Strategic Planning Analogy #387: Loss-Leader Customers

THE STORY
The movie “The Lincoln Lawyer” is about a lawyer who defends mostly criminals and low-life people from the bad side of town. One of the groups he frequently defends is a rough motorcycle gang. Everyone knows this motorcycle gang is involved in illegal activities, but the Lincoln Lawyer, named Mick Haller, keeps enough distance so that he doesn’t know what that activity is.

At one point in the movie, Mick needs some help, so he asks the motorcycle gang to beat up somebody who was threatening him. Later, when the gang needs Mick’s legal help again, they ask for a discount on the legal fees in return for beating up that person. Mick goes further and says he will take the case for free.

Earl, Mick’s driver, is surprised that Mick is willing to take the case for free. After all, Mick’s reputation is to do whatever it takes to make as much money off a deal as possible. Mick’s response, “Repeat customer, Earl; we will stick it to them the next time.”

THE ANALOGY
It seems that everyone knows about the principles of loss-leader pricing. The idea is that you price certain items at a loss, because you know that the customers lured by that loss will eventually spend enough to more than compensate for that loss. For example, if a supermarket sells milk at a loss, it will get more customers in the door to buy a basketful of profitable groceries. Having spent a few decades in retail, I’ve seen the effectiveness of loss-leader pricing.

Even the Lincoln Lawyer knew how to use loss leader pricing on a tough motorcycle gang. By giving the gang one deal for free, he knew that:

1) The gang would be a more loyal customer in the future (ensuring Mick more business);
2) The gang would be less likely to haggle over future fees, since they had gotten such a good deal on the free one (so Mick can charge more in the future—enough to more than recoup his expenses on the free deal);
3) The gang will be more willing to do more favors for Mick (for free) in the future;
4) The gang will recommend him to others (creating even more customers).

If you can use loss leader pricing on legal fees to tough motorcycle gangs, then you can use it on just about anything.

But here is the twist. Although it is common to think of products and services as loss leaders, we do not often think of having customers as loss leaders. As we will see in this blog, having loss leader customers can be just as viable a strategy as having loss leader products and services.


THE PRINCIPLE
The principle here is that you can develop a strategy where some of your “best” customers can be customers with whom you never make a profit. The reason is because these “best customers” are used strategically as “loss leader customers.”

Just as a supermarket can decide to never make a profit on milk because it helps them make greater profits on other items it sells, you can decide to never make a profit on certain customers because it will help you make greater profits on other customers. We will look at four strategies for loss-leader customers.

1. Gaining Credibility
In the fashion business, credibility and image mean everything. If your fashion product is not seen as the hot /“in”/gotta-have-it product, then it will fail. One way to get credibility as being a desirable fashion is to associate your product with the hot tastemakers. If you can get the hottest movie stars and athletes to wear or use your product, then the desirability of that customer will transfer to your product.

That is why people in the fashion business spend a lot of time and effort to get the hottest people to use their product. They know that they may never make a profit off of these customers (since they give these celebrities the product for free or even pay them to use it). However, these loss-leader customers make the fashion item more desirable to other customers. The celebrities give the product fashion credibility, creating a larger group of profitable customers who want the item.

But it doesn’t just have to be fashion items. I know of a cell phone service provider who was targeting the teen market. They gave away the service for free to the cool kids in school, such as cheerleaders. These were the loss-leader customers. When other teens saw that the cool kids were using this service, then they wanted to use it, too. Hence, the company got a larger pool of profitable customers, because they first invested in loss-leader customers.

I worked with a furniture retailer who did everything possible to please the members of the local garden club. The garden club had a reputation for having members with the highest of taste in home decor. By associating his furniture store with the garden club, he was gaining credibility as having a store with high-taste furniture. This meant that others who wanted a tasteful house would buy their furniture from this retailer, because the loss-leader garden club members were associated with this retailer.

This also works for industrial business products. There may be a business customer who has a reputation for being a very astute buyer of equipment. You may want to sell to them at a loss, because that will make other potential customers will see your product more favorably. Since that loss-leader company is perceived as always making a good buy, by selling to them you gain credibility as being a good buy to others.

2. Gaining Exposure
In a crowded marketplace, it is often difficult to make your product stand out and get noticed. One way to do this is by using loss-leader customers. For example, one can give away free samples of a product to influential bloggers. If these bloggers then say favorable things about your product or service in their blog, you gain invaluable exposure in the marketplace. You won’t make any money off the blogger (loss leader customer), but you may make a ton of money off the people who read the blog (profitable customers).

Anyone who has lots of access and exposure to the public can become a great loss leader customer. If you can get them to talk well about you, then you may gain a large mass of profitable customers from the people who see or hear them.

There is a big movement now to find out who the most influential Tweeters, You Tube users, and other Social Media users are. If you can influence these influencers, then you gain great exposure.

Even paid endorsements, such as getting your logo on the shirt of a famous golfer work. People see the logo on TV in a non-threatening way and it gets planted in their mind. There is a reason why you see so many product logos on race cars. It works.

3. Setting Standards
Often times, a product needs a critical mass of customers in order to be profitable. The idea is that people want to use the product which is the industry standard. The winner of the battle for the industry standard gets virtually all the business, while the loser gets almost nothing.

Think of the old battle for the standard on video tape. VHS won the battle and Beta lost. Or, with DVDs, Blue Ray won the battle and HD-DVD lost. The winners got all the business, the losers disappeared.

With so much at stake, it can very much be worthwhile to gather a large number of loss-leader customers in order to tilt the battle in your favor. The quicker you can tilt preference in your direction, the sooner you can be perceived as the de facto standard.

Remember, the best product does not always become the standard. There were many who thought that Beta and HD-DVD were superior products. Yet they lost the battle because they did not get enough early usage. By investing heavily in loss leader customers, you can get the momentum in your favor perhaps more effectively than investing in product superiority.

This applies to more than just high tech. Back when the Discover credit card was being introduced, it faced a difficult path. Visa and MasterCard were already the standard. Retailers did not want to offer use of the card because nobody had the card. Shoppers did not want to have the card because no retailer was using it. The product almost did not get off the ground.

Eventually Discover convinced the Dayton Hudson company to accept the credit card. They owned the Target store chain and many influential department store groups. That was enough of a start to get people to want the card and other retailers to then accept the card. I am sure that Dayton Hudson got a preferential deal to help make Discover another standard. And it was worth it for both Dayton Hudson and Discover.

4. Reaching Friends
When I was in high school there was a club which sold records by mail. They had a deal where every time you got one of your friends to join the club, you got free records. Well, a friend of mine and I worked hard to get as many people at our high school to join the club as we could. We got a ton of free records and the company got a ton of new members.

My friend and I were loss leader customers for the record club because we got our records for free. But it was worth it to them, because we exposed them to all of our friends (profitable customers). Hence, some customers are valuable to you, even if you lose money on them, if they can give you access to their friends.

Today, companies like Groupon work under a similar principle. They provide incentives to use social media to gather up your friends and expose them to a particular company. At home merchandise parties also work under this principle. They get you to invite your friends to a party which happens to include a sales pitch.

So What are the Strategic Implications
There are two main strategic implications from this principle. First, consider strategies which use loss-leader customers in order to reach a greater pool of profitable customers. Remember, just as you don’t have to make money off every product to be a success, you don’t have to make money off every customer to be a success.

Second consider strategies which make you desirable as a loss leader customer. In other words, make a profit off of the companies catering to you at a loss. Many sports and entertainment figures make more money off of endorsements than they do off their core activity. They are exploiting their loss-leader status. You may be able to do this as well. Convince vendors to give you an outstanding deal because of your loss leader status.

SUMMARY
Just as products can be loss-leaders, so can customers. Consider strategies where you can either create loss-leader customers, or become a loss leader customer for someone else.

FINAL THOUGHTS
If the Lincoln Lawyer can use a loss leader principle on a rough motorcycle gang, then what’s stopping you from finding a way to apply loss-leader customer ideas in your business?

Strategic Planning Analogy #386: Embracing Maturity

THE STORY
I enjoy talking to new first-time parents about their small children. The new parents truly love their little baby and think parenting them is such a wonderful thing.

Then they will mention some little parenting problem they are having. I warn them that this little problem is nothing compared to all the problems they will face when that child becomes a teenager.

Many of those who have had experience or knowledge about parenting teenagers have half-jokingly mentioned to me a desire to hand off their children when they become teenagers and pick them back up when they reach their twenties. Of course, the problem would be finding someone to hand them off to during that period.

THE ANALOGY
Being the parent of a cute little baby can seem like such a wonderful, fulfilling experience. Being the parent of a teenager, however, can often seem like torture—something to be avoided if possible. Unfortunately, those cute little babies eventually grow up into those frustrating teenagers. You can’t just stop being a parent when the child is no longer a cute little baby.

A similar situation appears to happen with many strategic planners. In general, strategic planning for brand new baby businesses can be seen as wonderful and fulfilling. You get to set the direction and positioning from scratch. With all that potential growth in front of it, there are lots of fun strategic options to consider.

However, when a business reaches maturity, strategic planning can seem more frustrating. Positions are already set and difficult to change. The fun of growth has been replaced by the pain of intense competition. Rather than talking about great strategic options, the discussion moves to cutting costs. In business maturity, it appears as if strategy is less influential on outcomes (sort of like parenting a teenager).

Like those parents, many strategists would be happy to just deal with the baby businesses and hand off those mature businesses to someone else. But guess what? Most industries and most businesses in the world are relatively mature. That’s where most of the action is. If strategists want to be relevant, then they had better get excited about building strategies for mature businesses.

THE PRINCIPLE
It bothers me that the discipline of strategic planning is out of favor in so many areas of business. Its influence has diminished significantly. There are many reasons for this phenomenon. I believe that one of the many reasons why strategic planning is seen as irrelevant is because the discipline tends to be pre-occupied with early stage businesses. Little focus from strategic planning thought leaders is given to strategic planning in the mature stage of a business. Therefore, it is no wonder that mature businesses see little value to intense strategic planning. And since most businesses are mature, that makes strategic planning appear irrelevant in most places.

One way for strategic planning is to regain its stature is by making it appear more indispensible in the way mature businesses are run. In this blog, we will look at four ways to do this.

1. Reclaim Productivity as a Strategic Agenda
As I have mentioned many times before, I believe that there are three components to effective strategic planning;

a) Positioning – A reason for consumers to prefer you.

b) Pursuit – Aggressively achieving as many ways to exploit that position as possible (top line orientation)

c) Productivity – Making the most money off the areas where you pursue (bottom line orientation).

Although all three are important at all phases of a business lifecycle, productivity tends to be the area requiring the most attention during the mature phase. Therefore, for strategic planning to be relevant and essential during maturity, it needs to take ownership of the productivity agenda.


In many places, productivity is not even seen as a strategic activity (even among some strategic planners). Strategists aren’t even invited to the table when productivity is discussed. It is just seen as a cost cutting exercise, or at best, a budgeting exercise. Just tell people to cut 15% of costs from their budget and you are done.

In reality, productivity is very much a strategic issue. Not all cuts are created equal. Some cuts hurt your strategic position more than others. If strategic implications are not addressed during cost cutting, the wrong cuts can be made—cuts which can totally undermine a business.

For example, a few years back the consumer electronics retailer Circuit City wanted to increase productivity. They noticed that labor was one of their largest costs at store level. They also noticed that their most experienced sales people tended to be the most expensive sales people. Therefore, to increase productivity, Circuit City got rid of its most experienced sales people. It wasn’t too long thereafter that Circuit City declared bankruptcy. As it turns out, those experienced sales people were a critical component of the strategic success of Circuit City. Eliminating those people also eliminated the chance of strategic success.

Strategists need to be at the table to point out the strategic implications associated with various cost-cutting options (and perhaps provide cost-cutting options of their own). This isn’t an option. The destiny of the business is at stake.

2. Move the Discussion Away from Merely Cost-Cutting
Some of the best ways to increase productivity have nothing to do with cutting costs. Often the productivity problem is not how much you spend, but rather what you do. It is a more a question of effectiveness of process rather than efficiency of spending.

For example, I could be the most efficient Morse Code operator on the planet. However, that does not make me the most effective communicator on the planet. Almost nobody understands Morse Code anymore, so nobody will hear my Morse Code message, no matter how efficiently I use it. Rather than trying to make my Morse Code process more efficient, I need to switch to a more effective communication process, like Twitter, Facebook or Email.

If you only focus on cost-cutting, you may miss far more effective options for improving the bottom line via changes in process. Strategists can be an important source for discovering and championing alternative processes.

Strategists can also play a vital role in helping companies avoid new processes which negatively impact a strategy. Take outsourcing, as an example. It makes a lot more sense to change a process from in-house to outsource when the process is less critical to the overall strategy. By contrast, if you outsource a core competency, you may destroy your ability to control your destiny and destroy your competitive advantage.

3. Help People See Productivity as an Investment Opportunity
Productivity is ultimately about increasing profits. Sometimes, you can increase profits faster by investing rather than cutting. If the return on investment is high, investments make sense, even in the mature phase of a lifecycle. Strategists can play a key roll during maturity by discovering and championing those types of investment opportunities.

Strategists are already often a key part of investment decisions during the early phases of a lifecycle. Why not continue that roll into the mature phase?

4. Change M&A to M&A&D
M&A stands for Mergers & Acquisitions. These are activities which tend to do with building and growing a business. However, as a business reaches maturity, it makes sense to give more consideration to the strategies of shrinking and eliminating businesses. This would be the strategies of Divestiture.

Most companies do not take a proactive approach to divestitures as a strategy. Instead, it is seen as the option of last resort—to be used only when backed into a corner with no other option. The thought of divesting while a company is still doing well is often never considered. Yet, the most profitable time to divest may be when the company is still doing well.

Look at the chart below. Outsiders often tend to overestimate the value when a company is just reaching maturity. They may mistakenly see it as still in the growth phase or see a longer mature horizon than you do. Conversely, once there is no longer any doubt that a company is in decline, the potential pool of people to sell to shrinks dramatically. The “bottom-feeders” who go after distressed companies tend to be very cheap and pay very little. As a result, in decline, others tend to underestimate your value. As a result, divesting early can be a great strategic option. We talked about this more in earlier blogs (here & here).


Therefore, divestitures can be just as strategic as acquisitions (read more here). And just as strategists are often a part of the acquisition discussion, they should be a part of the divestiture discussion. And this is more likely to happen if you change M&A to M&A&D—Mergers & Acquisitions & Divestitures.

SUMMARY
One way to improve the stature of strategic planning in companies is by making strategic planning appear more vital in the mature phase of the life cycle. This can be done by:

1. Reclaiming Productivity as a Strategic Agenda
2. Moving the Maturity Discussion Away from Merely Cost-Cutting
3. Helping People See Productivity as an Investment Opportunity
4. Changing M&A to M&A&D

FINAL THOUGHTS
There’s an old poem which goes something like this:

“The problem with kittens is that,
They eventually grow up to be cats.”

We need to move beyond a focus on cute kittens and embrace the reality of mature cats.

Strategic Planning Analogy #385: Truthful Exaggerations

THE STORY
My wife doesn’t like it when I exaggerate. When she starts getting on my case and criticizing my exaggerating, I like to answer as follows:

“Oh, no. I never ever, ever, ever, EVER, E-V-E-R exaggerate. I’ve never ever exaggerated in my whole, entire life.”

Somehow, she doesn’t see the humor in that response like I do.

THE ANALOGY
I think the reason why my wife doesn’t like my exaggerating is because she sees it as similar to lying. But what if you could exaggerate and tell the truth at the same time?

Businesses can do this. They can exaggerate their business model in one of a variety of different directions. For example, a business could exaggerate its product assortment. They could make it much broader, significantly narrower, more distinctive, or far more customized than the typical company in their industry. Similarly, they could exaggerate service levels, prices, features, and so on, relative to everyone else.

Then, a company could tell the world about the benefits of that exaggeration. In doing so, they would be talking exaggerations and telling the truth at the same time. I think even my wife would be okay with that.

THE PRINCIPLE
The principle here is that you will never achieve above average results if you act like everyone else in your industry. Having a business model just like everyone else will make you, by definition, average. If you want superior results, you have to do something different. You have to exaggerate the industry business model to the extent that:

a) Customers will perceive you differently from other industry players (enough to change their expectations of how to interact with you);

b) You can exploit the inherent difference caused by the exaggeration in a manner which allows you to tap into extra profit opportunities that the rest of the industry cannot imitate.

Allow me to demonstrate this with a couple of examples.

Save-A-Lot
Save-A-Lot is a large chain of limited assortment hard discount grocery stores. It is very similar to Aldi. Save-A-Lot is very different from the traditional supermarket because of its exaggeration related to assortment. Save-A-Lot carries only a small fraction of the number of items (called stock keeping units, or SKUs) found in a typical supermarket. Typically, there is only one brand in each category, like one brand of peanut butter, one brand of ketchup, one brand of canned vegetables. And that one brand is a private label controlled by Save-A-Lot.

Service levels are also exaggerated—much less than a typical supermarket. You have to purchase your shopping bags. You have to bag your own groceries. The stores are typically not open as long as a traditional supermarket. There is nobody there to make you a custom cut of meat.

Because of these exaggerations in assortment and service, Save-A-Lot has a much lower operating cost than a typical supermarket. This allows them to charge much lower prices and still make a good profit.

The customer sees that Save-A-Lot is obviously not playing the same game as a typical supermarket. The stores are much smaller, they don’t carry everything, the brands are unfamiliar, and the prices are a lot lower. The customer is willing to accept a selection and service level they would never tolerate from a traditional supermarket, because they see it as a fair tradeoff to get the lower prices that they cannot get from a supermarket.

Save-A-Lot has permission to shout about having exaggerated low prices, because the exaggerated business model makes lower prices possible. In other words, this is an exaggerated statement rooted in truth, something my wife can accept.

This exaggeration allows Save-A-Lot to tap into profit opportunities unavailable to traditional supermarkets. I remember talking to Bill Moran, founder of Save-A-Lot about this. He said the following:

“The beauty about being a limited assortment store is that people do not expect you to carry everything. As a result, I only need to carry those items I can make a profit on.”

In other words, the exaggeration allows him to avoid carrying a lot of the loss-leaders which customers expect traditional supermarkets to carry. The example Bill Moran gave me was jars of baby food. He said that in some markets, jarred baby food is priced at a loss. In those markets, Save-A-Lot carries no jars of baby food. In other markets, baby food is priced more normally, so in those markets he carries his private label baby food, where he could under-price the supermarkets and still make a profit.

Another example is Kraft Velveeta cheese. Bill Moran could never find a way to make a private label version of Velveeta which tasted as good and could profitably under-price Velveeta. As a result, Save-A-Lot has no Velveeta-like cheese. When customers ask why Save-A-Lot doesn’t carry a Velveeta-like cheese, he would tell them that he couldn’t find a way to give them a value on the product. If he had to carry it, he would have to raise the other prices in the store to make up for it. Because customers know that Save-A-Lot is a Limited Assortment store (and they appreciate the drive to keep prices low), they accept the explanation and are happy.

Now think of what would happen to a traditional supermarket if they told the customer they didn’t carry their favorite brand because they couldn’t make a profit on it. The customers would have a fit, because they expect a full assortment from supermarkets. In fact, back in 2009 and 2010, Wal-Mart tried to cut way back on the grocery assortment in their superstores. The customers got angry and took their business to the competition. Wal-Mart lost market share. Eventually Wal-Mart had to go back and add a lot of those items back to their mix. Wal-Mart could not use the same profit tactic as Save-A-Lot, because they had not exaggerated the business model enough to get permission from the customers to do so.

And, by the way, Save-A-Lot is one of the more profitable parts of the Supervalu corporate portfolio, a portfolio which includes traditional supermarkets. It creates above average results because it does something different with the business model (made possible through exaggeration).

Southwest Airlines
Southwest Airlines is another company operating under an exaggerated business model. The key point of exaggeration is that they only do point-to-point flying. In other words, Southwest will not book you through on multi-stop flights. They do not use the traditional hub-and-spoke approach to create a lot of flight connections. If you need to make a connection on Southwest, you have to go pick up your bags and re-check them in. You also have to go through the ticketing process again.

Southwest uses this point-to-point exaggeration (a few other similar exaggerations) to create a meaningfully different business model, which they can exploit in a manner which allows them to be more profitable while still charging far lower prices. Customers believe them when Southwest shouts about their lower prices, because they know they do things differently in a way that justifies the lower prices. It is not just a price war. It is a true pricing differential caused by a true costing differential. This is truthful exaggeration.

Let’s just look at one aspect of this. In a point-to-point system, every bag on a plane has the identical journey. Baggage for a Southwest plane all comes in from that airport’s baggage drop off. There are no transfers from other planes to that plane. Similarly, all the Southwest baggage leaves a plane and goes to the same place, the baggage pick-up area. None of it is transferred to another plane. This makes the cost of running baggage for Southwest far lower than for a traditional airline, which has transfers of baggage going all over the place, even to competitor’s planes.

As a result, while other airlines feel a need to charge high fees for checking baggage, Southwest can brag that bags fly free. Southwest did the math and found out that because their baggage costs are so low (due to the exaggerated business model), they can afford to do baggage for free because it created enough extra market share to more than cover any losses due to not charging for bags.

And it should also be pointed out that for decades, Southwest has been far more profitable than then average US airline. By being different, they can tap into profit opportunities the traditional operators cannot touch.

SUMMARY
Hollow claims are not the path to superior results. If you want above average results, you need to act differently from the rest of the industry—you need to exaggerate the business model in a meaningful way. These exaggerations change consumer perception and business processes in such a way that you can tap into extra profit opportunities unavailable to the rest of the industry.

FINAL THOUGHTS
Take a tip from my wife: If you want to get away with saying an exaggeration, first you had better BE an exaggeration. Otherwise, you are just a liar. Truthful exaggerations are the way to go. Are your strategies based on truthful exaggerations?

Strategic Planning Analogy #384: Salty Popcorn

THE STORY
Back when I was a young boy, I was part of the Cub Scouts, the younger version of the Boy Scouts. One time, the leaders took a group of us young Cub Scouts to a scout campground to spend the weekend camping in tents.

One night during that weekend, a few of us boys got hungry for some popcorn, so we quietly left our tent and sneaked over to the rustic kitchen. Without any adults to supervise us, we made a big batch of popcorn. This was in the days before microwaves. I’m surprised we didn’t burn the place down.

One of the boys wanted to be in charge of salting the popcorn. He put practically an entire box of salt on the popcorn. This made the popcorn so salty that it was inedible. So we got the bright idea that if we made a second batch of popcorn and mixed it with the first, the whole thing would taste good. So we made a second batch and mixed the two. It was still too salty to eat.

So we decided to mix in a third large batch of popcorn. The end result was still extremely salty, but almost tolerable, if you only ate one handful and had a lot of water to wash down the salt.

Of course, by now we had a huge supply of popcorn—more than we could possibly eat. So we went outside and yelled that we had free popcorn for anyone who wanted it. Suddenly, all these other Cub Scouts showed up to get some popcorn. They each took only one handful, because it was too salty. But eventually that got rid of most of the popcorn.

Unfortunately, our yelling also woke up the leaders who were supposed to be supervising us. They weren’t very happy when they found out what we did.

THE ANALOGY
At the campground, we had something bad—over-salted popcorn. We thought we could make it good by adding something good to the mix—unsalted popcorn. However, we kept adding more and more good and the end result was still bad. In the end, all we had was a bigger pile of bad. We would have been much better off just throwing away the first batch and starting over.

It seems like a lot of businesses act like I did at that campout. They have a bad situation on their hands—not enough growth, not enough profits, etc. And just as I tried to fix my bad popcorn by adding new popcorn to the mix, these businesses try to fix their bad business situation by adding new businesses to the mix. It could be line extensions, diversifications, or other types of new product introductions. Whatever the means, the focus is on growing the top line with new lines of business. Unfortunately, the net results are usually still below expectations. They probably would have been better off if they had focused on tossing out the bad businesses rather than adding the new businesses to the already toxic business situation.

THE PRINCIPLE
The principle here is that our strategic goal should not be to become bigger, but to become more profitable. And many times, the most effective way to increase profits is by shrinking the scope of our business. Tossing away the elements which destroy huge amounts profitability can often provide a greater improvement than layering on more elements which are only marginally profitable.

Just as it takes a huge amount of new popcorn to overcome a small salty batch, it can take a huge amount of new business to overcome a dysfunctional business base—probably more than you can afford to undertake (either in money or manpower). Rather than adding, it may be more desirable to subtract.

Proctor & Gamble Example
Think about Procter & Gamble. Back at the beginning of the 1990s, they had 31 varieties of Head & Shoulders shampoo and 52 versions of Crest dental products. All of those were a lot of additional versions which drove up the costs of manufacturing, distribution, inventory management, marketing, management and so on. So P&G decided to cut its variety.

By the end of that decade, P&G had cut the number of its products by one-third. In hair care alone, the variety was cut in half. So how did all that cutting impact sales? Well, the market share in hair care went up nearly five points and overall P&G sales grew by one-third during the mid 1990s.

And while sales were rising, costs were dropping, because a lot of costs can be eliminated when you eliminate all of the inefficiencies from excessive variety.

And it didn’t stop there. Back in December of 2010, P&G leaders talked to analysts about the benefits from even further simplifying their business. In 2008, P&G had 500 manufacturing platforms. By 2014, they plan on having only 150. That is expected to produce savings of about a half a billion dollars.

They are also going to simplify the processes used to run the business. By moving to fewer, but stronger regional centers over the next three years, they expect annual savings of $160 million. By replacing bad inefficiencies with new technology, they anticipate annual savings of about $50 million per year, not to mention other ways to cut which will add even more.

When you add it all up, we’re talking about an annual increase to the bottom line for P&G of hundreds of millions of dollars. Just imagine how many new businesses P&G would have to add to their mix to get the same amount of net impact on the bottom line. Keep in mind that a lot of that new innovation would probably cannibalize other P&G businesses and add to the complexity costs of the company. So these new businesses would have to create even more profits than this to make up for that cannibalization and added complexity costs.

It’s like that popcorn. Rather than trying to add on layer upon layer of new business (unsalted popcorn) to the mix, P&G threw out the salt that was causing the problems in the first place (too much variety, too much overhead, too many platforms, etc.). Getting rid of the salt (bad costs of excessive complexity) got to a good flavor much faster than heaping a lot more popcorn (marginal business) on top of the bloated cost structure. Tossing away can be far more profitable than adding on.

Wilson and Perumal, in their book “Waging War on Complexity Costs” claim that a focus on cutting out complexity can reduce a typical business’ cost structure by 15 to 35%. Can you imagine how much new business innovation would have to occur to create a similar improvement to your profitability?

Pressure to Innovate
Yet the current pressure in the business world is to increase innovation and pump even more new businesses into the company’s bloated product pipeline. Everywhere you look in the business press, one sees the thrust to innovate more and create more lines of business.

Remember, innovation can be very expensive, and about 80% of new business ventures fail. And, as P&G and others have found out, added variety doesn’t necessarily lead to additional net sales. It may just spread the same sales volume across more product lines (causing less volume per line—fewer economies of scale).

Worse yet, new ventures often lead to added overall business complexity, which increases the costs for every product you sell, even the old established ones. So you may be hurting the profitability of the status quo product mix almost as fast as you are adding marginal profits from the incremental variety. In other words, your business mix will still be too salty even though you add a lot of new popcorn to the mix.

Therefore, when you are having your strategy sessions, don’t just focus on ways to grow the top line. Don’t let the current wave of innovation pressure you into seeing additional new product lines as your only strategic option.

Instead, consider spending time strategizing around the benefits of cutting out complexity and redundancy. Look for ways to simplify your processes through standardization. Consider places to eliminate the variety and scope of what you offer. In other words, look for ways to get rid of your excess saltiness.

Yes, this approach can potentially hurt top line growth rates. But, it can make your bottom line skyrocket. And, at the end of the day, if profits are growing wildly, the market will reward you very well.

SUMMARY
When seeking to improve your business performance, don’t just look at strategic options which attempt to increase sales through new product innovation. Instead, consider ways to eliminate marginal businesses and all the needless complexities they bring. Shrinking the business and tossing away the bad can be a quicker and more powerful way to improve profits.

FINAL THOUGHTS
With all the emphasis on the word “innovation”, I figure we need another word to counteract it in the discussion. Innovation comes from the Latin—“in” for “in” and “nova” for “new”. In other words innovation is about bringing something new into the business. But what about the idea of taking something old out of the business? I fiddled around on the internet and invented my own Latin-like word: “eximotraditionalis.” This word means to remove some the stuff you traditionally have been doing. Hopefully, “eximotraditionalis” will become as popular in the business press as “innovation” (but somehow I doubt it).

Strategic Planning Analogy #383: Showing Up (Part 2)

BACKGROUND
In the last blog, we began a discussion around strategic success. We said that strategic success requires more than just having a great vision and a great plan. One also needs to have employees united around making that plan a reality.

Unfortunately, people do not always naturally unite around a plan. Due to different thoughts and agendas, there can be differences of opinion. People may not see a reason to fight for plan. In fact, some may want to sabotage the plan.

Strategies typically involve change. Not everyone sees the benefit in change. Many will resist change.

Unless you deal with these roadblocks of resistance, your strategy will die before you have a chance to implement it. Therefore, a key part of the strategic process is working to get everyone on board, to show up and be committed to the plan.

In the last blog, we looked at three areas where roadblocks can occur (Motivation, Beliefs, and Perspective). In this blog we will look at four more.

MORE POTENTIAL AREAS FOR ROADBLOCKS

4. Goals
In a race, people run towards the goal. If there is a disagreement about what the goal is (or should be), then everyone will be running in different directions. For a united effort in a singular direction, you need an agreement on what the goal should be. So what should that goal be?

One way to choose a goal is to say “We should do what is right.” Although this sounds good, it is actually a terrible goal. The problem is that it assumes there is only one right thing and that everything else is wrong. This causes people in a discussion to focus on trying to prove that everyone else is wrong. And of course, nobody wants to be proven wrong, so they fight back to prove you are wrong. This leads to discord rather than unity. In the end, nobody wins.

Worse yet, this assumption just isn’t true. There are a lot of divergent points of view which are all “right.” It is right that a company focus on the crisis of today. It is also right that a company focus on tomorrow. It is right that individual departments need to fight for their needs. It is also right that sometimes departments need to give up something for the good of the whole company. It is right for a company to provide financial returns today for its stakeholders. It is also right for a company to invest money for the future. And the list goes on and on.

Therefore, instead of fighting for what is right (and what is wrong), a better goal is to “do what is best.” This way, everyone can save face in the discussion, since their positions are not necessarily viewed as wrong. They are still right—but just not the best right thing to focus on at this time. Instead of attacking, people are comparing.

So how do you determine what is “best”? As I mentioned in the last blog, I am adapting many of my thoughts from the writings of Chris McGoff. McGoff suggests that groups choose between three methodologies:

a) Ends-Based: Best = What Does the Greatest Good for the Most People.
b) Rule-Based: Best = The Best Universal Standard
c) Care-Based: Best = Best Outcome for the One Most Impacted by the Decision

After choosing a methodology, the best goal tends to be rather apparent to most people.

At this point, another roadblock can appear. That is the roadblock of then assuming that you need 100% agreement on this decision (or any other decision) before moving on. An old friend of mine who used to do consumer research liked to say that if you survey a large enough population, you will always find 5% who will believe almost anything. His point was that there will always be a fringe group holding divergent views. They will never be swayed to change their mind. If you wait for 100% agreement, you will be waiting forever. That is not the path to winning in the marketplace.

Therefore, instead of having a goal of 100% agreement, strive for a goal of having 100% willing to live with and commit to the decision. If you want people willing live with and commit to a decision, McGoff suggests two principles:

a) Have a process which people agree was explicit, rational and fair.

b) Make sure everyone in the discussion was treated honorably and that their points were heard and considered. The good news is that switching the orientation from “right” to “best” tends to help with this principle.

5. Balance and Separation
As we noted above, there can be multiple truths in an organization. Many of these multiple truths appear to be bi-polar opposites:

a) Individual/Department Needs Vs. Corporate Needs
b) Near-term Concerns Vs. Long-term Concerns
c) Improving the Current Business Model Vs. Transforming to a New Business Model
d) Analysis Vs. Action

The goal is not to only do one pole and not the other. Instead, the goal is twofold:

a) Find a balance of time between the two poles. Both need an adequate share of your time. For example, if all your time is spent on Analysis, you will never get anything done (paralysis of analysis). Conversely, if you only spend time on Action, you will likely do the wrong things because there was no prior analysis.

b) Make a separation of time between the two poles. Don’t try to work on both of them at the same time. The conflicting objectives will create chaos.

If a discussion hits a roadblock, it can often be because the balance or separation is not working. Either one of the poles has been ignored for too long or the discussion is confused because both poles are being worked on at the same time. Check to make sure that the principles of balance and separation are not violated.

6. Focus
Not everything is bi-polar. There are some things which deserve far more time than others. For example:

a) Focus on what you can control (Empowerment) instead of what you cannot control (Victimization)

b) Focus on The Future (What we can do to improve) rather than The Past (Where we can place blame)

c) Focus on that which impacts our stakeholders rather than that which is just internal bureaucracy.

d) Focus on what advances the Vision.

e) Focus on Results.

Perhaps your roadblock can be fixed by getting more on focus.

7. Culture
What you tolerate becomes your culture. If you tolerate bad behavior, you will get bad behavior. The bad behavior will take over your culture. However, if bad behavior is not tolerated, then it is less likely to dominate your culture.

It is harder to reach unified commitment if people do not trust each other and there is no respect for each other. Toleration of gossiping, back-stabbing, lying, slander, and irresponsibility are a poison to any strategic discussion. You cannot discuss in good faith when you have no faith that there is any good.

If discussions are bogged down, perhaps it is because a poisonous culture has gripped your company. Remember, culture is determined by what is tolerated, not by what is on a piece of paper. Enron had a great culture on paper, but it tolerated poisonous behavior. To eliminate a poisonous culture, you need to have severe negative consequences for bad behavior (including termination). This roadblock can take awhile to fix.

SUMMARY
To be a success, you need more than just a great strategic vision and a great plan to achieve it. You also need to have your employees united around making it a reality. If the employees don’t show up with enthusiasm to achieve this common purpose, the rest of the work is a waste of time. There are seven roadblocks to achieving this employee commitment to the plan. In today’s blog, we looked at four of them:

• Goals – Seek what is Best rather than what is Right; Seek what people can live with rather than 100% agreement.

• Balance & Separation – Balance significant time between both bi-polar truths; Focus on each pole separately (at different times).

• Focus – Focus on what you can control, the future, what advances the vision, what impacts stakeholder, and results.

• Culture – Don’t tolerate poisonous behavior.

FINAL THOUGHTS
It’s hard enough to compete in the marketplace when all your resources are put into the battle. Don’t make it worse by handcuffing your people with unnecessary roadblocks.