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Do more than just satisfy your customer - profitably delight them.

A competitive edge. It is what every company needs. But the past areas of differentiation from competitors are losing value. At one time, being able to buy raw materials cheaper than anyone else was a critical advantage. Resource rich nations and colonial empires all had this edge. But today, the raw material market is worldwide. Everyone now buys the raw materials they need at the same or similar global prices.

Reducing labor costs was the next area of differentiation. Productivity programs, industrial engineering and incentive systems were all tried to reduce labor costs and all were very successful. Most recently, the drive to produce in low-wage rate countries and import into other markets was another attempt to reduce labor costs. But the productivity programs were so successful that the amount of direct labor in a dollar of shipments today averages 7 cents. In some companies it us down to 3 cents. It is difficult to visualize that you will gain a competitive edge by driving the 7 cents down to 6.9. This is especially true if using offshore labor -- the costs of importing and the additional overhead to manage offshore businesses will often eat up any direct labor cost savings.

Superior technology, of product or process, can give you an edge. But today, technology is flowing around the world like water. Your new product or process is copied or even surpassed a few months after introduction.

Better sales and marketing than the competition can give you an edge. But any program you develop in this area can quickly be copied by the competition as it is very visible. And there is just so much you can do in this area. The choices in sales and marketing are not infinite.

Product quality is the latest program to give you an edge. This was the program of the 1980s. And it was successful for most companies. But there is little room for an edge when every company has improved their product quality. Today, product quality is a given just to be in the ball game.

So what is left? The answer: To figure out how to profitably delight your customers. This is an edge that cannot be taken away. You can lose it of course.

Note I do not say we should satisfy customers. There are two reasons for this. First, the customer paid to be satisfied. There is no edge from giving customers what they expect.

On top of this there is considerable risk. Several surveys, some recent and others quite old, all state that twice as many people tell others about their bad experiences with products and services as tell about their good experiences. With this human bias, it is obvious you must always err on the good side -- delighting. You cannot tolerate the notoriety of the bad side.

Second, the job is to make money. So you have to figure out how to make a lot of money while treating customers like royalty. Having the objective of satisfying the customer without the profit motive just does not make sense.

Figure 1 shows this idea clearly. From your point of view, the producer, you see the prices you charge for products less total business costs as profits. I probably should add to this figure something about assets because it is obviously return on assets (ROA) that you are interested in.

Your customers see the picture quite differently. They receive value from your goods or services. They also see the prices they paid. The differential is worth or delighting the customer.

The objective is clear. Increase the worth to the customer as you increase profits, or, more correctly; ROA.

This will be the battleground of the 1990s. The winners in this decade will be able to transition from past ways of behavior, mainly internally focused, to the new ways which are externally focused, shown in Figure 2. The left side results in delighting the accountant, which may be your objective. The right side profitably delights the customer, which should be your objective.

What elements constitute delighting the customer? There are obviously many and these could differ depending on the type of customer. They range from such simple things as how the receptionist answers the telephone to the performance of the product or service. I am going to focus on one element, the availability or delivery of the product or service when needed. I believe this is the core of delighting the customer, maybe as much as 50 percent of the total. All other facets, such as product quality, price, performance, etc. are worthless if your customers cannot get the products they need when they need them. And as mentioned earlier, most competitors today are very similar with their product performance, quality and price. They are not close with availability and delivery when needed. Here is an opportunity that should be exploited to differentiate your company from your competition.

It is also an opportunity to put the word "profitably" in front of delighting the customer. The costs of meeting customer need dates are often excessive and the assets to do it are also often high. Hence both the numerator and denominator in the ROA equation are adversely affected. You are delighting the customer, but at what cost? I will get you to look at this problem from a different perspective and you will see the potential for great improvements.

Flex the factory

So far I have been discussing products and services together. And my earlier comments apply equally well to either industry type. But now I am going to focus on manufactured products. I am doing this because this is the more complex of the two industry types. It is also where a lot of work has gone on already at the factory level so can be used as a foundation for the balance of the article. But the ideas are just as applicable to the service industry. Hopefully those of you from that segment will be able to glean the concepts from the factory examples and apply them to your business.

The majority of marketplace demand is dynamic. It is a rare company that has stable demand from both a volume, mix or product design standpoint.

One way of solving the dynamic marketplace problem is with a flexible factory. Most of the programs embodied in the just-in-time (JIT) philosophy address this very subject. Quick changeovers, cross trained workers, fast flow processes, cell layouts, and co-makership relations with vendors allow fast response to product mix variability from your customers. But this response is limited, it cannot be infinite. And as just stated, most of these JIT ideas give flexibility to mix dynamics. Volume dynamics is a different story. Few companies are able to quickly adjust volumes up and down because of the ramification to working hours, hiring and firing, and the need for extra capital equipment. What if you have done everything you can think of to increase factory flexibility, both volume and mix, but it is still not enough to cover the marketplace dynamics? You have implemented most of the JIT ideas and have continuous improvement programs going to continue the process but there are no huge gains to be made left. You have also tackled product design to ensure variability can be added at the last moment. You still cannot flex as fast as the marketplace dynamics demand.

You have three choices left. First, decouple the factory from the marketplace with inventory. This is a risky business in a dynamic marketplace because forecast error increases with dynamics. If you cannot have the right inventory in place you will fail to delight the customer at the same time as you increase assets. Not too smart a move.

Second, decouple the factory from the marketplace with lead times. As business increases, quote longer lead times.
MANUFACTURERS' CHANGING VALUES
 Old New
(Internal Focus) (External Focus)
Efficiency Quality
Absorption Value
Utilization Delivery Time
Variances Flexibility
Standard Costs Total Costs


As it contracts, shorten them. This could be done to a segment of the marketplace, not all of it, if you wish. You would do this to that segment that you could live with alienating at times, not to your core business. This means you deliberately plan not to delight all your customers with availability or delivery when needed. This tack will not hurt your ROA except for the business you might lose from the alienated customers.

Third, address the causes of demand instability. See what you can do to reduce the marketplace dynamics down to the flexibility of the factory. You wont need inventories or excess capital equipment now, and you gain the volumes from delivering to all customers when needed. Now you will delight your customers always and earn a high ROA doing it.

Desirable demand characteristics

Ask any business manager, "What would you like your customer demand to be?" and they will say, "Stable, growing at a pace I can successfully accommodate." Ask them what they would not like the demand to be and they will say, "Peaks and valleys, feast or famine."

The volatility they are against is volume dynamics. This is the toughest type of demand instability to handle because of its negative effect on capital equipment needed, hours worked, number of employees, etc. Mix volatility is much easier to handle, especially with many of the JIT changes mentioned earlier. Volume volatility means demand is unpredictable. You will not be able to delight your customers with the right product delivered at the right time. And all your attempts to do so will be costly.

A dynamically changing factory costs you. High inventories to accommodate the dynamics or excess capital equipment to allow you to adjust outputs in tune with the dynamic volumes will also cost you. Hence your ROA performance is cut drastically.

But many companies experience severe volume fluctuations and they are not tied to seasonality or other environmental causes. The desire of managers for stable growing demand is not being met; instead they get the peaks and valleys, the feast and famine they say they do not want.

There are two causes of marketplace dynamics. First, there is the underlying dynamic caused by changes in the economy, competitors, customers buying habits, seasonality influences, etc. Second, there is an induced dynamic, caused by policies or actions we or the competitors introduce into the marketplace. It is this second cause of dynamics I want to address.

The company sees the total of these two causes of dynamics as its demand pattern which it must try to accommodate. If the factory cannot easily adjust product volumes to suit this dynamic, then all the negatives mentioned earlier start.

What if we were able to reduce or eliminate the induced dynamic? Perhaps now the volume volatility is within the volume flexibility of the plant. You can start to profitably delight the customer under this condition.

Causes of instability

I will use a favorite analogy from the JIT movement to start the discussion of instability causes. The analogy is the lake and rocks, shown as Figure 3, but applied to sales and marketing. The depth of water in the lake is inventory, to keep the boat from crashing on the rocks. But this does not give good customer response because the inventories are invariably the wrong things. And the rocks are all costly, designated as non-value-added-waste (NVAW) by the JIT philosophy. ROA suffers greatly under this scenario as does profitably delighting the customer.

The few rocks shown in Figure 3 are the tip of the iceberg. A more complete list is shown as Figure 4 but note the "etc." at the bottom. This is not a complete list. You can think of others that apply generally as well as some specific rocks for your company.

What do these pictures mean? They say that sales and marketing do not work hard to profitably delight their customers. They apply policies and take actions that result in induced marketplace dynamics. And these result in hurting customers or requiring excess costs and assets to try to delight them. Sales and marketing are the victims and the culprits at the same time.

A few items from Figure 4 have been chosen to explain clearly the problem of induced dynamics. The solutions are clear although tough for many people to accept, especially those in sales and marketing. It will take some excellent leadership from general managers to ensure the solutions are implemented.

Periodic sales targets

Most sales departments measure their order intake against a budget figure for a month, quarter or year. This gives rise to spikes of demand late in the budget period as everyone scrambles to meet the target numbers.

For example, a large computer company, headquartered in the Northeast, experiences a repetitive pattern of feast and famine during the year, caused solely by a periodic sales targets process.

They try to deliver a customer specified unit within 48 hours after receipt of order. Hence order booking and planned shipment are almost synonymous.

In the first month of every quarter they book 20 percent of that quarter's revenue target. In the second it is 30 percent and the last month it is the remaining 50 percent. This pattern repeats regularly every quarter. Based on this you can see that the sales of computers are seasonal.

How does that hurt customer service? In the first month of every quarter, the factory produces about one third of the budgeted sales for that quarter (it has to produce levelly because of capital equipment and people constraints). This means 13 percent of the quarter's revenue value flows into inventory. This inventory is produced based on sales forecasts of future orders.

In the second month, the factory again produces one third of the sales budget, sales sells 30 percent, so the inventory changes only slightly. And then along comes the third month.

The factory produces one third, and then has to reconfigure all the inventory made to sales forecasts (forecasts are always wrong). Overtime in the plant is enormous, a chaotic situation exists, and mistakes get made. You can trace the quality problems in the field to the month produced. Invoice errors occur in the last month of the quarter because many of the special deals the sales people make to get the order do not get transmitted to the order billing department. The credit memos get written the first month of the next quarter. And even though there is huge effort and expense, some customers still do not receive their computers when promised. This company is certainly not delighting their customers profitably.

The solution is very clear. If you agree with the earlier statement that you want stable, growing sales, then this is what you must motivate. Sales targets should be daily. Production targets for most plants are daily. And there are just as many things that could go wrong in the factory to hurt daily production as there are in the marketplace. Reward stable growing sales, penalize peaks and valleys, especially those that are self induced. The difference in demand patterns will astound you.

Invoicing schedules

A billion dollar division of a large European electronics company only invoices their customers twice per month, around the 10th and 25th. This is to minimize work in accounting and data processing -- you only have to run the order billing programs twice per month. Payment terms are from the date of invoice, not the date of shipment.

The products they sell are consumer goods that are made to stock and shipped out of their central warehouse.

When do most of the orders come in? On the 11th and 26th. That way, customers get an extra 15 days free ride on this company's cash.

But now picture the work load in the warehouse. Immediately after the invoice date, overtime is used to try to deliver products in their quoted delivery cycle. They fail a good percent of the time. Later, prior to the invoice date, the work load in the warehouses is almost zero. The employees try to look busy or get laid off temporarily, to get rested up for the peak they know is coming.

Are they profitably delighting their customers? Of course not. The solution is obviously invoicing daily, with payment terms from date of invoice which will be almost the same as shipment. But this company is experiencing difficulty in introducing this change because their customers like the extra 15 days of defacto credit terms they are getting under the old system. They are having to extend their normal payment terms with large customers to appease them. But when daily invoicing becomes the norm, they will see a significant leveling of their demand, with subsequent improvements in customer service and their profitability.

Sales promotions

Many companies use a variety of promotional techniques to stimulate sales. We are familiar with those aimed at consumers, such as two for one, discounts, rebates, or lower credit interest rates.

Do promotions give you stable, growing demand or peaks and valleys? The obvious answer is peaks and valleys. Are promotions a way to profitably delight the customer? The answer to this question is not so obvious. But a recent article, "Getting the Most Out of Advertising and Promotion," Harvard Business Review, May/June, 1990, describes a scientific way of evaluating promotions and gives some results. These results are from the actual promotion itself plus some lingering effects after the promotion ends. The results do not include any costs in manufacturing to support the promotion -- it is a sales only evaluation.

Based on this study, the authors claim, "Only 16 percent of trade promotions are profitable -- and for many, the cost of an extra $1 of sales is greater than $1." How is that for profitably delighting the customer? If we include the additional manufacturing, inventory and storage costs to get ready for promotions, the 16 percent is optimistic.

Do promotions motivate steady, growing sales? Of course not. They deliberately create peaks and valleys, the hope is that the peaks will be higher each time giving you growth and market share. But if you major competitors also use promotions, aren't you simply stirring up the marketplace and losing money in the process?

Some promotions are obviously beneficial. When you have excess, slow moving inventory, a promotion to get rid of this millstone round your neck can be very profitable compared to the alternatives. But the promotion must be approached with this objective, so it ends when the excess inventory has been disposed of.

What is the alternative to promotions? Some companies are promoting "everyday low prices," rather than a high price sometimes and discounts during promotions. Anyone watching the domestic car manufacturers and their on again, off again rebate programs cannot help but wonder if they priced their cars reasonably to start with and then used their promotion dollars on advertising or other programs to stimulate increased showroom traffic, whether they would not make a lot more money in the end.

Do promotions always delight the customer? Sometimes. Sometimes they do not. Many promotions are so successful that the company runs out of stock. Customers are now put on backorder, even regular customers who need your product but cannot get it. Capacity is now diverted to make more of the promotional item, perhaps hurting the availability of other items. You have done more damage than any temporary benefit you get from a lift in sales of the promotional item.

Please look at your sales promotional activity and determine if it is profitable in total. Also determine if promotions delight your customers. If you get a resounding "yes" to both questions and you cannot think of a better way of motivating sales, continue. If the answer is "no" to either question, challenge whether promotions belong in your tool kit of selling activities.

Volume discounts

Many-companies charge less per unit the greater the volume purchased. This is normally communicated to customers through a published discount structure.

Is this technique designed to give stable, growing demand? Of course not. It is designed to give peaks and valleys.

Does it profitably delight the customers? Rarely. Just like sales promotions, discount structures can make a lot of trouble.

A company in the mid-West used to sell using published discount structures. The largest discount was given if you bought 4 truck loads of one item. They only had 3 companies large enough to justify buying in these quantities.

When one of these large orders came in, there was great rejoicing in the sales department. They would make their monthly sales budget now.

However, four truck loads of one item was more than this company normally carried in stock. And the arrival of the order was unpredictable. So they could not build the needed inventory ahead of the order.

They pulled every piece of inventory out of stock and shipped a partial to the customer. Now they are on backorder to this customer plus any others who want to buy this item, many of them paying higher prices because of smaller discounts. They lose some business because of being on backorder and now scramble the plant schedules to get some more of this product built. This is obviously at some incremental cost, and perhaps hurts the availability of other items. When they get the backordered item produced, at some incremental cost, they now ship it out at the lowest possible price to the large customer who bought at the largest discount.

Science at work

You can now see why I said this company used to use published discount structures. They believe this technique did not profitably delight their customers. And it is obviously a questionable activity. Your customers need a certain flow of products into their companies on a regular basis. Capture as much of their needs as you can.

Discount structures take a fairly smooth demand and make it peaks and valleys. On top of this, the demand now becomes unpredictable so excess inventory or poor service is the inevitable result. And your customers, who need a fairly regular flow of product, are incentivized to receive large globs now and then. They now have all the costs of storing, handling and inventory financing. This does not delight your customers.

A better approach is to give discounts based on annual volumes, not individual shipments. You will still get a peak towards the end of the annual period as customers buy extra to get to the next discount level. Level this out by having the year end different for different customers or sales territories.

A case study

A 3M plant was experiencing severe fluctuations in demand from its customers. The customers saw the problem as poor delivery performance from 3M. 3M was building inventory on overtime and depleting it with idle time in a futile attempt to compensate for the demand variability.

The customer alternated between inventory levels that were too high and poor customer service. A lose situation existed.

Analysis of the situation showed the overall demand to be relatively stable. Actions taken by customers and 3M took the stable demand and caused it to become peaks and valleys.

A joint program between 3M and one of its customers addressed the induced dynamics and removed the causes. Demand is now much smoother with interesting results:

* Customer inventory turns improved from eight to 50 within six months;

* 3M has shipped 100 percent on time since the inception of the program;

* The customer awarded 3M certified vendor status in May 1986; and

* The program has been accepted by all major customers, accounting for over 70 percent of total demand, with almost identical results to the case study.

How is that for profitably delighting the customer?

A double-edged sword

Variety is a parameter that can be very beneficial or detrimental to a business. What do I mean by variety? Well, there is several kinds of variety, such as end products, options, raw materials, components, customers, order sizes, processes, vendors, tooling, machinery, tolerances, finishes, packaging and so on. Each of these varieties brings benefits to the business along with extra costs or needing additional assets. It is obvious that increasing variety is a good strategy if the benefits pay for the incremental costs and assets in heightened ROA. Variety is detrimental when the costs or assets make the benefits negative.

It is important for the rest of this discussion that you realize I am not for or against variety. My comments might lead you, to think I am against variety, but I am not. I am for managing variety to the optimum, where you earn maximum ROA.

The reason my comments might be viewed as negative to variety is most companies have far more variety than the optimum. Cutting back should be the norm, not increasing.

We can all agree, I hope, that one end product is not enough. I hope we can also agree that infinity is too many (this may be tough to swallow by sales and marketing people but give it a try). Now the bounds of the problem are clear, the question is, where should we be? What range of products should we have to reach the optimum, which I will continue to define as profitably delighting the customer?

Additional product variety increases sales volume. The facts are that most companies get 90 percent of their sales from 10 percent of their product line. The 80/20 rule rarely applies. So the incremental sales revenues from adding new products, unless they fall in the 10 percent range garnering 90 percent of sales, is very small. The incremental margin is obviously smaller still.

The costs of managing variety are a function of the number of items being managed. The function is not lineal, but exponential. The additional costs are mainly in overhead, indirect, and problem resolution areas such as scrap and rework. Hence, the costs of managing variety quickly eat up the margins variety bring, causing a loss of profits after variety passes a certain point.

Professor Thomas H. Johnson, one of the authors of Relevance Lost, says, "An illusory view: that 85 percent of the products make 110 percent of the profit and the other products are losers. The reality is that 25 percent of the products make 200 percent of the profit. The other 75 percent are losing money."

If we bring assets into the picture, of inventory, tooling, machinery, warehouse space, additional computer equipment, and so on, the picture of ROA is probably 10 to 15 percent of products are contributors, the balance subtract.

I am not suggesting that we should cut the product line at the 10 to 15 percent mark. Some products are new and it is no surprise, neither is it bad business judgment, that we need to subsidize these for a while. It is also possible that some losing products are needed to sell the winners -- the linked sale idea. What I am suggesting is every product that does not directly carry profits to the bottom line or contribute positively to ROA must be challenged and justified. This challenge must be regular, perhaps quarterly, to ensure that losers are tolerated for good business reasons, not accepted because of misconceptions about which products contribute and which subtract.

Managing a flock of varieties

So far the discussion has been about end products. What if I substitute options, raw materials and components for end products in the preceding discussion? I think you will agree that my comments apply just as much to these varieties, perhaps more so, because there is no incremental revenue from adding more raw materials or components, only additional costs and assets.

How about customer variety? Isn't it obvious that you make a lot of money on some customers and lose it on others? The support costs for some customers exceed their annual margin value.

It is often a surprise, too, which customers are which. One of my clients in Europe, making a paper product, thought that small customers were the most profitable. The whole sales and marketing strategy was to develop leads for small companies. The large customers demanded large discounts so were assumed to be less profitable.

Upon more analysis, it was found that the small customers needed a lot more support, in sales, order entry, advertising, invoicing, freight and so on. The large customers needed very little attention. The upshot of the analysis was that their few large customers generated most of their profits. The small customers contributed very little or even cost more than they contributed.

To make it even worse, the fastest growing companies were the large companies. The small ones were growing, albeit slowly. Hence this company had exactly the wrong strategy, foregoing market share by not focusing on the large companies because their profitability belief was exactly wrong.

How about changing the variety discussion to order size? By this I mean large orders from customers versus small ones. It is obvious that the costs of handling small orders is about the same as large ones but the margin in a small order is far smaller. In many cases companies have found that their costs to process small orders exceeds the margin content in the order. Every order under a certain size is therefore a loser.

Again, you have to support some big customers with small orders now and again to get their business. But not all small orders come from these big customers. Challenge all these losing small orders and weed out those you can with minimum order sizes or make them profitable with up front charges just to enter the order.

Early on I said that I would focus on a key element of delighting your customers, having products available when they need them. I suggested this is the core of delighting customers, may be as much as 50 percent of the total.

It is obvious that as variety increases so does forecast error. The law of small numbers guarantees this relationship. If forecast error increases, so does the inventory needed to meet customer demands. This additional instability of the marketplace means a lower customer service is almost preordained. Earning a high ROA and delighting the customer becomes a much tougher, perhaps impossible condition, with excess variety of any of the varieties mentioned earlier.

A war on all varieties must be started in every company. Keep the beneficial forms, weed out those that are detrimental. Your return on assets will show great improvement as service to customers leaps upwards.

Profitably delighting the customer is the next challenge for companies worldwide. The winning companies in the next decade will be those who can succeed in this objective.

Many facets add up to profitably delighting the customer. I have focused on one, availability when needed. I have done this because the degree of availability certainly influences customers' opinions of our performance. On top of this, availability also seriously influences our costs and the assets needed to support delivery, so it also influences our profitability and return on assets.

Availability when needed is a complex subject. Most solutions to date address increasing factory flexibility to enhance responsiveness. Most of these changes can be grouped under the heading of the JIT philosophy.

But a complementary program is needed to address demand instability. Instability hurts delivery when needed, because unstable demand is also unpredictable demand. You cannot possibly have the right products ready at the right time. On top of this, assets are increased, of inventories or machinery, to react to the market dynamics. Minimizing marketplace volatility, at least those elements that are self-induced, will go a long way to meeting our objective of profitably delighting the customer.

Lastly, variety must become a management controlled variable. Any variety will cost you. Ensure the benefits from variety exceed the costs. And realize that excess variety of anything will make profitably delighting the customer impossible.

INVENTORY CAUSES (SALES & MARKETING)

* Periodic Sales Targets

* Uncommunicated Promotions

* Payment Terms

* Erratic Advertising

* Logistically Ineffective Promos

* III-Defined Product Needs

* Incomplete Customer Specs

* Excess Product Variety

* Poor Discount Structures

* Extreme Sales Objectives

* Poor/Missing Performance Measures

* Created Seasonality

* Etc.

Hal Mather is president of Hal Mather Inc., an Atlanta, Ga.-based international management consulting and education company. His many articles have appeared in publications such as Harvard Business Review and Chief Executive. He is a member of IIE.
COPYRIGHT 1993 Institute of Industrial Engineers, Inc. (IIE)
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Author:Mather, Hal F.
Publication:Industrial Management
Date:Mar 1, 1993
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