Summarize Articles Module 6

IDEAS AT WORK

Gauging-and communicating-

what your products and services

are worth to customers has

never been more important.

Business Marketing:

Understand What

Customers Value

by James C. Anderson ami James A. Narus

"Everything is worth what its purchaser will pay for it.' Publilius Syrus, first century B.C.

H OW DO YOU DEFINE VALUE? CAN YOU MEASURE IT?What are your products and services actually worth to customers? Remarkably few suppliers in business markets are able to answer those questions. And yet the abihty to pinpoint the value of a product or service for one's customer has never been more important. Customers - especially those whose costs are driven by what they purchase-in- creasingly look to purchasing as a way to increase profits and therefore pressure suppliers to reduce prices. To persuade customers to focus on total costs rather than simply on ac- quisition price, a supplier must have an accurate under- standing of what its customers value, and would value.

Put yourself, for a moment, in the role of a commercial grower. Two suppliers are trying to sell you mulch film: thin plastic sheets that are placed on the ground to hold in mois- ture, prevent weed growth, and allow melons and vegetables to be planted closer together. The first supplier comes to you with this proposition: "Trust u s - o u r mulch Him will lower your costs. We'll provide superior value for your money." The second supplier says, "We can lower the cost of your mulch film by $ 16.8 3 per acre," and offers to show you exactly how. Which proposition would you find more convincing?

fames C, Anderson is the William L. Ford Distinguished Professor of Marketing and Wholesale Distribution and a professor of behavioral science in management at North- western University's J.L. Kellogg Graduate School of Mdn- agement in Evanston. Illinois. He is also the AT&)T ISBM Research Fellow at the Institute for the Study of Business Markets. located at Pennsylvania State University, fames A. Narus is an associate professor of management at the Babcock Graduate School of Management at Wake Forest University in Charlotte, North Carolina. Their book, Busi- ness Market Management: Understanding, Creating, and Delivering Value, has iust been published by Prentice Hall.

HARVARD BUSINESS REVIEW November-December 1998

IDEAS AT WORK UNDERSTAND WHAT CUSTOMERS VALUE

Many customers, like the com- mereial grower, understand their own requirements but do not neees- sarily know what fulfilling those requirements is worth to them. To suppliers, this lack of understanding is an opportunity to demonstrate persuasively the value of what they provide and to help customers make smarter purchasing decisions.

A small but growing number of suppliers in business markets draw on their knowledge of what cus- tomers value, and would value, to gain marketplace advantages over their less knowledgeable competi- tors. These suppliers have developed what we call customer value models, which are data-driven representations of the worth, in monetary terms, of what the supplier is doing or could do for its customers.

Customer value models are based on assessments of the costs and ben- efits of a given market offering in a partieular eustomer application. De- pending on circumstances, such as availability of data and a customer's cooperation, a supplier might build a value model for an individual cus- tomer or for a market segment, draw- ing on data gathered from several customers in that segment.

Customer value models are not easy to develop. But the experiences of suppliers that have built and used them successfully suggest several guidelines that we believe will be useful to any company attempting to define and measure value for its eustomers.

A Common Definition of Value To measure value in practice, it is crucial to have a shared understand- ing of exactly what value is in busi- ness markets. Before we go into any detail about building value models, we need to provide a brief explana- tion of what we mean by value. Value in business markets is the worth in monetary terms of the technical, eco- nomic, service, and social benefits a customer company receives in ex- change for the priee it pays for a mar- ket offering. We will elaborate on some aspects of this definition.

First, we express value in monetary terms, such as dollars per unit, guilders per liter, or kroner per hour. Econo-

mists may care about "utils," but we have never met a manager who did! Second, by benefits, we mean net benefits, in which any eosts a cus- tomer incurs in obtaining the de- sired benefits, except for purchase price, are ineluded. Third, value is what a eustomer gets in exchange for the price it pays. We see a market of- fering as having two elemental char- acteristics: its value and its price. Thus raising or lowering the price of a market offering does not change the value that sueh an offering provides to a customer. Rather, it changes the customer's incentive to purchase that market offering, finally, consid- erations of value take place within

some context. Even when no compa- rable market offerings exist, there is always a competitive alternative. In business markets, one competitive alternative may be that the eustomer decides to make the product itself rather than purchase it.

We can capture the essence of this definition of value in the following equation:

j Pricej) > (Valueg - Priceg)

g and PricCg are the value and price of the supplier's market offer- ing, and ValuCjj and Price^ are the value and price of the next best alter- native. The difference between value and price equals the customer's in-

Using Customer Focus Groups to Assess Value

Although field value assess- ment-gathering data firsthand whenever possible-is the most common way to huild customer value models, not all situations lend themselves to it. Indeed, in some cases, the only way to obtain information for a value model is to rely on customer per- ceptions. The results of such as- sessments may not be as precise as those calculated from field value assessments; nonetheless, they can be quite effective. Con- sider a t e l e c o m m u n i c a t i o n s company that used focus groups to gain a better understanding of the worth of an advanced in- telligent network service called single-number reach.

Single-number reach is de- signed for people who want callers to reach them easily, even if they are not at a single location or phone number dur- ing the course of a day, Provided from a central office switeh, the service allows a caller to seek the buyer of the service via a se- quence of programmed tele- phone numbers. To determine the target market segment, the

company conducted four focus groups with itinerant Genera- tion X professionals, some of whom had six telephone num- bers on their business cards.

At the beginning of each focus group, the moderator demon- strated the service using a spe- cially arranged prototype and then asked focus-group partici- pants to write dtiwn their first impressions of the service and how much they would be will- ing to pay for it per month. The participants then engaged in a discussion of the service, how they would most likely use it, and so on. At the conclusion of the approximately hour-long discussion, the moderator asked the participants to write down their interest m the service us- ing a ten-point scale and again, how much they would be will- uig to pay for it per month.

Although the company was interested in the actual mone- tary amounts given at the begin- ning and at the end, xt was more interested in any pattern of dif- ferences between the amounts. An ominous pattern would be

54 HARVARD BUSINESS REVIEW Novtrmber-December 1998

UNDERSTAND WHAT CUSTOMERS VALUE IDEAS AT WORK

centive to purchase. Simply put, the equation conveys that the customer's incentive to purchase a supplier's offering; must exceed its incentive to pursue the next best alternative.

Building Customer Value Models Field value assessments (also known by other names, such as value-in-use or eost-in-use studies) are the most commonly used - and, we believe, the most accurate-method for building customer value models. Field value assessments call for suppliers to gather data about their customers firsthand whenever possible. Clearly, however, conducting such direct research isn't always an option. In

steep declines from the initial amounts to the ending amounts, indicating that the participants were initially intrigued with the service but, upon further con- sideration, concluded that it would not offer t h e m much value. No significant change be- tween the initial amounts and ending a m o u n t s would be a preferable pattern, provided the specified amounts were suffi- ciently large. The final pattern, considerable increases from the initial amounts to the ending amounts, would indicate that when the participants thought about the service, they recog- nized a greater potential value. That pattern would suggest the crucial role of husuicss market- ing communications in convey- ing the value of using the ser- vice to prospective customers.

The company used the results of the research to provide esti- mates of the service's worth to local telephone-service providers and It) show those providers an approach for segmenting the market, targeting customers, and positionuig the offering.

cases where field value assessments are not feasible, it is possible to gain a w o r t h w h i l e u n d e r s t a n d i n g of value through such methods as di- rect and indirect survey questions, conjoint analysis, and focus groups, all of which rely primarily on cus- tomers' perceptions of the function- ality, performance, and worth of a supplier's offering. (See the insert "Using Customer Focus Croups to Assess Value.") Below, we describe a process for building a value model using field value assessments.

Get started. Witht)ut a doubt, the most difficult customer value model that a supplier will build is its first one. Indeed, gaining a comprehen- sive understanding of the value of a market offering in a particular cus- tomer setting may appear monu- mentally difficult. But it can be done. The first step is putting together the right kind of value research team. The team should include people with product, field engineering, and marketing experience, and two or three forward-think ing salespeople. Having salespeople involved at the start is particularly important. They know the customer and how the offering is used; they also know which customers might be willing to etx)peratf in value research. Sales- people who are part of a value assess- ment initiative from the outset are also more likely to understand and appreciate it. They will, therefore, support the approach and can then persuasively relate their experiences to others in the sales force.

Selecting the right market segment to target is the next step. Because the supplier will need to conduct value assessments with at least two and perhaps up to a dozen customers to build an initial value model, it's a good idea to start with a segment in which the supplier has particu- larly close, collaborative relation- ships with customers, extraordinary knowledge of how customers use the offering in question, or relatively simple offerings.

Before approaching a customer, the team should think through what it will need from the customer and what the customer will gain, aiid be prepared to otfer an incentive. For example, the supplier might offer to

provide the resources to gather the data at no charge to the customer and guarantee to share all findings. For most companies, the promise of shared research findings among par- ticipating customers in an aggregated or disguised manner is an irresistible incentive because it allows them to benchmark. W.W. Crainger, a major distributor of maintenance, repair, and operating supplies in North America, offered both incentives for the 15 companies that participated in its initial model-building effort.

Generate a comprehensive list of value elements. Value elements are anything that affect the costs and benefits of the offering in the cus- tomer's business. These elements may be technical, economic, service, or social in nature and will vary in their tangibility. How well a pigment disperses in a coating, for example, would be a technical element; provid- ing a consolidated monthly invoice rather than a separate invoice for each purchase would be an econom- ic element; design assistance would fall under the service heading; and ease of doing business with the sup- plier would be social. As it is generat- ing the list, the team should consider the entire life cycle of the offering in question, from how the customer acquires and uses it to how the cus- tomer disposes of it when it is no longer needed. The list should cap- ture all the potential effects that do- ing business with a supplier might have on the customer's business.

It's important to be as inclusive as possible. Leaving out elements, par- ticularly those tbat might make tbe supplier's market offering k)ok unfa- vorable next to the incumbent or next-best-altcrnative offering, will undermine the project's credibility.

By identifying as many elements as possible, the team will be able to gauge more accurately the differ- ences in functionality and perfor- mance its offering provides relative to the next best alternative. Broadly stated categories, such as the cost of an hour of downtime in a customer's plant, may be easier to identify. But they tend to leave out cost elements, producing less valid estimates of worth. A bottle breaking in a filling

continued on page s 8

HARVARD BUSINESS REVIEW Ntwcmber-December 1998 55

IDEAS AT WORK UNDERSTAND WHAT CUSTOMERS VALUE

line causes downtime, certainly, but it also generates costs in scrap, dis- cards, disposal, maintenance labor, cleaning and sanitizing chemicals, and so on, many of which tend to be buried in various plant-overhead accounts.

Often, the value research team will have to make trade-offs between relying on a customer's perception of

Frequentlyy the customer doesnt know that it has the data or information the supplier is looking for.

what all the relevant elements are and actually observing firsthand the ways in which the supplier's offering affects the customer. The customer's management may not have an accu- rate understanding of all the value elements associated with a particu- lar offering. Believing that this was frequently the case, Alcoa Aerospace developed a program in which the company trained its salespeople in field-value-assessment methods and then gave them an assignment in which they had to comprehensively chart all the steps a customer took in acquiring, converting, and disposing of an Alcoa offering. Interestingly, the program gave salespeople a rea- son to approach customers: to ask them to cooperate in letting them do their assignments. The promise of enhanced knowledge of their own businesses provided an incentive for those customers.

Alcoa's initiative paid off. At the end of a two-month period, the sales- people got together and presented their findings to one another. The presentations allowed participants to learn from others' experiences and to exchange ideas about various cus- tomers' situations and the potential for future sales. The customers bene- fited because they learned about cost and benefit elements they had previ- ously been unaware of-elements they could now factor into their own assessments of suppliers' proposals.

Gather data. With a comprehen- sive list of value elements in hand.

the next step is obtaining initial esti- mates for each element and finding out what each one is worth in mone- tary terms. Sometimes, suppliers find it useful to gather data by plac- ing a team member in a key func- tional area of the customer's organi- zation for a week or two in order to gain a better understanding of what is actually being done and where

things can go wrong dur- ing the day. For example, a supplier might have a team member work in the customer's receiving department. To allay any concerns on the part of the employee, customer management should tell them that the person is

there to help out and to learn.

Frequently, the customer doesn't know that it has the data or informa- tion the supplier is looking for. The customer may think the information does not exist. In fact, the kind of data that needs to be pulled together in the analysis may reside on six or seven databases or systems in differ- ent functional areas.

Sometimes, the only way to find the data is for team members to ask around until they come across the individual who knows where the in- formation is.

Focus groups made up of represen- tatives from each functional area in a company can also be an effective mechanism for uncovering data. The Proaction Group, a Chicago-based consulting and strategy implemen- tation company, recently conducted four internal focus groups at a cus- tomer company for exactly that pur- pose. To prepare themselves and the prospective focus-group participants, Proaetion consultants met individu- ally with each prospective partici- pant before the session, learning what the issues might be and gather- ing some initial data. During the ses- sion, participants were asked what kinds of information they thought should be used in a value model and then where in the organization to look for that information. The con- sultants discovered sources of data in places that neither they nor the customer's management had previ- ously identifi.ed.

The value research team also needs to he creative in finding other sources of information. Indepen- dent industry consultants or knowl- edgeable personnel within the sup- plier company can be good sources of initial estimates. San Diego-based Qualcomm, a supplier of satellite- based mobile communications sys- tems for truck fleets, for example, drew on the American Trucking Association's research studies to provide ranges for some of the ele- ments in the value model it devel- oped for its OmniTRACS mobile communications system.When a supplier provides a service that miti- gates the customer's risk, it can be useful to tap actuarial consultants to estimate what the cost of the poten- tial difficulty would be.

The ease with which the team can establish monetary estimates for its value elements will vary. The value of social elements such as greater peace of mind, for example, is gener- ally very difficult to express in mon- etary terms. In fact, most suppliers do not even attempt to assign mone- tary amounts to social elements. In- stead, they put those elements aside and discuss them with the customer in a qualitative way after presenting quantitative results. Qualcomm docs not assign monetary amounts to many less-tangible elements but still includes them in its analysis as "value placeholders." in this way, Qualcomm conveys to its customers that those elements are worth some- thing and leaves open the possibility that a specific monetary amount might be ascertained in the future.

In any field value assessment, sup- pliers will find that some assump- tions must be made in order to com- plete an analysis. These assumptions might be about the functionality or performance a market offering actually provides in the customer's specific setting, particularly for ele- ments that are extraordinarily diffi- cult or costly to measure. Or they might be about the monetary worth of perceived or measured differences in functionality or performance that an offering provides in the customer's setting. It is critical for the supplier to be explicit about any assumptions it makes. If the customer doesn't

58 HARVARD BUSINESS REVIEW November-December 1998

UNDERSTAND WHAT CUSTOMERS VALUE IDEAS AT WORK

know how or why the team assigned a certain value to an element-or is not encouraged to offer its own ratio- nale if it disagrees with the suppli- er's estimates and then to join the supplier in researching a mutually acceptable solution-the supplier's credibility will be compromised.

Validate the model and under- stand variance in the estimates. Af- ter building the initial value model, the supplier should validate it by conducting additional assessments with other customers or potential customers in the market segment. Conducting further assessments en- ables the supplier to refine its value estimates and to understand better how the value of its market offering varies across customers' applica- tions, eapabilities, and usage.

What's more, as the supplier con- ducts additional value assessments, it will develop a greater understand- ing of where it needs to use firsthand data and where it can rely on cus- tomers' perceptions. [In soliciting perceptions, the supplier should re-

member that people are generally better at making comparative judg- ments [more or less than) than ab- solute judgments [it's worth X\. In other words, the supplier should pro- vide the initial estimate and ask the informants whether that element is more or less valuable to them than the estimate.)

In conducting additional assess- ments, the supplier will also learn how the value its offerings provide varies across kinds of customers. The supplier ean then build a database that contains value estimates-and the individual customer characteris- tics, whieh we call descriptors, that might affect those estimates - from all participating companies. Looking at all of the data together, the supplier can then determine which descrip- tors have more impact than others on the value customers receive from the offering in question. As a result, the supplier can choose to pursue those customers and prospective customers for which its offering will provide superior value.

Create value-based sales tools. Suppliers can not only use value models to inform and guide their own decision making but also to create persuasive sales tools. One common sales tool is a value case history. Value ease histories are writ- ten accoxmts that document the cost savings or added value that a cus- tomer receives from its use of a supplier's market offering. Sonoco Products Company's protective packaging division, for example, tracks the savings its customers gain from implementing an offering it calls total packaging solutions. Rather than selling customers the more commonly marketed corrugat- ed-cardboard packaging materials, Sonoco offers packaging systems that, it maintains, are stronger, lighter, and smaller. The major ele- ments in Sonoco's value model thus include savings from reduced prod- uct damage, packaging costs, ship- ping costs, and storage costs. When a customer has used these "solutions" for a year, Sonoeo constructs a case

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IDEAS AT WORK UNDERSTAND WHAT CUSTOMERS VALUE

How BT Products Uses Value Models as Sales Tools

BT Products, a suhsidiary of BT Industries Group, whieh is based in Sweden, is a worldwide producer of warehouse trucks for inventory handling. In 1993, the company created BT Compass, a logistics- planning software system, to help its eustomers improve their prof- itability by lowering the total cost of the inventory-handling process. The BT Compass system provides the following: • a full analysis of the customer's

operational requirements, • a fast comparison of different

pallet handling and order- pieking solutions,

• optimum warehouse layout, • accurate calculations of

handling capacities, • complete analysis of projected

life-eyele costs. The BT Compass system has been developed to work in seven lan- guages, and all inputs and outputs can be translated into any language with a single keystroke. It displays different layout options by using high-quality color graphics, and ail plans can be printed quickly using a printer or plotter.

BT Produets uses the Compass system when a customer is con- templating a ehange in materials handling or is adding a new facil-

ity. The system helps the cus- tomer figure out, for example, the optimal aisle width that will ac- commodate the dimensions of a counterbalance lift truck, and it calculates the layout and equip- ment requirements to meet peak- hour needs.

BT Products measures the actual performance of its competitors' equipment, often buying the equip- ment to test it. Thus it knows the critical performance measures that customers use to judge lift trucks. BT Products also gathers informa- tion about the customers' individ- ual systems. Customers sometimes provide functional specifications and ask the lift truck supplier to tell them the number and types of trucks required. If the performance is not met, the selected supplier has to provide additional trucks at no cost to the customer.

The data the customer must enter into Compass requires some eompetence on their part. To help the customer gather tbe required data, BT Produets has developed a one-page worksheet that pulls to- gether the necessary input data. (See the worksheet "The Informa- tion BT Products Gathers to Build Customer Value Models.") Some customers know the required data

very well; others do not. BT Prod- ucts' most senior salespeople work with the customers in doing the analysis. They even provide hands- on data collection as needed at the customer's facility.

One of the advantages of using Compass is that it eombines ware- house planning with an analysis of the kind and number of trucks needed to optimize warehouse per- formance. Recently, Birkenstock, the German shoe manufacturer, decided to build a new warehouse in Asbach, Germany. An in-house consultant responsible for the pro- curement process for this new warehouse had proposed a layout that required three lift trueks to handle the pallet movements. By using Compass, BT Products was able to demonstrate how an alter- native layout in conjunction with its high-performance trucks re- quired only two trueks-one less truck and one less operator. Accord- ing to BT Products' managers, with- out Compass, they would not have been able to find this new solution and provide the detailed perfor- manee results for their trueks. In addition, they believed that they would not have been able to con- vince Birkenstock management tbat their solution was correct.

study about the cost savings and re- ports the findings to the customer. Sonoco maintains a file of these ease studies, which its salespeople draw on when making proposals to other prospects. The studies persuasively convey the cost savings that the prospects themselves would likely realize.

Value assessment can also become a service that suppliers offer as part of a consultative selling approach. For example, a supplier can develop a spreadsheet software applieation that salespeople ean use on-site with a laptop computer to evaluate

the potential value of the offering to a particular customer. (For an illustra- tion of how such a tool can be used, see the insert "How BT Products Uses Value Models as Sales Tools,")

Putting an Understanding of Value to Use Suppliers ean use their understand- ing of value to strengthen perfor- mance and create competitive advan- tage in several ways. For example, a supplier can use its knowledge to tailor supplementary services, pro- grams, and systems in its current market offerings and to guide the

development of new offerings. Inte- grating everything it has learned about value into its marketing ef- forts, it can also gain new customers. Finally, it can better sustain eus- tomer relationships by documenting its delivery of superior value over time and by discovering new ways to update and reinvigorate those relationships.

Managing Market Offerings. In the article "Capturing the Value of Sup- plementary Services" (HBR January- February 1995), we argued that suppli- ers ean capitalize on the inevitable variation in eustomers' requirements

60 HARVARD BUSINESS REVIEW November-December 1998

UNDERSTAND WHAT CUSTOMERS VALUE IDEAS AT WORK

The Information BT Products Gathers to Build Customer Value Models

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This chart represents the BT Compass value-assessment worksheet. It shows the parameters that affect the costs and benefits of the supplier's offering. Clearly, many of the elements listed won't be relevant in other industries, but they are central to assessing value for this company.

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within market segments and in- crease their profitability by provid- inj; flexible market offerings. Doing so entails construeting what we call naked solutions with options. Naked solutions consist of just tbose product and service elements that all customers within a market segment value. We said that suppli- ers should strive to sell naked solu- tions at the lowest possible price that will yield a profit. Then suppli- ers should "wrap" those solutions with options-specific product and service elements that some, hut not all, customers value.

A company's ability to manage flexible market offerings suceessfully rests on its understanding of the value each component of an offering creates as well as its associated cost. An understanding of how eustomers value those components-and what they cost the supplier to deliver-en- ables suppliers to identify and elimi- nate what we call value drains. These are services that cost the supplier more to provide than they are worth to the customers receiving them and that have no strategic significance.

Consider this: A producer of chemicals used in extracting oil

HARVARD BUSINESS REVIEW November-December 1998

from wells routinely performed a field analytic monitoring service for its customers to determine when, and in what amounts, they should apply its products. A salesperson vis- iting one of the eompany's small, less sophisticated customers noticed the reports staeked in a corner of the production shed. When asked about their usefulness, the customer replied that he was not using the in- formation at all and instead just had the producer's truck driver pump a few gallons of the chemicals into each well whenever the truek came hy. Learning this, the supplier offered

61

IDEAS AT WORK UNDERSTAND WHAT CUSTOMERS VALUE

Understanding Value: How W.W. Grainger and Its Customers Benefit

W.W. Grainger distributes maintenance, repair, and operating (MRO) supplies and related information to the c<»mmercial, industrial, contractor, and institu- tional markets in North America. Grainger's mission is to provide the lowest total-cost distribution for 173,000 MRO supply items, such as claw hammers, replacement motors, safety eyewear, and lubricants. In the early 1990s, Grainger's managers realized that to reaeh their ambitious goals for growth, the company would have to help its customers better understand the total cost of MRO supplies acquisition and man- agement. At the same tune, a growing number of Grainger's large customers were becoming concerned about the money they were spending-beyond the actual purchase prices - for MRO supplies. Recognizing an opportunity, Grainger's managers formed Grainger Consulting Services (GGS) to help customers under- stand the total cost of MRO supplies management.

GGS hegan hy performing a heachmark study free of eharge for i s of Grainger's large customers. At each company, GGS detailed the steps involved in acquiring an MRO item and outlined the estimated costs associ- ated with each step. Since the original studies, GGS has gained extensive experience and knowledge in building customer value models, which it calls total cost models. Anil as its reputation has grown, it has increasingly offered its consulting services on a for-fee basis to clients.

GCS's experience with Pharma Lahs [a disguised name) provides a good illustration of how it huilds and uses customer value models.

Pharma Labs is a rapidly growing Pharmaceuticals manufacturer. At one of its largest plants-a facility with 5K0 employees - purchasing managers were questioning whether to outsource their MRO procure- ment and inventory management processes. During a routine sales call, the Grainger account manager learned ot the managers' concerns and arranged a half- day meeting with the viee president of operations, the purehasing manager, and the maintenance manager at that facility.

During the meeting, two GGS managers toured the facility to gain an overview of its MRO-supplies-man- agement processes. Also during this meeting, GGS consultants showed Pharma managers how GGS de- fines cost savings and outlined the sometimes hidden eosts of MRO supplies management. The consultants

told the Pharma managers, for instance, that some companies do not account for MRO supplies inventory and associated carrying costs.

Following the meeting, GGS proposed that it per- form what it calls a baseline assessment, which docu- ments the total costs of MRO supplies management and then, following that assessment, offer Pharm;i managers some strategic recommendations ab(tui how they eould improve their operations. GCS told Pharma Lahs that the assessment and the strategy de- velopment would take 6 to 12 weeks to complete and would cost $4S,ooo. Pharma Lahs management agreed to the proposal, hiring GCS in January 1997.

To begin, GCS put together a case team, which con- sisted of a consulting manager, a consultant, and a husiness analyst. Pharma Labs formed a steering com- mittee and a projeet team. The steering eommittee comprised the relevant department heads, such as maintenance, purchasing, manufacturing, inventory management, management information systems, and finanee, and was responsible for project oversight and strategy development. The project team was a smaller cross-functional group with representatives from each of the departments on the steering commit- tee and was responsible for working with the GCS case team.

Generally, GCS looks for the elements of its eus tomer value models in four primary areas: processes (from how the need for items is identified to payment of invoices), products (product price, usage factors, brand standardization and application), inventory (on-hand value and earrying costs), and suppliers (per- formance, consolidation and value-adding serviees provided), hi each area, GCS defines value and cost saving elements (such as freight and courier charges and the cost of overtime), specifies the measures for the elements (such as procurement cost per purchase order, number of suppliers, and inventory accuracy), collects the data and analyzes them, and specifies measures for monitoring performance. At Pharma Labs, the measures for monitoring performance in- eluded supply expenditures, number of suppliers, and transaction volume.

In a baseline assessment, GCS uses process mapping and activity-based costing to build customer value models, drawing on proprietary databases that the company has huilt from its findings in past engage-

62 HARVARD BUSINESS REVIEW Novombcr-Dci;ember 1998

UNDERSTAND WHAT CUSTOMERS VALUE IDEAS AT WORK

mcnts. At Pharma Labs, GCS applied an activity- based-costing approach to identify procurement costs across all typical functional areas-purchasing, main- tenance, receiving, and accounts payable. These iden- tified costs were generally in line with costs tracked in the GCS databases.

In any analysis, GCS attempts to use the customer's electronic: data whenever possible. The team usually attempts to get one year's worth of data. Early on, the case team makes a site visit to examine the customer's data and to assess how accurate and complete they are. In the case of Pharma Lahs, GCS analyzed two years' worth of purchasing and accounts payahle data, as well as six months of procurement card data. The data provided GCS and Pharma with insights ahout the potential for consolidating the numher of products Pharma purchased regularly from various suppliers. It also suggested htjw Pharma might consolidate its purchases in return for lower prices and greater value- adding services from its remaining suppliers.

At Pharma Lahs, as in most GCS engagements, the case team also had to do an invoice analysis ^actually inspecting past invoices to gather usahle d a t a - t o vali- date the electronic data and to provide additional line- item product detail when available. The level of detail that the customer has is usually not adequate. The customer's system may contain only aggregated pur- ehase-order information, showmg only how much was paid in total. Complicating the task further, invoices themselves often have incomplete item descriptions that make it difficult to determine exactly what was purchased.

The GCS team also found from its inventory analy- sis that Pharma Lahs had no records of the amount of inventory on hand or its usage, Inventory levels were extremely high-the team later found that Phar- ma had more than $i million worth of slow-moving i n v e n t o r y - h u t no actual record of this inventory was maintained in a system to track and manage the items.

The GGS case team supplemented its analyses hy interviewing the Pharma project team members. In these interviews, GCS shared its preliminary findings, tried to uncover anything that they might have over- looked, and learned what the Pharma managers them- selves perceived to be potential areas of improvement. The interviews were, in fact, fruitful, alerting GGS and

Pharma managers to at least one significant finding in the procurement area. It turned out that Pharma lah technicians played an unusually large role in the procurement process, handling some routine purchas- ing, maintaining detailed, handwritten logs of all transactions, receiving the items into inventory, and managing that inventory. The GCS value model showed that Pharma Labs was spending 10% of its procurement costs-or the equivalent of nearly three full-time positions-on lab technicians who could he redeployed from this purchasing function to more value-adding activities in their intended function. Pharma Labs eventually signed a supply agreement with another company, which, in return, put one of its people on site to manage this procurement process.

After GCS completes a haseline assessment, it then tries to specify improvements that the customer can make in 6 to 12 months. It also works with the cus- tomer to formulate changes in the MRO-supplies- management strategy.

At Pharma, GCS identified at least $327,000 in total cost savings on the $6.1 million Pharma was spend- ing yearly on MRO supplies, including the costs of acquirmg and managing them. These projected cost savings came ahout through consolidation of suppli- ers and product-spending reductions ($165,000), in- ventory reduction ($72,000), and process improve- ments ($90,000). For example, GCS recommended that Pharma Labs dramatically consolidate its MRO supplies purchases. Pharma Labs agreed and initiated a national account agreement with Grainger in June 1997. In return, Grainger provided Pharma Lahs with an on-site Grainger representative to manage the purchase and inventory processes at the company. This allowed a Pharma Labs maintenance technician wbo had been spending 100% of his time purchasing MRO supplies to return to performing value-adding maintenance activities.

What were the ultimate results of Grainger's work with Pharma Labs? In December 1997, GCS and Phar- ma Labs jointly conducted an audit of achieved cost savings, which were found to he $387,000 during the first six months. What's more, for the whole of 1997, W.W. Grainger sales to Pharma Labs increased seven- fold, from $50,000 to $350,000. Clearly, a better un- derstanding of value created substantial benefits for each company.

HARVARD BUSINESS REVIEW November-December 1998

IDEAS AT WORK UNDERSTAND WHAT CUSTOMERS VALUE

to discontinue the service and, in exchange, give the customer a 7% per-gallon price reduction. The cus- tomer readily agreed, and the profit- ability of that account jumped from minus 6% to 32%!

Rather than finding value drains by chance, as in the example, suppliers can set out to detect them by using field value assessment in conjunction with activity-based-costing analysis.

use value assessments to determine what improvements are worthwhile and which ones have the highest priority. For example, the supplier could ask managers in different func- tional areas of customer companies to evaluate potential improvements. One cbemieal pigment supplier asked managers in its customer's production and R&JD areas to perform a conjoint analysis for potential

changes in its offering. Specif- ically, the sup-Knowing that an improvement

r • V. • • ^ ^ i plier wanted to

in some functionality is important does not tell a supplier if a customer is willing to pay for it. Identifying and eliminating value drains results in better allocation of resources and improved profitability. Virtually always, the results more than pay for the cost of doing the field-value-assessment research.

Guiding the Development of New or Improved Products and Services. Most market research that is con- ducted to provide an understanding of a customer's requirements and preferences does not address the question: "If we do X, what is it worth to that eustomer?" Knowing that an improvement in some func- tionality is important does not tell a supplier if the customer is willing to pay for it. Value models provide that information.

In cases where the supplier's new offering will introduce technology into the market, for example, a value model can demonstrate to prospective customers how tbe tech- nology can provide greater value for them. That's an especially critical point when the new technology makes the market offering itself higher priced than the alternative choices, which may use more estab- lished and familiar technologies. At the same time, a model allows the supplier to see how the value of its new technology varies across applications, eustomer capabilities, and usage situations.

When a supplier is developing a new offering in response to cus- tomers' requests or demands, it can

know bow the customer would value some near- term-aehievable changes in tech- nical attributes,

sueh as gloss or dispersibility. At the same time, the supplier asked the customer's general managers and purchasing managers to consider tbe potential value of ehanges in the products' commercial attrihutes, such as the supplier's delivery ser- vice and payment terms. Although the findings largely conformed to the supplier's management expectations, there was at least one important dis- covery: tbe relatively high value the customers placed on improved dis- persibility. Subsequent field investi- gation confirmed tbat tbe supplier's eustomers were indeed having many troubles witb "floeking," tbe clump- ing that can sometimes oceur as a dry pigment is dispersed into a liq- uid solution.

Gaining Customers. Knowledge of how their market offerings specif- ically deliver value to customers enahles suppliers to eraft persuasive value propositions. Consider the case of Greif Brothers Corporation, which produces fiber drums, plastie drums, and intermediate bulk con- tainers for food products and ehemi- cals manufacturers. Ratber tban competing on a price-per-container basis, Greif markets complete pack- aging systems. Tbat is, Greif stays involved witb its eustomers through- out the life cycle of tbe containers- monitoring how tbe customer uses the container, following tbe contain- er's path to the end user and retriev- ing it when it is empty, and disposing

of it or reconditioning it. Greif s value proposition - total-cost-based pack- aging-promises that its systems can significantly reduce a customer's total packaging costs.

How does Greif develop its propo- sitions? First, a Greif strategic ac- count manager, together witb a representative from the customer, builds a value model to understand total costs. (Greif developed its cur- rent model based on information from 20 major customers.) Key ele- ments include the eosts associated with tracking and retrieving tbe drums, cleaning and maintaining them, testing and recertifying recy- cled drums, and all the associated paperwork.

Greif has found that customers- both existing and potential-can readily assign monetary values to some elements but that other ele- ments are more difficult to pin down. For those elements that are harder to quantify, Greif takes its analysis to a deeper level. Consider the benefit of environmental stewardship. To get a handle on tbe value of that element, Greif determines wbat per- centage of its customers' customers' locations (that is, the end users' loca- tions) are in landfill-restricted areas, where tbe cost of disposing of the containers is higher tban at other locations. Greif's service-which, as we said, includes retrieving the con- tainers - not only eliminates this cost but also indemnifies its customers against improper disposal by tbe end users, protecting them from fines levied by the Environmental Protec- tion Agency. While these analyses do not account for all tbe reasons that environmental stewardship would be worth something to a customer, such as the value added to tbe cus- tomer's reputation, they nonetheless make environmental stewardship worth something to the customer in monetary terms.

Using tbe value model to construct several viable total-cost-based pack- aging solutions, Greif's strategic ac- count manager and a team of Greif experts from logistics, handling sys- tems, and computer services then give a comprehensive presentation to tbe prospective customer's senior managers. During the presentation,

64 HARVARD BUSINESS REVIEW November-December 1998

they discuss the merits and prices of each solution.

Sustaining Customer Relation- ships. At tbe core of all successful working relationships are two es- sential characteristics: trust and commitment. To demonstrate their trustworthiness and commitment to customers, progressive suppliers periodically provide evidence to cus- tomers of their accomplishments. Sales managers at Greif, for exam- ple, give customers quarterly re- views tbat document actual eost savings. Applied Industrial Tech- nologies (AIT), a major distributor of specialty replacement bearings, power transmission components, and fluid power products in tbe United States and Canada, provides another good example.

AIT primarily serves maintenance, repair, and operating (MRO) supplies markets within the primary metals, mining, pulp and paper, utilities, chemical processing, textiles, food processing, and agricultural indus- tries. It operates more than 337 branch locations across tbe United States. In 1990, tbe company began to market a value proposition promis- ing to help its customers improve productivity ratber than simply selling them parts at a low priee. Through value assessment, the com- pany began to work with its cus- tomers to belp tbem save money in areas such as maintenance, inven- tory, and energy consumption - any measurable area other than purehas- ing. The results were collected in what AIT ealls documented value- added savings, whicb is now the cornerstone of tbe company's part- nering efforts.

AIT trains all of its employees- from branch managers to field asso- ciates to delivery drivers - to look for ways to improve customers' opera- tions, and the company rewards tbem for their successes. And to sup- port their efforts, the company has developed a customized software program tbat calculates cost savings. Sales representatives can run the program on laptops while visiting customers. Working with customers' managers, representatives input data for potential value-adding and eost-reduction variables - variables

that AIT and the customer have pre- viously agreed on. Then, either on a quarterly or a semiannual basis, AIT presents each customer with a re- port that documents the savings, al- lowing customers to assess firsthand the value AIT has delivered.

In order to establish credibility for its reports, AIT asks customers to sign and retum a copy. Tbe company keeps track of the performance of eaeh cost-savings initiative and ag- gregates the totals. AIT calculates that last year it provided more than $100 million in cost savings to its customers.

Delivering Superior Value and Getting an Equitable Return Understanding value in business markets and doing business based on value delivered gives suppliers the means to get an equitable return for their efforts. Tbe essence of customer value management is to deliver superior value and get an eq- uitable return for it, both of whicb depend on value assessment. W.W. Grainger, the MRO supplies distrib- utor, is an excellent example of a company tbat has realized the bene- fits of measuring and monitoring value for its customers. Tbe company has even establisbed a consulting arm, Grainger Consulting Services, specifically to help customers un- derstand the total cost of MRO supplies management. (See tbe in- sert "Understanding Value: How W.W. Grainger and Its Customers Benefit.")

Perhaps equally compelling, though, is an observation made by a senior manager at one company tbat does business based on value: "Sell- ing only on price - where's tbe fun in that ?" This manager recognized that when there is market pressure on price, bis business unit needs to re- spond by demonstrating tbat it has something different to offer-some- thing that will provide superior value, Assessing and truly under- standing value in business markets is the beginning of the path to prof- itable fun. ^

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