the customer has evolved to the point where your type of services are no longer needed. Perhaps they became large enough to hire someone to do that work in-house. Perhaps they changed their strategic focus so that work is no longer necessary. In any case, the work can end, even if you were on very good terms with your contact.

Therefore, don’t put your hopes on a full silo. It may not be as full as you think and it may get depleted faster than you think. It is better to brand yourself, so that you are better able to replenish the silo.

2) I Just Have to get my Name out There (The push marketing fallacy)
In the old days, small business branding was little more than putting your name in the Yellow Pages of the phone book. The idea was that if I just get my name out there in the one place where people look for small businesses, I will be found.

Unfortunately, the internet has destroyed that old world. Customers get their information from a wide multitude of sources, including customer rating sites and company hate blogs. The power of the customer is making the old push marketing approach of “just getting your name out there” obsolete. It is now the world of pull marketing where you need to brand yourself so the customer will want to pull you into their world.

If you do not proactively create a positive brand for yourself in cyberspace, the people using the internet will create their own brand for you in the way they talk about you—and you might not like what they say. This is one reason why I was so disappointed with many of the web sites my friends had put up for their small businesses. They were not trying to control the conversation around how they were becoming branded.

SUMMARY
Just because you are a small company does not mean you can skip the tasks of strategic planning and branding for your company. In many ways, you need it more than the big guys, because your size makes you more vulnerable. And if you want to be a strategic planning consultant, it is even more important that you prove that you have done strategic planning for your own firm. If you cannot plan for yourself, why should I believe you can plan for me?

FINAL THOUGHTS
I was inspired to write this blog based on a suggestion from one of my readers. If you have some topics you would like me to cover, let me know.

Strategic Planning Analogy #330: Write a Complete Prescription

THE STORY
Suppose you were very sick and your doctor knew exactly what medicine would cure you. The doctor hands you bottle with a liquid in it and says, “The medicine in here will cure you. Well I’m busy and have to go see another patient, so good luck.”

After the doctor leaves, you look at the bottle. It has no label. There are no dosing instructions. Do I take a little? Do I take a lot? Do I swallow it or do I need a needle? How often do I take it? What about drug or food interactions? Do I take it with meals or on an empty stomach? Will it make me drowsy?

Now you become perplexed. If you take too little, it might not work and you might die. If you take too much, it might kill you as well. Other food and drug interactions could make the drug worthless or harmful. In other words, without additional information, this liquid, which has the potential to cure you, also has the potential to kill you.

THE ANALOGY
Strategies are often viewed as being like medicine—something to cure a sick company. Strategists are like the doctor who prescribes the right cure—the medicine to put the company on the path to prosperity.

Unfortunately, these strategists are often like the doctor in the story. After they prescribe the strategic medicine, they disappear. If they are consultants, they often move on quickly to their next patient at another company. If the strategist is internal, he or she moves on to the next strategic challenge. They don’t stick around long enough to get involved in the “mundane” work of execution, i.e., how to successfully implement the strategy they just handed you.

You can think of dosages (how much, how often, how ingested) as being like an execution plan (what do I do make the strategy a reality). You can think of drug interactions as being like how a strategy interacts with corporate culture (combine a strategy with the wrong culture and the strategy won’t work). Just as a drug can be worthless or dangerous when dosages and interactions are ignored, a strategy can be worthless if execution and cultural issues are ignored.

And just as you would not find it acceptable for a doctor to give you medicine without dosage and interaction information, don’t accept a strategic process which is separated from execution and cultural issues.

THE PRINCIPLE
Often times, we can fall into the “blame game” trap of trying to determine what is more important in business success—strategy, execution, or corporate culture. To me this is like arguing which is more important in a prescription—the medicine, the dosage, or the interaction information. All are important and they all need to be integrated.

All About Execution?
For those who think it is all about execution, I would say that is like someone who only focuses on dosage. Their approach is to put all the emphasis on getting the job done. Using the medical analogy, they would say, “If you just religiously take one tablet, twice a day, every day, all your problems will be over.”

Yes, getting the process down right and executing it every day is very important. If you never take your pills, you will never be cured. But what if you are taking the wrong medicine? Or what if you take pills randomly from an assortment in your medicine cabinet? Religiously taking one tablet, twice a day, every day then becomes meaningless at best, and deadly at worst.

Finding a way to run faster in the wrong direction doesn’t get you any closer to the finish line. Neither will taking a dosing instruction on the wrong drug get you closer to a cure.

I’ve worked with companies who were strategically adrift. They had no clue what medicine they should be taking. Many times, these firms were very, very busy. People were putting in long hours struggling to meet all kinds of execution expectations. In fact, these companies were so busy executing all sorts of random acts that they did not want to take time to sit back and figure out what their strategy should be. Unfortunately, because they were strategically adrift, all those actions were not helping them. Some of these very busy companies ended up going bankrupt.

As I saw in these companies, often times the problem is not about lack of dedication to execution, but in lack of focus (or the wrong focus). Given the right focus (based on a sound strategy), the activity becomes more productive.

Strategies tell you how to win in the marketplace. Without a good strategy, the only thing you can do is to try to out-hustle the other competitors who are also adrift. So perhaps, if execution is all you are relying on, it is a warning sign that you need to find a better strategy.

All About Culture?
There are others who put all of the emphasis on people and the corporate culture they work in. They would say that success is most dependent on building a healthy culture.

Yes, getting the culture right is very important. Doctors will tell you that a healthy lifestyle is very important—often more important than taking the right medicine. Almost any strategy is worthless when given to a company with a toxic culture.

But just having a healthy culture is not enough. Consider a healthy athlete who exercises well, eats the right food, and doesn’t abuse his body with tobacco or alcohol. Sounds useful, right? But what if he only sits on the bench and refuses to get into the game? That lack of execution makes the athlete not very useful. And what if the athlete doesn’t know the rules of the game or the strategy the team wants to use on the field? Lack of strategic insight will also make the athlete fairly useless.

Focusing on culture alone is not enough. It makes a great environment for success, but success won’t happen without execution or strategy.

All About Strategy?
There are others who put the emphasis on strategy. These people would say that if you position a company properly and point people in the right direction, everything else will take care of itself. But if strategy is all you are concerned with, you are no better than that doctor who handed off the medicine without any instructions. Unless I have instructions to know how to apply that cure, the cure is not very valuable.

Knowing what to do is not the same as knowing how to do it. For example, I may know that my strategic success is dependent upon being a leader in innovation, but that doesn’t mean that I know how to become an innovation leader. Strategy is only as useful as is actionable. Without the behavioral means, I will not achieve my strategic ends.

The Whole Prescription
We don’t argue about which part of the prescription is the most valuable—the medicine or the dosage or the drug interactions. We just see it all as just one thing—the prescription. If any of the parts are missing, the prescription is incomplete.

This is how we should approach our strategic process. Somewhere in the process we need to determine the strategic direction, the execution plan, and the cultural fit/health. And they all need to work together in harmony. If any part is missing, it should be seen as an incomplete process.

This is why strategists and strategy formulation should not be isolated from the rest of the process. Great strategies need to be appropriate to the context in which they will be executed. Unless strategy, execution and culture are addressed together, they will not work together.

THE SUMMARY
Success is a combination of having the right strategy, great execution, and a healthy culture. They are so intertwined that it is hard to separate them. As a result, our approach to achieving success needs to simultaneously incorporate all three.

FINAL THOUGHTS
If someone were to ask me which of these three is the most important to focus on, I’d say it depends on which one is the most broken. Since each company has different levels of brokenness, the answer would be different for each company. As they say, a chain is only as strong as its weakest link. So focus on the weak link, wherever it may be.

Let's Make This A Conversation

Over the last three years, I've been expressing my views on various issues related to strategy. Now, over 300 blogs later, I'm reaching out to all of you.

I want to know what strategy issues you'd like me to talk about. Send me suggestions of blog ideas you'd like me to tackle.

When I started this blog, I wanted to create more of a discussion, a dialog. So send me some comments about topics you'd like me cover.

Strategic Planning Analogy #329: Different Strategies

THE STORY
Early in my career, I was making a presentation in front of all the senior executives at a company. One of the items on the agenda was choosing the name for a new retail format. After my presentation of consumer research on store names, the CEO started off the discussion by saying he liked store names with the word “Mart” in them (like Wal-Mart or K Mart). His opinion had little to do with the research.

After that, we went around the room so that all the other senior executives could voice their preference. Almost without exception, every senior executive said that they also preferred names with “Mart” in them. Gee…what a coincidence that everyone liked what the CEO liked.

It was at this point in my career I learned that even though meetings can look like a democracy, they can really be a dictatorship. The CEO always got his way, so after that I spent all my time for future decisions focusing on persuading the CEO. I knew that if I got him on my side, the rest would follow like sheep.

THE ANALOGY
It usually doesn’t take people long to figure out who the key decision-makers are in a company. Once that’s figured out, those who want to get something approved focus their efforts on these key individuals. Like in the story, equal effort is not given to everyone. Disproportionate time is given to the executives who are most influential in the decision process. The “Yes-men” and the “Puppets” are basically ignored, as I started to do.

While this seems obvious and natural when working within a company, I have found that many forget this when working outside the company. Just as not all executives are created equal, not all customers are created equal. Some are worth a lot more than others.

Just as we don’t treat executives equally, we shouldn’t treat our customers equally. Our strategies should take into account the variation in customer power.

THE PRINCIPLE
The principle here is that a “one-size-fits-all” strategy should not be applied equally across all customers. Instead, different strategies (often radically different strategies) should be applied, depending on who the customer is.

Sure, a lot of you may say that you do some segmentation and treat some customers differently. But how radical are those differences in how you treat different customers? Are they as radically different as the customer base you serve? Consider the following data…

Not All Customers Are Equally Profitable
Back in 2001, Hax and Dean, in their book The Delta Project, said that on average, 35% of a company’s customers provide 146% of their profits. Worse yet, they found that about 65% of a typical company’s customers are unprofitable to serve.

A more recent study in 2005 by Deloitte Development LLC found something similar. Deloitte claimed that the top 20% of customers typically provide 175% of a company’s profits. The middle 60% of customers (as a group) were found to be breakeven, and the bottom 20% were unprofitable—often very unprofitable.

Although the figures between the two studies differ a bit, the conclusion is the same...over 100% of your profits come from a small sub-set of your customers. And if you are a typical business, a meaningful percentage of your company’s customers lose you a lot money. That’s a wide variation in customer contribution. Is your strategic approach as varied as your customer contribution?

And things are not getting better. Take, for example, the “freemium” business model used often on the internet. The freemium model works like this: The vast majority of the customers use the basic version on the internet, which is free. A very small subset pay money for a premium version. Virtually ALL the profits come from just those few people who buy the premium version. They need to pay the full weight of the costs for serving the vast majority, who use the product for free.

A good example of the freemium model is LinkedIn. The vast majority of those who use LinkedIn use the free basic version. It is only a small subset who pays for one of the premium versions—Business Version at $24.95 per month, Business Plus at $49.95 per month, and Pro Version at $499.95 per month.

As more and more of the economy moves to the internet—where many expect things to be free—more and more of a company’s profits will come from an even smaller number of customers. In fact, perhaps all the customers will be unprofitable and profits will only come from a small handful of advertisers. At this point, the advertising “customers” who DO NOT use your service (other than as a site to place an ad) may take on far more significance than those customers who use your service, but pay you nothing.

When this occurs, the people who use your product may almost cease to be customers in the traditional sense and instead be seen more as “inventory” to sell to advertisers.

Technology to the Rescue
The good news is that data management technology is getting pretty good at helping out in this process. The data management tools can help us do two things. First, they can help us discover the differences in individual customers. Second, they can help us provide a different strategic approach based on those differences.

Kroger gives a lot of credit for its recent success to Dunnhumby, its technology partner. Dunnhumby helps Kroger understand its customers at a more individualized level, providing insights that create different strategic approaches to its grocery customers.

It’s a different strategic approach than getting a few executives together for an annual off-site strategy meeting. Instead, it involves a room of around 200 Dunnhumby employees (many with statistics PhD’s) working every day, sifting through something like 300 terabytes of data representing 40 billion purchases made during 4 billion shopping trips by 42 million card-carrying Kroger shoppers.

Other Approaches
Not all strategic approaches need to be this data intense. Sometimes, it only takes a little bit of digging to find the key factors that make a customer highly profitable or highly unprofitable. In the freemium model, it is really easy to see who the more profitable customers are—it’s the ones who buy the premium service.

Once you segregate the customers, you can apply different strategic approaches. One can apply a more intensive strategy to appeal to the highly profitable segment, because it will pay off well. Then one can use a lower cost approach on the rest. More value (that is more customized) can be offered to the ones who pay the bills.

Keep in mind, that just because a customer is unprofitable does not mean that they should be encouraged to go away. They can still have value. For example…

1) If all the free LinkedIn customers went away, the product would be far less valuable to the premium customers. Without the free customers, there would be no reason for those premium customers to come to you.

2) Some customers may be unprofitable today, but have high potential later when their situation changes.

3) Even if a customer is unprofitable in total, as long as you can cover your variable cost serving them and make at least some contribution to the fixed cost, they are helping subsidize your business so that you can better serve your best customers.

4) If your model is based on advertising, more money-losing customers can result in more advertising income.

5) In the race to become known as a leader in a category, it helps to have lots of buzz about your brand. The additional positive buzz from unprofitable customers may be the difference between getting to #1 and ceasing to exist.

6) You may lose money giving away samples to key influencers (like mommy bloggers or celebrities), but if they like your product, they will influence a lot of profitable customers to patronize you. Like decision influencers in the office, these people are worth a lot of time to cultivate favor.

So don’t always try to get rid of the money-losers. Instead, use them to your advantage. Also, look for ways to make them less unprofitable—either by using a lower cost-to-serve model with them or by converting them to more profitable behavior. For example, when a profitable customer calls the company, they can get instant personalized service, but unprofitable customers are put at the back of the queue on an automated phone service.

The important thing is that you cannot do any of these strategic options if you do not understand how your customers are different and how that difference impacts profitability.

SUMMARY
Customers do not behave the same. Some behave in a way that is very profitable. Others behave in ways that are very unprofitable. These different customer types may require different strategies in order to optimize results. The smarter you are at understanding this (their behaviors, your costs), the better strategic decisions you will make. Recent advances in data management are making this easier and more desirable.

FINAL THOUGHTS
If your strategic approaches become too drastic in their variety, one may need a portfolio of brands in order to deliver the variety of options without destroying a particular brand image.