Insights from Dr. Thomas Nagle
There was a dramatic difference in how successful CEOs and CFOs responded to the Great Recession and a dramatic difference in the resulting pricing and profitability of those companies that shifted their focus from market share to profitability.
Forward-thinking companies finally recognized that their goal in a recession should be to preserve profitability, even at the expense of volume. The ultimate winner over a business cycle is not the company that can “rent” the most market share but the one that can sustain the best margins. Market share is “rented” in this case because companies that sell more by lowering price can do so only so long as they keep price low. They do not own the share they gain. In contrast, companies that focus on managing to superior margins can invest in activities like R&D, advertising, sales contact, trials and demonstrations that may enable them to win sustainable market share. Exceptional profitability drives market share growth because it makes investments that drive sustainable growth worthwhile. Because many companies focused on sustaining margins in the most recent recession, the natural sales growth that has come with the climb out of the recession, even though smaller than in past recoveries, is actually having a larger impact on profits.
The focus on profitability initially sent companies to pursue cost reduction mostly driven by improvements in sourcing and operations. But efforts at cost reduction are subject to diminishing returns. It gets harder and harder to achieve each incremental gain. Moreover, copying is always easier than innovation, so that laggards in cost reduction have been closing the gap.
Most profit-driven companies began to take the next step to focus on the other half of the profit equation: price improvement. Still, most looked at pricing only at the level of transaction management: “Where are we leaking margin in unintended ways?” “What are the bad deals and how do we prevent the sales organization from doing them?” “How do we make sure that we are actually collecting for the extra labor or shipping costs that are involved in executing rush orders?” Transaction management involves fixing the easy stuff, but it tends to provide only a one-time gain. It’s not a way to get continuing improvement.
The best companies moved beyond improving pricing one transaction at a time to developing overarching pricing strategies that were value-based and driven by the pursuit of sustainably profitable growth. They built pricing capabilities and value-based cultures that supported profitability on an ongoing basis. A value-based culture is very different from the traditional idea, espoused by some marketers, that the goal should always be to over-deliver, to delight the customer, to make the best product. Rather it involves giving customers only what they are willing and able to pay for. That works especially well when buyers of everything from consumer retail goods to industrial polystyrene have migrated away from looking for the “best product” or the “best service” to search for “the best value”.
Value management creates a new way for companies to become more profitable by creating better alignment between the costs they incur and the things that customers really value. Their competitive advantage comes from their superior understanding of how their products and services can impact their customer’s businesses. In fact, the leading companies in value management understand how their products and services impact their customers better than their customers do! And then they adapt their operations to enable flexibility in creating different offers, not just different prices, for different customers and segments.
Creating a company that is consistently more profitable than its competitors requires consistent attention to profitability, not just sales. The key to sustainable profit is found in a deeper understanding of what drives value for customers, how to communicate value to customers, and how to manage an organization to create and capture value cost-effectively. Building an organization that does this is not just a marketing or sales initiative. It requires executive-level leadership and commitment.
Note, this post was adapted from “Emerging from the Great Recession: 8 Keys to Driving Profit Growth and Customer Value from the C-Suite” by Dr. Thomas Nagle. Download the white paper to get more insights from Dr. Nagle and understand how to build a customer value-based organization, and bring value to pricing, sales, and product innovation.