Strategic Planning Analogy #453: What Are You Really Selling?

THE STORY
A few days ago, I wanted to get an idea of what I might save if I changed my insurance.  I went to a web site to get a FREE estimate.  All it asked was a small handful of questions.  Then I hit the “submit” button.

Almost immediately after hitting that button, my phone started ringing.  It was someone offering to talk to me about insurance.  At first, I thought that was an odd coincidence, since the insurance company which called was representing a different company than the one on the internet.  While I was talking to this new company on the phone, I got three messages on my phone saying that three other insurance companies were also trying to contact me. 

For the next four days, my phone rang virtually non-stop from dozens upon dozens upon dozens of insurance companies eager to talk to me about my insurance.  It was a nightmare that wouldn’t stop.

I soon realized that I did not receive a FREE service from that internet site.  I paid dearly with time and aggravation.  

I also began to realize that I had never really been a “customer” for that web site.  No, I was the “product.”  They were trying to sell me like a slave to all of these bidding insurance companies. 

Just before hitting that “submit” button, I did not see anything in the fine print saying I agreed to sell my soul to that company (for no charge) nor that I agreed they could re-sell me like a slave in a bidding auction.

And then, after all that aggravation, I decided that my current insurance was a better deal and did not switch to any of those companies.

THE ANALOGY

In the story, I was initially confused about what was the product and who was the customer.  At first, I thought that I was the customer and the insurance was the product.  As it turned out, I was the product and competing insurance companies bidding for me were the customer.   

A similar confusion can happen when designing strategic business plans.  A successful business plan sells a product (or service) to a customer.  And hopefully, the cost to the business of obtaining or manufacturing/producing that product is less than the price the customer is willing to pay for it, so that you can make a profit.

As we will see in this blog, there are a lot of choices one can make regarding products and customers.  And the most obvious choices might not be the most profitable choices.  Therefore, careful consideration needs to be given to these choices.  It should be an important part in the development of one’s strategy.

In addition, if you are not clear in your business plan as to what is the product and who is the customer, you may create confusion within your organization.  People could focus on producing the wrong thing for the wrong person.  The confusion could create inefficiencies and reduce the profitability of the business model.

 

THE PRINCIPLE
The principle here is that depending upon how you define the customer and the product, you’ll come up with a different strategy.  And if you want an innovative new strategy, consider less-conventional definitions of products and customers.

1) Selling Slaves

Usually, we think of the people we are appealing to (or advertising to) as the customer.  However, as we saw in the story, you can also look upon these people as the product you are selling.

There’s a popular saying that goes something like this: “If the customer is not paying, then they are not really the customer—they are merely the product being sold to the one who is really paying.”

There could be many options for the real customers who are bidding for your “human slave” product.

a) Insurance Companies – In the story, we saw insurance companies as the real customer.  But here’s another example.  Ever see those commercials on TV where lawyers offer to represent you for free if you suffered from something where a lawyer can successfully sue for damages?  You are not the customer.  You are product, being “sold” to the insurance company on the hook to pay damages. 

b) Government – Governments hand out all sorts of money for things like health care, aid to the poor, help for the disadvantaged, etc.  There are plenty of opportunities to represent people in order to tap into government funds.  The people are the product you are selling to the government.  For example, consider all of those TV advertisements for medical devices and supplies.  The commercial says that this stuff is FREE to you, provided you are on government medical assistance.  Another example is commercial universities which aggressively manufacture students in order to tap government student loan assistance.

 
c) Advertisers – Advertisers are buying exposure to their ads.  That exposure is to people, so what they are really buying are people.  Therefore, the media are not really selling their media as much as they are selling the people they attract to the media.  So much of the internet business models are based on giving their content away for free in order to attract other sources of income, like advertising.  When you use these internet sites, you are the product being sold, like when Google sells you in order to get paid ads on their search page.  When internet companies talk about monetizing their sites, what they are really saying is that they are looking for more ways to sell you to more people.

d) Investors - For a lot of start-up companies, the original proposal is not the same as what eventually ends up being the business model.  The service can change and the target market can change.  Knowing this, start-ups understand that the real customer is the investor in the start-up.  The people lured to the start-up are merely the product.  The real selling pitch is to the investment community, because they are the only one paying the bills in the start-up phase.  If the investor wants something else, you change the model to please them, because they are the customer.

Using your imagination, I’m sure you can think of a lot of additional customer types which differ from the users (like parents for children’s products, large employers for daycare centers, future acquirers for small start-ups, etc.).

2) Manufacturing the Right Kind of Slaves

If people are merely slaves to be sold in your business model, then you need to think about them differently.  You are in the business of manufacturing people.  Therefore, you need to think of them in the same way other manufacturers think about their product.

When developing a manufacturing a process, a manufacturer must consider several things, including the QUALITY of the product (% of defects), the APPROPRIATENESS of the product (is it what the customer really desires), the FUNCTIONALITY of the product (does it deliver on the desired features), and the PRICE of the product (can you manufacture it cheaply enough).

So, if you’re selling people, you need to consider these same things about your people-manufacturing model.  It’s not just about gathering lots of people.  They need to be the right people (with the right quality, appropriateness, functionality and price).  And what is “right” depends on the people who are paying the bills (your real customer). 

That’s why it’s so important to clearly define the real customer.  Otherwise you won’t know what they want so you won’t manufacture the right kind of people.

Think about Disney.  One of the most important products Disney creates are people who pay to surround themselves (or someone they love) with manifestations of an icon.  In other words, their best product is someone who would buy everything associated with one of their icons, like Buzz Lightyear.  These are the people who buy all the Buzz Lightyear videos, toys, games, dolls, amusement park rides, posters, pajamas, sheets, underwear, and whatever else the image of Buzz Lightyear is on.  Disney sells this person to all of its divisions as well as to any business who wants to license the icon.

Therefore, the manufacturing of an icon lover goes something like this.  First you create an icon.  Then you create a way to get people to fall in love with the icon (like a movie).  Next, you create all the tie-ins to all the ways for this icon lover person/product to be valuable to others.  Then you sell this person to them, principally through licensing fees.

Therefore, Disney’s goal is not just to have a movie which draws a lot of people.  It has to be the right kind of people—icon lovers.  That’s why the movies are designed to create lovable icons more than to create great entertainment.  Those creating the movie have to understand that in order efficiently manufacture the right kind of movie-goers.

Internet sites need to see themselves in a similar fashion.  The goal is not just to attract a lot of eyeballs.  They need to be eyeballs specifically manufactured to appeal to someone who wants to buy those kinds of eyeballs.    And you cannot do this if you don’t specifically plan the whole thing as seamless manufacturing process.   

And if you want to justify your marketing effort to manufacture that person, use the same type of criteria used to justify efficient manufacturing.  Is it the right type of product and is it produced at a lower cost than you can sell it to others for?

SUMMARY
The real customer is the one who gives you the money.  And in many business models, these customers give you the money in order to access the people you have accumulated.  To optimize this model, one needs to clearly identify the real customer and then find the most efficient way to manufacture the type of people these customers specifically want. 

FINAL THOUGHTS
This is a two-step strategy.  First you manufacture something to lure the right type of people.  Then you package these people so that they are the most desirable to the people who will pay for them.  In the end, that insurance web site didn’t care if I was made happy (which I wasn’t).  What they wanted was to make those other insurance sellers happy, because they were the customer.  I was merely the second stage of their manufacturing process.

Strategic Planning Analogy #406: Reference Points

THE STORY
Recently, I was watching an old movie from 1992 on DVD, called “The Player.” The movie is about a guy who works at a movie studio. His job is to listen to writers pitch ideas for new movies. He hears thousands of pitches each year.

Because he has to listen to so many movie ideas in such a short time, he keeps telling the writers to limit their pitch to 25 or fewer words. Well, it’s hard to describe an entire movie in only 25 words, so the writers use short-cuts. Since everybody in the movie industry knows about all the prior movie hits, the writers explain their plots by referring to the other movies it is similar to.

A common approach used in the movie (and in real life) is for the writer to pick a couple of movies the new movie is like (we’ll call them “Movie X” and “Movie Y”) and then pitch their new idea as “Movie X meets Movie Y.”

Of course, the movie exaggerated the absurdity if you try to combine too many concepts.

In the move, a studio executive is trying to summarize a crazy, convoluted movie idea he’s hearing by saying, “So it's a psychic, political, thriller comedy with a heart.”

The writer agrees, saying, “With a heart, not unlike Ghost meets Manchurian Candidate.”

Not all possible movie combinations should be combined.

THE ANALOGY
Just as movies don’t get made unless they are successfully pitched to studio executives, strategies don’t come to life unless they are successfully pitched to management. And just like the movie studios, the business executives you are trying to pitch to are very busy. If you cannot crystallize the essence of the strategy in 25 words or less, the executives may never take the time to grasp what you are talking about.

Therefore, if you want to get your strategy implemented, you need to think and act like those writers trying to get a movie made. You need to use short-cuts—reference points with which your audience is familiar. For example, you could describe your strategy as being like “Competitor X meets Competitor Y,” implying that you want an assortment strategy like company X but add to it the service levels of competitor Y. This short-cut helps management quickly understand what you’re trying to do—in a way that they can easily visualize. And if they like what they see, it is easier for them to implement the plan, because they have those reference points to fall back on.

THE PRINCIPLE
The principle here has to do with reference points. The idea is that reference points can be a strategist’s best friend AND their worst enemy. Therefore, they must be used carefully.

The Benefits of Reference Points
We’ve already talked about many of the benefits of using reference points when pitching a strategy. It speeds the process, it makes it easier for the audience to understand, and it makes it easier for the audience to implement. These benefits occur because reference point help take an abstract concept more tangible.

For example, Zapmeals had an idea to try to get quality food quickly into the hands of people who didn’t want to waste time sitting in a fancy restaurant. Their idea was to use the internet to connect local chefs (who can provide the great meals) with local people (who want the great meals). To pitch the idea, they used a reference point of a success people were aware of: “eBay for takeout orders.”

The Dangers of Reference Points
Although there are many benefits to the use of reference points, there are also many dangers. Reference points refer to what the audience knows. And what the audience knows is what already exists. It is impossible to become an innovative leader if all you are doing is copying what already exists in the industry.

As a result, reference points can keep one locked into minor variations of the status quo, if used improperly. This is particularly true if all of your reference points come from within the industry.

In the worst case scenario, competitors start clustering around the current winning strategies in the industry, because that is the common reference point for success. With all that competition fighting for the same spot, a brutal war for market share will develop. There will be a race for the bottom as everyone cuts prices to gain share. In the end, all will fail.

For example, I knew of a retailer who described his company’s strategy as being like Company X, a direct competitor. I asked him how he planned to differentiate himself that retailer. He really didn’t have an answer. He just saw a successful competitor and wanted to emulate it. The problem was that this competitor already strongly owned that position and there was no way he was going to be able to take the position away from them. Therefore, his reference point was going to make him an inferior imitation—not a formula for success.

Great strategies tend to create business in a space that in currently unoccupied. You won’t find unoccupied spaces if you look for reference points among companies that already occupy a space.

There’s a reason why one finds very few original movies. They all tend to look like other movies you’ve seen before, because the reference points when they were pitched were movies you have already seen before.

Solution: Borrow from Other Industries
To get around this problem, one needs to use reference points which come from outside the industry. That way, you get the benefits of a reference point without all the problems which come from copying what is already in the industry.

As Clayton Christensen has pointed out in the Innovator’s Dilemma, most great new innovations tend to come from people who are outsiders to the industry. They are not trapped by conventional industry reference points, so they can come up with something entirely original.

You can do the same, by searching for reference points outside your industry. For example, I was speaking to someone in the banking industry who was using retailers like convenience stores as a reference point. He liked the way mass oriented retail stores created impulse sales through effective signing and display endcaps. He liked the way they could sell a lot through minimal service by creating self-service. He liked the way customers felt comfortable in a convenience store instead of the uncomfortableness people felt in a bank. He wanted to replace those scary desks in a bank with friendly aisles full of financial packages. In other words, he wanted to be “the 7-Eleven of banking.”

So, spend some time looking beyond the walls of your industry. Think about how others do their business. Look for principles you can transfer to your industry.

The idea here is to look for successes in areas totally unrelated to your industry and envision what would happen if you applied their success formula to your industry. It may turn out that a full space in one industry is actually an open space in your industry.

It is so difficult to get management to embrace a strategy in a space that is empty (they say “if it is so good, why is the space empty?”). Therefore, if you can point to tangible examples of other industries where that position is very successful, you have a better shot of selling the idea.

SUMMARY
Great strategies need to be sold before they can be implemented. And it is easier to sell the idea if you can relate it to a concept the audience already understands (a reference point). The trick is to look for comparison insight outside your core industry. Otherwise, you will end up just copying one of your competitors and become a weak imitation.

FINAL THOUGHTS
With over 400 of these blogs, I have shown how easy it is to understand complex strategic principles by finding analogies in unrelated fields. This same approach can be used to sell your strategy. Find a great analogy and then your selling process will be a lot easier.

Strategic Planning Analogy #325: We’re All Greece

THE STORY
Greece has a problem. For years, Greece has been very generous in its benefits to its citizens, especially those employed by the government. And, for years, Greece has been generously spending this money at a far greater rate than its income. The generosity is has come from borrowed money.

The turning point came this year when those loaning the money said they had had enough. They did not want to fund this generosity anymore because they didn’t see a path to getting their money back.

Greece was forced into a corner. The only way to fix the debt was to have austerity measures imposed from the outside lenders. The Greek citizens, used to the government generosity, rioted in protest. They still demanded the generosity.

And now it looks like Greece may just be the first in a wave of other countries who have followed the same path. What’s a leader to do?

THE ANALOGY
When you live beyond your means for a long period of time, it becomes a habitual pattern. Those living this pattern come to define it as “normal” behavior—at least normal to them. There is not much incentive for change. After all, it has “worked” for a long time.

The problem is that eventually one has to pay back that borrowed money. Even if the time span for living beyond your means is long, eventually the time will run out. The creditors will eventually demand payment for all those loans—money which these people do not have. Then it becomes really messy, because the people who think living beyond their means is normal have no desire to adapt to living within their means, let alone live in austerity in order to pay for their past.

This is not just a problem for Greece. This is a problem for most businesses today. For example, the internet economy has created a world where most people expect to get almost anything digital for free. That sounds a lot like living beyond our means.

Meanwhile, back in the “old” economy, a lot of companies severely slashed prices during the great recession. Customers have gotten used to the low prices, which are viewed as the new normal. Although a lot of firms want to raise those prices back up in the latter half of this year, I think people will resist, similar to the riots of the Greeks (although not as emotionally or violently).

Many parts of the business world have followed the pattern of the Greek government—generously giving value to its customers at a non-sustainable rate. Eventually, someone will have to pay for all this.

Just as Greece is an early warning country of problems to eventually turn up in other countries, there are business industries that are early warnings of problems for other industries. The news and entertainment media are an early warning area, a lot like Greece.

The digital economy has trained many people to expect news to be free. New media were borrowing news from the old media and redistributing it for free. If you can get news from the new media for free, why pay for the old media? As a result, newspapers are disappearing all over the place. Last week, Newsweek magazine was put up for sale and it looks like nobody will buy it (who wants a property that loses millions of dollars a year?).

The problem is this: what will the new media distribute for free when there is nothing left from the old media to borrow? If you can no longer borrow the news, you will have to get it on your own. And then you can no longer afford to be free. But if free is the new normal, customers will rebel when you start charging them what the news is worth. Substitute the words “money” or “government benefits” for the word “news” and it sounds a lot like Greece.

THE PRINCIPLE
The principle here is about sustainability. I’m not talking about business sustainability the way the media typically uses the term. They are looking at ecological issues like carbon footprints. I’m talking about sustainability in terms of value—giving value in proportion to what the market is willing to support. If the cost required to provide the value you give exceeds what people are willing to pay, your business is ultimately not sustainable. You are living beyond your means.

Consider the value menus at the fast food restaurants. Many of those items are sold well below cost. They have created a new “normal,” where people expect food to be priced below cost (like the Greeks expecting government benefits that the government cannot afford to give). Why pay full price for a Big Mac when you can get all that beef off the value menu for a lot less?

The restaurants are in a bind. Either you have to:

a) Put the value menu on an austerity program (shrink the burgers, take off the cheese) to the point where it is no longer a value;
b) Raise the price of the value menu (which destroys the value); or
c) Hope that there are enough high margin non-value menu orders to subsidize the value menu orders.

The same problem exists in the airline industry. People are used to buying airline tickets at a value that the airlines cannot afford to give (unsustainable). Therefore, the airlines are scrambling to find other way to get money, like charging for baggage, food, and now even toilets. They’re putting more advertising in the planes and getting other firms to subsidize the frequent flyer points programs. Getting others to pay…hmmm…sound a bit like Greece?

Big airline mergers, like United and Continental, are hoped to cut costs to pay for the unsustainable current ticket price business model. Unfortunately, the traditional airlines have tended over the years to treat many of their employees similar to how Greece treated its employees, with high benefits. Therefore, there may be less benefits to consolidation than one thinks, especially if workers (and work rules) cannot be touched.

Then there is the digital world. Facebook is huge, with about 500 million users. Some think an IPO of Facebook could fetch as much as $20 billion. Yet, it is only now starting to reach the point where it may be approaching profitability. And profitability does not mean it has a cash flow that can pay back all the investment from the early years in setting up the servers to run this thing.

Right now, Facebook is free to its customers. No wonder so many people like it. Awhile back, an idea was floated to perhaps charge a small monthly amount to its customers. The negative reaction from the customer base was huge. Many threatened retaliation (like the Greek riots?) and would quickly move to one of the other still-free sites. Ironically, one of the popular pages on Facebook is a page devoted to people against having Facebook charge a fee. And these Facebook customers do not want a lot of advertisements on the site, either (and many advertisers have not found it to be a particularly effective place to do advertising)..

And what about Twitter? It is loved by many (after all, it is free), yet there is no sustainable business model to support it (nor is one proposed for the future). Is this another Greece in the making?

Given this problem of sustainability, what should a strategist do?

1) Consider Sustainability In the Beginning
How you set up the original business model helps determine how people define “normal.” If you start off with an unsustainable model, unsustainable practices are expected forever. It is hard to later add the austerity program needed to sustain the business.

Way back in 1923, Claude Hopkins wrote the classic book Scientific Advertising. In this book, he explains why he invented couponing for new product introductions. He said if you originally introduce a new product at a discounted price or give away samples for free, you are building expectations that the product should be discounted or free. But if you sell it from the beginning at full price (and customers pay for part of the full price with the coupon), customers will accept the full (sustainable) price in the future. This is why the Wall Street Journal started its web site as one you pay for. They wanted people to expect a sustainable model.

2) Give High Priority to an Effective Business Model
It’s great to have an offering that people want. But if you lose money on every sale, then you have a non-sustainable business. Make sure your business model has a path to sustainability. As CK Prahalad speaks about in his campaign for The Fortune at the Bottom of the Pyramid, you can get items profitably priced low enough so that even the poor can afford it (and be sustainable) if you start with this premise at the point when you design the business model.

3) Look for Subsidies
If your customers are not willing to pay enough to sustain the business, make sure you put into your strategic plan additional sources to subsidize the cash flow. That could be subsidies from governments (like for building cleaner technology), or subsidies from advertising, or partnering with complementary businesses, and so on.

In essence, you need to think of these subsidizers as another one of your customers—someone you need to serve well in order to get their subsidy business. If this is not fully thought out in the plan, you will not optimize the subsidy potential.

4) Consider Selling Out Before the Debt Comes Due
If you find it hard to create long-term sustainability, then perhaps the best strategy is build into your plan a way to cash out early. Most business value is created at the point in time in which a company changes hands. Often, the seller achieves the most value, particularly if they proactively time when the company changes hands. If you know the creditors are coming, and you are in a unsustainable debt position like Greece, sell out before others realize what’s coming.

Market bubbles are unsustainable. Sell before the market bursts. Better yet, proactively build your business model so that it is easier to sell (and more desirable) to the type of people who might eventually buy it before the burst. In essence, these potential buyers of the entire company become the true customers of your business strategy (we spoke more about this idea here, here, and here).

SUMMARY
Unsustainable businesses eventually die. To avoid this, make sustainability a key part of your strategic planning, particularly when designing the business model for a new concept. And if that doesn’t work, plan to sell before the debt comes due. Otherwise, you may end up like Greece.

FINAL THOUGHTS
All strategies eventually die. Even once highly sustainable business models, like newspapers, can fall apart if the environment changes enough. That’s why we need to go back and challenge our assumptions every once in a while, to make sure the model is still relevant and sustainable...and if it isn’t, change the model.

Analogy #230: And the Contents are Free

THE STORY

During one of the long garbage worker strikes in New York City, one man had an ingenious idea. 

 

Every day during the garbage strike, he would put his trash into a box.  Then he would wrap the box up in wrapping paper—just like a birthday present, complete with a bow.  He would put the box in plain sight on the front seat of his car, and leave it there after driving to work.  In addition, he left his car door unlocked.

 

When the work day was over, he would go back to his car, and sure enough, every day that box was gone—it had been stolen.  As a result, the man was able to get rid of his undesirable garbage every day—for free. 

 

THE ANALOGY

During this current economic crisis, people have cut back on their spending.  What we sell has become less desired.  Sometimes it feels as if we are trying to get them to buy undesirable garbage.

 

In the story, the man got rid of his undesirable garbage by hiding it inside something which appeared more desirable—a gift.  In other words, instead of trying to get people to take something they didn't want (trash), he offered something people desired (a gift) and threw in the trash for free.

 

This same principle can work in business.  Rather than trying to sell what people do not want, sell them what they do want (even if it is just an illusion) and throw your product in for free.

 

THE PRINCIPLE

The principle here is that there is a difference between "stuff" and "status."  Stuff is what you make—goods and services.  Status is what people desire—an enhanced sense of self-worth.  People want to buy status and you want to sell stuff.  Therefore, success comes when you can hide your undesirable stuff inside a pretty box of status.

 

To a large extent, it really doesn't matter what stuff is inside the box.  So long as it is packaged inside a status box, people will want it.  If the box is pretty enough, they will even take your garbage.

 

Take transportation, for example.  It used to be that status came from owning the newest, biggest, most powerful, most gadget-laden SUV on the block.  People abandoned cars and bought SUVs in droves, even though none of them ever planned to take these cars off-road.  They really didn't want the SUVs, per se.  They wanted the status which came with the SUV.

 

Now, the SUVs are positioned as wasteful, earth-hating, gas guzzling, obnoxious vehicles.   Their status is gone.  The new status symbol is the earth-friendly, responsible, fuel-efficient Hybrid car.  So people are buying the Prius in droves.  Again, a lot of people buying the Prius really don't want a Hybrid.  They want the status which comes with owning the Prius.

 

So the idea here is stop focusing on how to sell your stuff and instead create a strategy which places your stuff inside a desirable box of status.  Think of it this way:  What if you had to put the price tag on the box and treated the contents as if they were free?

 

I worked on a project like this for an upscale consumer electronics retailer.  This retailer saw itself as in the business of selling stuff—items like televisions, speakers, and amplifiers.  We told them they would be better off seeing themselves as selling a status laden in-home entertainment experience.  The idea was to reposition them as experts in designing the home entertainment room that would make customers the envy of the neighborhood. 

 

Sure, they would still be putting televisions, speakers and amplifiers into your home.  But for all intents and purposes, that "stuff" was being given to the customer for free.  What the customer was really paying for was the status of having home entertainment experts designing the perfect home entertainment option for them.

 

In today's economic environment, the accumulation of more stuff appears to be out of favor.  Frugality is the new chic lifestyle.  Trying to get people to open up those wallets and pocketbooks just to get more stuff will be a tough sell.  The better idea is to sell the box of the new "Frugal Chic" and give them the stuff inside for free.

 

According to Marian Salzman, partner at public relations firm Porter Novelli, "We all have enough stuff; it's not where our heads are anymore.  We're going to value a lot of other things."

 

Therefore, position your brand as something that imbues those other things being valued—the current attributes of status, such as "earth-friendly" or a wise use of resources.  Then sell those attributes rather than trying to sell the stuff.  Treat the stuff as being thrown in for free.

 

For example, look at Apple.  Their successful commercials in the US for the Mac never really mention anything about the computer itself.  The stuff of the Mac is ignored.  Instead the commercials focus on the enhanced status of being associated with Apple.  They're selling the status box and throwing in the computer for free.

 

Almost anything can be put into the box, provided the box is desirable (even garbage).  Link your stuff to the best box, and the customers will pick your box.  Remember, your competition is not other firms selling the same kind of stuff.  Your competition is anyone putting stuff into the same kind of box.

 

Your competition could be a computer, a car, a vacation, food, clothing, or whatever.  All can be positioned as being the most "frugal chic."  The money will flow to the one who wins the "battle of the box"—the one most linked to the current status, regardless of the contents.

 

SUMMARY

The problem today is trying to sell stuff in a post-stuff environment, a time when conspicuous consumption is out and frugality is in.  The solution is to quit selling the stuff and focus on the current definition of status.  Sell the status and throw in the stuff for free.

 

FINAL THOUGHTS

At Christmas time, it is not unusual for parents to buy their child an expensive toy, only to find the child more interested in playing with the box than the toy that was inside the box.  We adults can be the same.  We can be more interested in the status box than the stuff inside the box.  Pay attention to your packaging.

Analogy #217: Hot Potato

THE STORY
There’s a children’s game we played when I was young called “Hot Potato.” Although there are lots of versions of the game, it goes something like this:

First children stand, facing each other, in a circle. They have a small ball, which is called the potato. The ball is tossed around as if it is a hot potato—as soon as you catch it you quickly toss it to someone else in the circle so that it won’t (theoretically) “burn” your hand.

All the while you are tossing the ball around, someone else is keeping track of the time. When the allotted time is over, the timer yells “STOP!” Whoever has the hot potato in their hand when the time stops loses and has to leave the circle.

THE ANALOGY
A lot of business strategies rely on the tactic of buying or selling companies/divisions. In these transactions, assets change hands from one owner to another. It’s sort of like the game of hot potato. Property ownership gets tossed around from firm to firm, just like that ball gets tossed around with the children.

One time when asset tossing is particularly frequent is when the growth phase of an industry is long over and an industry is well into maturity or is starting to decline. The lack of growth creates a period of consolidation. At this point, a firm typically decides to either “get out” or “double-down.”

The ones who want to get out toss their assets away, as if it is a hot potato. The ones who want to double-down collect all of potatoes that the others are tossing out.

Just as in the game of hot potato, eventually the time for consolidation stops. In the game, whoever is holding the “potato” when the time ends loses the round. My observation is that more often than not, the company holding all the assets when the consolidation phase ends also tends to be a loser.

In this blog, we will see why.

THE PRINCIPLE
The principle here is that during consolidation, the company that is doing the consolidating more often than not creates less value than the one who is exiting the business. In fact, the consolidator often ends up destroying value.

Although not directly applicable, you could see some of this principle at work in the dotcom bubble. There were a lot of young college dropouts who started up all kinds of businesses. Eventually, big companies wanted to get in on the action, so they started buying up a bunch of these dotcom startups, with the hope of creating something great out the accumulation of many dotcom assets.

After the consolidation phase ended, businesses realized those assets were purchased at bubble-sized prices. After the bubble burst, the consolidators found they were holding onto fairly worthless assets, while the ones who sold out were sitting on piles of wealth beyond belief. The ones holding the hot potato when the bubble burst lost.

Now you may argue that this was not a true consolidation phase and that bubbles are not the norm. That may be true, but the principle still holds true. It just may take a little longer to see the results.

The rationale for doubling down during the consolidation phase tends to go as follows:

1) There are economies of scale on the cost side in becoming large.
The logic is that if I buy up the assets from others and combine them with mine, I can create a ton of synergies and eliminate a boatload of duplications and waste. For example, in the recent talks to combine Chrysler and GM, there are estimates that the economies of scale could possibly cut out $10 billion in costs.

2) There are top-line sales benefits if the number of competitors are reduced.
There’s a reason why governments tend to discourage monopolies or near monopolies. They believe that if too much power is placed in the hands of too few companies, prices will go up, hurting the consumer, and putting excessive profits in the hands of the remaining firms. Although a company would not admit this is true (in order to get the deal approved by the government), there is a belief that being a large player with fewer competitors is helpful in the fight for sales and profits in a no-growth industry.

Unfortunately, reality tends to makes these two points less powerful than they at first appear. Instead, what occurs is the following:

1) The consolidator overpays for the companies it purchases.
In today’s sophisticated environment, it is highly unlikely that one can acquire a business at a lowball price (the current situation with the valuation of banks and other financial institutions notwithstanding). Everyone knows all the tricks in how to valuate companies (or can hire someone who does). Therefore, one typically has to pay a fairly high price to consolidate the market. In other words, in the purchase price, the consolidator has to pay the other company a portion of the expected synergies in order to get a deal done. So the seller gets part of the benefits of the synergies without taking any of the risk.

2) The economies of scale are less than expected.
Although people may argue about the cause, the raw fact is that business plans tend to overstate the economies of scale—both in the amount and in how soon they will occur. As a result, most of the remaining synergies are too small to cover the premium price paid. And you probably gave that amount away to the seller when you overpaid.

3) Not all of the Sales Stick
There is a reason why some customers preferred doing business with your competitor rather than with you. For some reason, a certain percentage of the market preferred not to do business with you and chose the competitor in order to avoid doing business with you. When you buy that competitor, you are buying a customer list which includes people who have been avoiding you. They may continue to want to avoid you and defect to another firm once you make the acquisition. Therefore, there are usually top-line dis-synergies in an acquisition, causing your combined sales to be less than the sum of what each firm did separately.

4) The integration of the assets is harder than one thinks.
Pride, differing cultures, different IT systems, key employee defections, and other such factors often make integration of companies slower and more costly than anticipated. All those expected synergies come up short. You save less than you think.

5) The market shrinks faster than one thinks
The reason why industries stop growing is not because people stop spending. Typically, what happens is that another industry provides a superior solution and the growth moves to the superior solution. People didn’t stop buying photographic film because they stopped taking pictures. In reality, people are taking more pictures now than ever before. They just found digital photography to be a superior solution.

The problem in declining industries is that the consolidators tend to underestimate the growth of the new industry that is providing the superior solution, in part because they do not understand the new solution. In addition, they may not see how interconnected their old solution is to the new solution and not realize how the growth of the new is at the expense of the old. Kodak terribly underestimated the digital world, because it was not their world. They could not imagine cell phones replacing cameras.

Macy’s spent a fortune to consolidate the department store industry in the US. Unfortunately, many people have found superior solutions to the department store, such as the lower priced Kohl’s chain or in high-end specialty formats, like Williams Sonoma. In addition, apparel, the core of the department store, is not as hot a category as it used to be. The greater growth has been in areas like consumer electronics, which diverts money away from apparel into stores like Best Buy.

As I’ve mentioned many times before, study after study has shown that most acquisitions end up destroying value for the acquirer. A successful consolidation strategy usually depends upon making a series of acquisitions. Just getting one right is difficult. The likelihood that all will work is slim. That’s why the seller usually does better than the buyer.

So what is the solution?

1. Consider selling out early, while you can still get top dollar for your business. For more on this, see my blog “We Can All Act Like Sports Franchise Owners.”

2. If you still want to be the consolidator, make doing good acquisitions your core competency. Cisco succeeded in consolidation because they took the time to become world class at acquisitions. That became a big part of their value-added vision.

3. Discover early what superior solution is taking the growth out of your industry and shift to that superior solution. In other words, continue to be a growth company even through your industry is may not be by moving to where the growth is. Fuji saw that photographic growth was moving to digital and they rushed into the digital void early to stake out a position and sustain growth. Dayton Hudson saw that discount stores were growing at the expense of department stores, so they sold out of many of their department store divisions early and put the money into the faster growing Target chain.

SUMMARY
Becoming a consolidator can be an alluring strategy. You get to become the big fish in the shrinking pond. It strokes the ego to buy out those hated competitors and become the last big survivor. By contrast, selling out to the consolidator can look like defeat. However, the reality is that selling out is often the strategy which creates the greatest value, while the consolidator destroys value.

FINAL THOUGHTS
Remember the moral of the hot potato—if you hold on to it too long, you will burn your hand.

Be Like Tom

THE STORY
I’m sure you all know the story of Tam Sawyer and how he convinced others to paint the fence for him. However, I’ll bet it’s been awhile since you heard in Mark Twain’s words. We’ll pick up the story where Tom just about has Ben convinced to beg for the opportunity to paint the fence, when Ben pleads:

”Oh, come now - lemme try. Only just a little - I’d let you, if you was me, Tom.”

“Ben, I’d like to, honest injun; but Aunt Polly - well, Jim wanted to do it, but she wouldn’t let him; Sid wanted to do it, and she wouldn’t let Sid. Now, don’t you see how I’m fixed? If you was to tackle this fence and anything was to happen to it --”

“Oh, shucks, I’ll be just as careful. Now lemme try. Say - I’ll give you the core of my apple.”

“Well, here - No, Ben, no you don’t. I’m afeared --”

“I’ll give you all of it!”

Tom gave up the brush with reluctance in his face, but alacrity in his heart. And while the late steamer Big Missouri worked and sweated in the sun, the retired artist sat on a barrel in the shade close by, dangled his legs munched his apple, and planned the slaughter of more innocents. There was no lack of material; boys happened along every little while; they came to jeer, but remained to whitewash. By the time Ben was fagged out, Tom had traded the next chance to Billy Fisher for a kite in good repair; and when he played out, Johnny Miller bought in for a dead rat and a string to sing it with - and so on, hour after hour.

And when the middle of the afternoon came, from being a poor poverty-stricken boy in the morning, Tom was literally rolling wealth. He had, besides the things before mentioned, twelve marbles, part of a jew’s-harp, a piece of blue bottle-glass to look through, a spoon cannon, a key that wouldn’t unlock anything, a fragment of chalk, a glass stopper of a decanter, a tin soldier, a couple of tadpoles, a kitten with only one eye, a brass door-knob, a dog-collar-but no dog - the handle of a knife, four pieces of orange-peel, and a dilapidated window-sash.

He had had a nice, good, idle time all the while - plenty of company - and the fence had three coats of whitewash on it! If he hadn’t run out of whitewash, he would have bankrupted every boy in the village.

THE ANALOGY
Just like painting fences, not everything in the business world is particularly pleasant. Take selling, for example. Anyone who has spent much time doing cold-calling for sales will tell you that at times it can be a tough way to make a living.

Wouldn’t it be great if you could devise a system like Tom Sawyer, where people would actually pay you for the opportunity to endure a something undesirable, like sitting through a sales pitch? Believe it or not, it is possible.

THE PRINCIPLE
Today we are going to talk about the idea of altering the location of value in a transaction. Normally, we think of the value we offer as being tied directly to the product or service we are offering. For example, if we are selling automobiles, then we see the primary value as being in the value of the automobile—its performance relative to the price. Or if we are selling a credit card service, we might see the value in how well the card works and how low the interest rate is (or how many airline miles you get with it).

In other words, the customer does not receive the value until after the transaction—once they take ownership of the goods or service. However, what if we turned this on its head and said we want to create value elsewhere—like prior to ownership—and actually get people to gladly pay for the privilege of hearing a sales pitch (even if they end up buying no goods or services).

This is not that far fetched. Allow me to give a few examples.

Every community seems to have its share of “shows,” be it the Auto Show, the Boat Show, the Lawn & Garden Show, or whatever. Some place like a convention center is rented out to a number of vendors in that particular theme, and they ask people to come in and hear sales pitches. And people flock to the convention center by the thousands and pay good money to be given sales pitches. For example, opening day admission to the Miami Boat Show was $28. The Los Angeles Auto Show cost $10.

Not only do people pay for the privilege of hearing sales pitches, they often drive hundreds of miles for the opportunity. In addition, not only does the show get people to pay for the right to hear sales pitches, they usually get local TV stations to give them a ton of free publicity. It’s starting to sound a lot like Tom Sawyer.

And then there is the State Fair, where you pay money so that you can see exhibits where there are sales pitches and where you get the opportunity to pay outrageously high sums of money for greasy food, something you would not otherwise do if not at the fair. If there was ever something which smelled of Tom Sawyer, it would be the State Fair.

Or how about American Express credit cards? While others credit card companies are falling all over themselves to give you credit card deals, like free interest on transfers, airline miles, and cashback rewards, American Express goes the opposite route. They expect you to pay money for the privilege of getting a card. An American Express Platinum Card has a $450 annual fee, whether you use the card or not. And you are stuck paying off the bill in its entirety every month. Getting people to pay for the right to spend even more money when others let you do it for free (and even give you more time to pay it off) sounds like an idea Tom Sawyer would hatch up.

Finally, what about those warehouse clubs, like Costco or Sam’s Club? Depending on the type of membership you get, it can cost $50 to $100 a year to get one at Costco. Think about it—paying money so that the store will allow you to come in and spend money. Millions do. It’s sort of like having to pay money to get a discount coupon (or perhaps pay to whitewash a fence?).

What do all these examples have in common? They have shifted forward the value point in the equation. You don’t have to buy the auto to get the value of the auto. You get the value from the Auto show. The value at a State Fair comes from being a part of a spectacle, rather than the value coming from the food or what the exhibits are pushing. You don’t have to use a credit card to get the value of the card. You get the value from being a member. You don’t get the value from the goods you buy in the store, but the value is in being able to shop a particular store.

Once you realize that you can shift the value to a different location, lots of different opportunities open up—opportunities to get people to pay for things often thought of as being free.

To do so, you have to change people’s perception about what they are experiencing. At a Boat Show, the expectation is no longer to hear a lot of sales pitches (something one usually tries to avoid)—it is to enjoy visiting a world of dream boats and pretty girls—a place to fantasize. Now that has value!

What are some ways to change people’s perception and add value upstream?

1) Provide people with excitement or entertainment. Surround a sales pitch with enough excitement and entertainment and you have a Boat Show or a State Fair.

2) Stroke the ego by making membership at least as important as what the membership offers. That’s what American Express does. As they like to say, “Membership has its privileges.” The more exclusive the club, the more people want to clamor to get in.

3) Provide friendship or a place to hang out with your friends. The value comes through relationships and being with people you enjoy socializing with. The men of Mayberry didn’t hang out at Floyd’s barber shop just for the hair cutting. The value was more in being at the venue than in the service provided there. Even if a better hair cutting value came about, it would take a lot to give up the other value found in the friendship and camaraderie. To abandon Floyd’s would be like abandoning your friends.

We’ve just scratched the surface. Think about ways to apply this to your business.

SUMMARY
Value needn’t only be found in the product of service people buy from you. Value can also be added to the way you sell it, the improved image you imbue to people who purchase from you, the entertainment you offer, or the associations you provide. By surrounding your product or service with all of this, you may even get people to pay you money even if they don’t end up buying your good or service. Wouldn’t that make Tom Sawyer envious?

FINAL THOUGHTS
If you are in the business of selling “stuff”, you run the risk of commoditization. Even if you win, you lose because the profitability is sucked out of commodities. However, if you are selling experiences, friendships and ego boosts (and oh, by the way, there might be a product or service purchased in there somewhere), then you can avoid the commodity trap.