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www.digitalinvestor.com.au | 5/45 William St | Melbourne | Australia | 3000
Profitably Serving Customers
Customer Lifecycle and The Service-Profit Chain
Walter Adamson
June, 2003Version C
Contact:
Tel: +61 403 345 632
Slide [email protected] | June 2003 |
Introduction
The Service Profit ChainCustomer Lifecycle
Profitably Serving Customers
Followed by:Part One – Linking the Customer Lifecycle and Business LogicPart Two – Developing the Customer Value PackagePart Three – Developing Service Products to fill the Value PackagePart Four – Understanding Service Pricing StrategiesPart Five – Improving Margins through the Service Value Chain
Slide [email protected] | June 2003 |
The Service Profit Chain
Connected through Value
Employee Productivit
y
Internal Performance
Employee Loyalty
When we have this .....
Employee Satisfactio
nProfit & Growth1
Customer Loyalty
Customer Satisfaction1
Customer Value1
Service Value1
External Performance
1Focus of This Presentation
Slide [email protected] | June 2003 |
Customer Lifecycle
Represents the total potential touch-points and profit capture
The Customer Lifecycle
Phase 1 Pre-sale
Phase 5 Value
Creation
Phase 9Disposing & Upgrading
Phase 2 Value
Identification
Phase 7Customer
Value Gain
Phase 8 Value
Improvement
Phase 3 Meeting Needs
Phase 4 Obtaining
Commitment
Phase 6 Customer Learning
Slide [email protected] | June 2003 |
Profitably Serving Customers
A systems thinking approach optimises: Value creation for the customer Value capture and sustainability for the provider
Customer Value Model
Customer Value
Package
Whole Product
Value Chain
Business Logic
When we have
this .....$$
Customer Lifecycle
Service-Profit Chain
Profit & Growth
Slide [email protected] | June 2003 |
From the market into the business strategy Drives the business logic and value packages Reflects industry trends and competitive forces Without this analysis the business has no grounding
A value package is a customer-oriented offer It includes a value proposition for specific customers Without this offers will be only features or advantages Requires an associated move to solutions selling
The Customer
Understanding the Customer Value Model drives the development of the
Customer Value Packages
Customer Value Model
Customer Value Package
Slide [email protected] | June 2003 |
The totality of what a customer buys Includes all touch-points, resources, and emotions Closely synchronised with the customer value package Required to understand pricing, costing and competition
The lifecycle represents the lifecycle touch-points Customer value packages must reflect different phases Whole product and business logic link to lifecycle Understanding required as a key part of solutions selling
The Service Product
Understanding the Whole Product concept allows business to be captured
and value created through the full Customer Lifecycle
Whole Product
Customer Lifecycle
Slide [email protected] | June 2003 |
The process of delivering the whole product Describes the activities and resources and interfaces Closely synchronised with the customer lifecycle Required to reduce inefficiencies and increase net profit
How the business operates and makes money Driven from the strategy and customer value model Measured by business targets and key result areas Without clear understanding the business is suboptimal
The Delivery
Understanding the Whole Product concept allows business to be captured
and value created through the full Customer Lifecycle
Value Chain
Business Logic
Slide [email protected] | June 2003 |
The Lifecycle Link to Profit
Understanding the complete Customer Lifecycle is essential in order to the satisfaction required in the Service-
Profit Chain
Customer Lifecycle
Service-Profit Chain
A satisfaction cycle
Reflects total costs and potential profit
If broken then breaks satisfaction
Customer satisfaction drives profit Value package drives satisfaction Solution selling meets value needs
Slide [email protected] | June 2003 |
Profitability and Sustainability
Successfully delivering service profits requires an understanding and
enablement of the linkages across the complete system
Profitability
Sustainability
Understand customer value
Sell value propositions that matter Effective resource deployment Efficient distribution of whole product
Satisfy customers and employees Capture fair share of value created Re-validate customer value & lifecycle
Slide [email protected] | June 2003 |
The Lifecycle Sales Approach - 1
Moving Sales from HOW & WHAT WHO & WHY
Solution(Why)
Product(What)
Advantages Promoter
Transaction,Product PusherSalesperson
Needs
Relationship,Value Provider
Problem Solver
Customer Needs(Who)
Stages of Sales Maturity
focus
process
4321
Slide [email protected] | June 2003 |
The Lifecycle Sales Approach - 2
The primary objective of the salesperson shifts FROM: Close the sale, and Sell the advantages and get through the process, TO: Solve the problem of why the customer needs the product Create customer value and capture a fair share of it
Solution(Why)
Product(What)
Advantages Promoter
Transaction,Product PusherSalesperson
Needs
Relationship,Value Provider
Problem SolverCustomer Needs
(Who)
focus
process
4321
Slide [email protected] | June 2003 |
The Service Profit Chain
Connected through Value
Employee Productivit
y
Internal Performance
Employee Loyalty
When we have this .....
Employee Satisfactio
nProfit & Growth1
Customer Loyalty
Customer Satisfaction1
Customer Value1
Service Value1
External Performance
1Focus of This Presentation
Slide [email protected] | June 2003 |
The Service-Profit Model
Linking the Customer Lifecycle and Business Logic
Customer LifecycleBusiness LogicCustomer ValueCustomer Value Model
Customer Value PackageCustomer Value Audit
1
Slide [email protected] | June 2003 |
Customer Lifecycle
The objective is to optimise the creation and capture of value
The Customer Lifecycle
Phase 1 Pre-sale
Phase 5 Value
Creation
Phase 9Disposing & Upgrading
Phase 2 Value
Identification
Phase 7Customer
Value Gain
Phase 8 Value
Improvement
Phase 3 Meeting Needs
Phase 4 Obtaining
Commitment
Phase 6 Customer Learning
Slide [email protected] | June 2003 |
Business Logic
To service customers you need operational business logic ‘The logic that organises a business’s approach to things’
Revenue Model
Marketing & Sales Logic
Service Product Design
Delivery & Customer Support
BusinessStrategy
CustomerValue Package
Resources
Customer’s NeedsCustomer Value Model
Profit Targets
Competition
Slide [email protected] | June 2003 |
Lifecycle and Business Logic
To maximise return on investment: The customer lifecycle is supported by the Business Logic
Business Logic
Slide [email protected] | June 2003 |
Business Logic Basics
Describes how a business operates and how it makes money
Business Logic
Value Creation
Value Capture
Value Chain
Customer Value
The Value Proposition
Marketing Model
Revenue Model
Core Competencies
Funds and Investment
People Management
Operations Model
Systems Management
Slide [email protected] | June 2003 |
Business Logic and Strategy
Business Logic is the essential logic of the business Needed in order to optimise value creation and capture Expressed in terms of a major action premise that can:
– Maximize market share, revenue, short-term-profit, ROI, or,– Whatever focus the Business Leaders have chosen
The Logic aligns the action premise and the people’s energies:
– Marketing and Sales Logic– Revenue Model– Service-Product Development Logic– Customer Delivery and Support Logic
Slide [email protected] | June 2003 |
Business Logic and Strategy
Marketing & Sales – how to we gain access to our customers?– Niche, vertical, horizontal, alliances, distribution
Revenue Model – how do we use and make our money?– Market share, growth, acquisition, cost performance
Service-Product – what value package will we take to market?– Commodity, uniqueness, speed, trend, lifestyle, informational
Customer Delivery & Support – how do organise ourselves to make the other logics work together?– Product focus, geography, function, matrix, account
You need to test the total business logic to see that it makes sense!
Slide [email protected] | June 2003 |
Strategic Model
The Strategic Model drives the Business Logic and the Customer Value Package – using the Customer Value Model
Vision
Customer Value Model Mission
Business Logic and Strategy
Business Targets
Customer Value Package
Core Values and Philosophy
Operating Environment
Key Result Areas
Slide [email protected] | June 2003 |
Customer Value
Customer Value Model
Customer Value Package
Business Logic and Strategy
Customer Value has three major
components
Slide [email protected] | June 2003 |
Customer Value Model
A set of critical factors that define customer value
– From the customer’s point of view– Requires detailed engagement and research– Input from the market– Drives the business logic– Drives the customer value package
Tells us what value we have to provide in order to win, and keep, the customer’s business over the complete lifecycle.
Slide [email protected] | June 2003 |
Competitive edge– Salespeople who understand their customer’s value model better than
their competitors have a better chance to win the business How do your customers define value?
– Must be derived from the minds of the customer• Effective engagement• Communication• Develop Value Propositions
– Must be validated in solid customer research• Who has best performance in the industry – key metrics, and why?
Must be able to implement the path to the customer’s ‘truth’
Building the Customer Value Model
The customer value model is an ‘invisible truth’ used by the customer to evaluate the quality of outcomes you provide.
Slide [email protected] | June 2003 |
There is a hierarchy of customer value satisfiers:– Base value – the fundamental components of the customer value
package you need in place just to stay in business– Expected value – what your customer considers ‘normal’ for you and
your competitors– Desired value – added value features that customers know about but
don’t necessarily expect because of the current level of performance of your competitors
– Unanticipated value – going beyond the customer’s expectations and desires – provided that the customer really values these “surprises”
You must go beyond ‘base’ and ‘expected’ to make a difference
Hierarchy of Customer Value
You must have mastered the first two levels in order to satisfy the customer on the higher levels. Failings in the first two levels will
waste the effort and investment in the higher levels.
Slide [email protected] | June 2003 |
Customer Value Package
The enterprise infrastructure for value creation PLUS, the Whole Product
1. Marketing & Sales Logic
2. Service Product Design
3. Delivery & Customer Support
4. Revenue Model
5. Branding & Reputation
6. Informational
7. Interpersonal
Enterprise Components
Slide [email protected] | June 2003 |
Customer Value Package
Enterprise capabilities are needed to deliver the Whole Product:
Post-Sales
Support
Life-Cycle Support
Pre-Sales Support
Integration
Services
Software
Consulting
Hardware
TheProduc
t
1. Marketing & Sales Logic
2. Service Product Design
3. Delivery & Customer Support
4. Revenue Model
5. Branding & Reputation
6. Informational
7. Interpersonal
The Whole Product
plus
Enterprise Capabilities
Slide [email protected] | June 2003 |
Customer Value Package
A multidimensional logic for managing the customer’s experience with your company, and with the value it creates
The customer value package must be right if you hope to build in the customer’s mind an impression of quality and value for money
Customers’ expectations vary enormously even in the same line of business
Slide [email protected] | June 2003 |
Customer Value Expectations
Potential value expectations are broad e.g. a fashion store
Customer Value Criteria
Supplier reputation and experience Branding Warranty package Information Quality specification and control Parts and service coverage
SECURITY
Continuity of benefits and costs profile Continuity of supplier support
RELIABILITY
Cash flow Operating compatibility Operating flexibility Status/prestige‘ Fashion’ currency
PERFORMANCE
AESTHETICS
Style Design Conformance Longevity Design/style continuity
CONVENIENCE
Transaction facilities and process Product service and parts availabilities Warranty service processing Sales and service response Time Location Information
ECONOMY
Acquisition costs Installation costs Set up and training costs Maintenance costs Disposal value and costs Supplier information Opportunity costs
Slide [email protected] | June 2003 |
Customer Value Audit
Does the design of your CVP reflect the customer’s value model? Or does it reflect just the convenience of your organisation? Cross-match Customer Value Model, to Customer Value Package
Customer Value Package Customer Value Factors
Marketing & Sales Logic
Service Prod Design
Delivery & Support
Revenue Model
Branding & Reputation
Informational
Interpersonal
CVM1 CVM2 CVM3 CVM4
Slide [email protected] | June 2003 |
Customer Value Audit
Will these Customer Value Packages lead to success? Where are the gaps, how to fill them?
Customer Value Package Customer Value Factors
Pre-Sales Support
Software
Hardware
Consulting
Integration Services
Post-Sales Support
Life-cycle Support
CVM1 CVM2 CVM3 CVM4
Slide [email protected] | June 2003 |
Market Value Audit
Determine the “defining features” by cross-referencing the value packages with the customer types – the market segment benefits
– Customers on one axis – cluster customers into sets– Value packages on the other axis – cluster value packages– The clusters (sets) represent meaningful defining features
1 2 3 4 5
Customer Types
CustomerValue
Packages
5
4
3
2
1
Look for Niches
Slide [email protected] | June 2003 |
The Service-Profit Model
Developing the Customer Value Package
Understanding ValueDeveloping a Value Proposition
Integrating the VP into a Customer Value Package
1 2
Slide [email protected] | June 2003 |
Understanding Value
Value is “mindware” created by the product/service you sell The end condition a customer deems worthy of their approval
eMotion-Value End Condition Approval
Emotional Reaction
Value Package
Customer’s Perception
Slide [email protected] | June 2003 |
Value is in the mind of a specific client
Value = Benefits – Cost
Benefits exist only with a particular client or set of clients in a particular business setting. Therefore, if there is no specific client and business setting you cannot promote value1.
Features are an objective characteristic of the product or service.Advantages indicate how the features might help sets of clients.
1In that case you will be promoting “features”, “advantages” or just technology.
Understanding Value - 2
AdvantagesLead ToFeatures BenefitsLead To
Slide [email protected] | June 2003 |
Understanding Value - 3
Perception of value is tied to emotion, and personal values
eMotion-Value = eMotion-Benefits – eMotion-Cost
The outcomes, which are stated as benefits, are as much perception as measurable factual reality.
Both facts and perception are reality. But interestingly, while facts belong to organisations, perceptions belong to individuals.
The eMotion Value Proposition Model1 explains:
– Why 'good' proposals stall – Why high return (high ROI) proposals are blocked – Why the 'best' proposal does not always win – How personal distraction and effort mould perceptions of benefits – How individual recognition and reward mould perceptions of value.
1For full details of the eMotion VP Model go to www.digitalinvestor.com.au
Slide [email protected] | June 2003 |
Developing a VP - Asking Questions
Start with good sense of the business situation– Industry– Company and its issues– Personal (relationship)
It is about the art of questioning and analysis
– What is the business’s perspective of the situation?– What are they doing now and why?– What are the tensions in what they are doing now?– What is the ideal or “tomorrow state” as currently perceived?– What barriers are faced in getting there?– Which barriers have the biggest impact and where?– What are their investment criteria?– What is the decision-making process?– What has been agreed to now and and in the past in IT initiatives?– How do they perceive the value added by IT so far? Why?– What is their ideal solution and how do they know when they achieve it?
Slide [email protected] | June 2003 |
Developing - Discovering Needs 1
The objective is to uncover the business’s specific needs– Concentrate on identifying the real needs:
• Place yourself in their shoes• Place yourself in their customer’s shoes
– Work on improving your questions and interaction– Be aware of “knowing too much” - let the business talk!
Then, move to offering a credible solution– Float options, build and test your solutions– Work in parallel to action the needs into an IT strategy
Do not spend time or energy– “Selling” features, unqualified advantages, and technology– Turning the needs analysis back to a generic IT solution– Disparaging alternative IT solutions from the business
Work to generate business ownership of the proposition
Slide [email protected] | June 2003 |
Developing – Discovering Needs 2
The most powerful tool is the “Day in The Life”:– Live a day in the life of the business and their customers
It is powerful because– The business commits to spend time and energy– You commit to contribute and report– It brings ownership through joint generation of the VP– It BUILDS WIDER RELATIONSHIPS
Focus on your customer’s customers
Workshop the outcomes to generate the VP– Build a case which delivers “ladders of value”– Also build ladders of compelling IT investment strategy
Slide [email protected] | June 2003 |
Developing – Generating the VP
A useful technique
When we have this .....
We will be able to do
these things ...
Which means this in
business terms ......
And we’ll be able to measure the benefits this
way .....
Slide [email protected] | June 2003 |
Testing the Value Proposition
Is there a common understanding of the central need?
Why should anyone want to use the proposed solution?
What genuine business value does it return?
Examples of things to consider:– What problem does it solve for potential customers?– Does it open a new market?– Does it better exploit an existing market?– Does it eliminate or reduce inefficiencies?– Does it solve the same problem as competing systems but at less
cost?
How does the value proposition fit into the development of the Customer Value Package?
Slide [email protected] | June 2003 |
Integrating the VP into a CVP
The VP guides development of a Customer Value Package:
Post-Sales
Support
Life-Cycle Support
Pre-Sales Support
Integration
Services
Software
Consulting
Hardware
TheProduct
1. Marketing & Sales Logic
2. Service Product Design
3. Delivery & Customer Support
4. Revenue Model
5. Branding & Reputation
6. Informational
7. Interpersonal
The Whole Product
plus
Enterprise CapabilitiesValue Proposition
Slide [email protected] | June 2003 |
Integrating the VP into a CVP
The Whole Product plus Enterprise Capabilities need optimisation:
The Whole Product must be tailored to include the VP
The Enterprise Capabilities have to support delivery of the VP
This combines to produce a specific Customer Value Package
Examples of things to consider– How does the Whole Product mix need to be modified?– How does the organisational infrastructure need to be modified?– What role do channels and does distribution play?– How does this CVP fit or blend with other CVPs which need support?– What is the revenue model associated with this CVP?– How can IT support and improve profitability of delivery of the CVP?
Slide [email protected] | June 2003 |
IT Support of the CVP
How can systems support the Customer Value Package:
What is the timing, sequence, priority and risk?
Can they be built and implemented within a reasonable time?
At an acceptable cost?
Examples of things to consider– Are the necessary skill sets available, and the technology?– Should it be insourced or outsourced?– How do they fit the current systems architecture?– Do they have to be integrated with other systems and data?– Do they improve the underlying technology fabric?– Do they improve the company’s overall operations?
Slide [email protected] | June 2003 |
The Service-Profit Model
Developing Service Products to fill the Value Package
Service-Product DevelopmentWhole Product Concept
Whole Product ValueTechnology Adoption Lifecycle
1 3
Slide [email protected] | June 2003 |
Service-Product Development
The fundamental elements of service-product formulation are coordinated market value propositions and delivery at a profit
Service Delivery
Value Proposition
Activity Costing/Profit
Go to Market
CustomerService ProductDesign
Slide [email protected] | June 2003 |
Integration Logic
Which Customer?
The model points to a customer, but which customer? This requires market segmentation including technology
lifecycle
Service Delivery
Value Proposition
Activity Costing/Profit
Go to Market
Customer?Service ProductDesign
Slide [email protected] | June 2003 |
Service Product Design Audit
The Customer Value Models are customer pulls Match those pulls to the Service-Product Design Elements
Lifecycle Adoption Phase Customer Value Factors
Value Proposition
Service Delivery
Go To Market
Activity Costing/Profit
Integration Logic
CVM1 CVM2 CVM3 CVM4
Slide [email protected] | June 2003 |
Whole Product Definition
Service-Products are complex - they have many dimensions The Whole Product is the totality of what a customer buys A whole product is the physical object, software or service from
which customer gets direct utility, plus other factors, services and perceptions that make the product:– Useful– Desirable– Convenient– People– Brand attractiveness - “Intel Inside”
For example Computer Operating System is:– Software + development + environment (hardware and software) +
documentation to use it + training program + reseller’s service & troubleshooting capabilities + availability of hardware drivers + suppliers enhancement plans, + reliability + interface design appeal + brand appeal (Mac) etc.
Slide [email protected] | June 2003 |
Whole Product Concept
The “whole product” gives the customer value satisfaction The cost of creating a complete product is often many times the
cost of developing the generic product or service
Generic Product
Expected Product
Augmented Product
Potential Product
Value
Slide [email protected] | June 2003 |
The Expected Product
A step above the Generic Product
The Expected Product represents the customer’s base expectations Delivery conditions, installation services, post-sale services, spare parts,
training, packaging conveniences Other examples of the minimum expectations:
– The bank: the loan officer who is cooperative – The realtor: who is on your side – The lawyer: who protects you– The retailer: who sells you products which work and are reliable
The expected attributes vary by customers and industries They could be sources of product differentiation
– Depending on how well vendors implement their value packages
Slide [email protected] | June 2003 |
The Augmented Product
Augmentations are means of product differentiation
Customers may be offered more than they expect:– Computer that comes with “Office 2000” already installed– Optical store that replaces customer’s lost contact lenses nights &
weekends and delivers them to customer’s home
Augmentations can also bring about customer dependency They can educate customers about what it is reasonable to expect This raises the competitive bar since augmented benefits may turn
into customer expectations (and move into the inner circle) Not all customers can be attracted by an ever-widening circle of
augmented benefits
Slide [email protected] | June 2003 |
The Potential Product
The Potential is everything feasible to get and keep customers– what can be feasibly done with the existing product & service– what is possible in the future– what is needed in the future
Suppliers, and customers, can compete more effectively with the Potential Product in the changed conditions of future
In high tech markets, customers desire extendibility for the product so that the platform and basic technology can last over several generations of technology lifecycles– e.g. semiconductor technology cycles
Building and maintaining a Product Roadmap is important
Slide [email protected] | June 2003 |
Product Lifecycle
Products are marketing inventions Product invention / definition is a continuous process
– Starts at the intersection of new technology capability and perceived market opportunity
– Continues past product introduction thru to discovery of new applications (not envisioned by the original developers)
Continues further– As product marches down the Technology Adoption Life Cycle and it
is redefined for new groups of customers– As the company diversifies into new market segments to capture
more market share
Slide [email protected] | June 2003 |
Whole Product Value
To the potential customer, value satisfaction is the “product” The generic “thing” or “device” is not itself the product. It is the
minimum necessary to get into the “game” Whole Product value has meaning only from the viewpoint of the
customer or the ultimate user - only they can assign value
Customers’ needs and wants define whole product value– Depending on the targeted market segment, the whole product offer
must change to meet different value expectations When positioning against competition, it is important to compare
complete whole product customer value packages The whole product must be defined differently in different
phases of the Technology Adoption Life Cycle
Slide [email protected] | June 2003 |
Technology Adoption Lifecycle
The Customer Value Package must be different for each stage At different stages customers buy and perceive value differently
2.5 %Innovators
13.5%Early
adopters
34%Early
majority
34%Late
majority16%
Laggards
Time
Slide [email protected] | June 2003 |
Technology Lifecycle Value Audit
Rate the Customer Value Packages against the adopter stage Look for gaps and misalignments in the offer and the adopter
Lifecycle Adoption Phase Customer Value Factors
Innovators
Early Adopters
Early Majority
Late Majority
Laggards
CVP1 CVP2 CVP3 CVP4
Slide [email protected] | June 2003 |
Customer and Technology Lifecycle
Effort and resource expenditure through the customer lifecycle needs to be optimised against the technology adopter lifecycle
2
1
1 2
1
1 2
2
1
Earlyadopters
Earlymajority
Latemajority
Laggards
These buyers1 need less selling and more confidence
that you will support the product they are willing to try
These buyers2 need more selling and confidence that
others have bought the product and are satisfied
Customer Lifecycle
Slide [email protected] | June 2003 |
The Service-Profit Model
Understanding Service Pricing Strategies
Service Pricing StrategiesPrice-Value Perceptions
Value Strategies for Service PricingService Costing
Activity-Based Costing
1 3 4
Slide [email protected] | June 2003 |
Pricing Strategies
Begin with costs and work towards selling price
Begin with selling price and work towards costs
Cost factorsPrice
Customer Value
Competition
Cost-based Pricing
Demand-based Pricing
Combination Pricing
Competition-based Pricing
Begin with Competitors’ Pricing
Above The Market
Below The Market
At The Market
Slide [email protected] | June 2003 |
General Pricing Challenges
Pricing strategies and challenges
Demand-Based
Cost-BasedCo
mpe
titio
n-Ba
sed
Cost-based problems: 1. Costs difficult to trace 2. Labor more difficult to price than materials 3. Costs may not equal value
Competition-based problems:• Small firms may charge too little to be viable• Heterogeneity of services limits comparability• Prices may not reflect customer value perception
Demand-based problems: 1. Monetary price must be adjusted to reflect the value of non-monetary costs 2. Information on service costs is less available to customers, hence price may not be a central factor
Slide [email protected] | June 2003 |
Service Pricing Strategies
What makes it difficult and different? Hard to calculate financial costs of creating an intangible
High ratio of fixed to variable costs - cost to serve one extra customer may be minimal (but must still recover fixed costs)
Variability of inputs and outputs - how to define a “unit of service” and establish basis for pricing?
Many services hard for customers to evaluate--what price can they put on the ‘value’ which is delivered?
Importance of time factor - same service may have more value to some customers when delivered faster
Use of physical or electronic channels - may create differences in perceived value
Slide [email protected] | June 2003 |
Pricing Strategies
Choice of strategy depends on: The technology, refer to the technology lifecycle (part three) The market and your customer power Your cost structure The competitive environment
– Threat of substitution– Threat of new entrants
Keys to Demand-based Pricing: Set prices consistent with customer perceptions of value Prices are based on the whole product value package
Slide [email protected] | June 2003 |
Incorporating Value into Pricing
You must fully understand what value means to customers:
What benefits does the whole product package provide? How important is each of these benefits as to the others? How much is it worth to the customer to receive a particular
benefit in a service product’s value chain? At what price will the service be economically acceptable to
potential buyers? In what context is the customer purchasing the service? What is the customer’s perception of ‘value’?
Slide [email protected] | June 2003 |
Price-Value Perceptions
Four customer-definitions of value:
Value is low price. Value is everythingI want in a service.
Value is thequality I get for the price I pay.
Value is all thatI get for all that I give.
Slide [email protected] | June 2003 |
Value Strategies for Service Pricing
Pricing strategies to reduce uncertainty– service guarantees– benefit-driven (pricing that aspect of service that creates value)– flat rate (quoting a fixed price in advance)
Relationship pricing--incentives to patronize one supplier– non-price incentives– discounts for volume purchases– discounts for purchasing multiple services
Low-cost leadership– Convince customers not to equate price with quality– Must keep economic costs low to ensure profitability at low price
Slide [email protected] | June 2003 |
Pricing Questions - Services
How do you calculate the total potential profit of offerings? Can you rank service-products by margin, by total profit? Can you rank service-products in the technology lifecycle? What does each function and process contribute to profit? How can you reduce costs by 20% in the service-product chain? What mix of service-products yields the highest profits? What new blends of services yield the potential best profits? What is your maximum possible revenue given the resources? What are the key ingredients of the offers that drive profits up? What continuing investment is needed to support current offers? What investments are needed to create new offers? Can costs be better distributed through a channel strategy?
Slide [email protected] | June 2003 |
Service Costing
Service costing is an application of strategic cost analysis, for: Modifying product mix and pricing
– Repricing customer value packages– Substituting services and offers– Eliminating elements and resulting excess capacity
Improving service-product design and development– Redesigning service-products– Improving delivery and whole product support processes– Investing in technology support
Improving customer relationships– Changing operating policies and strategy
Improving channel relationships
Slide [email protected] | June 2003 |
Strategic Cost Analysis
Strategic cost analysis uses activity costing to: Identify distorted service-product costs Determine unprofitable Customer Value Packages Highlight areas for different channel strategies Explain undercosting and overcosting of products and services Give management insight into the cost structures for making and
selling diverse products
Particularly, it must focus on whole product and the value chain: Assigning activity costs to whole product customer value packages:
– calculating the activity cost per unit of activity driver– preparing a bill of activities for each whole product
Slide [email protected] | June 2003 |
Strategic Cost Analysis Benefits
Particular benefits relate to service-product development:
Management can identify and evaluate new service-productsto improve performance by evaluating how service
and process designs affect activities and costs.
Companies can work with their customers toevaluate the costs and prices of alternative value packages.
Slide [email protected] | June 2003 |
For Service Firms
The general approach is very similar to that in manufacturing: Costs are divided into homogeneous cost pools and classified
as output unit-level, batch-level, product- or service-sustaining, and facility-sustaining costs
The cost pools correspond to key activities: Costs are allocated to products or customers using activity
drivers or cost-allocation bases that have a cause-and-effect relationship with the cost in the cost pool
Resources
CVP 1
CVP 2
CVP 3
Activities
Activities
Activit
ie
s
Slide [email protected] | June 2003 |
Service Costing - 1
Service costing is a critical element of performance management
Identify the processes for each CVP value chain Allows you to answer key questions:
What does it cost to deliver these services? Are we delivering our services cost-effectively? How do our service costs compare? How much should we charge for these services? Is there is an alternative, less costly, way to deliver these
services?
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Service Costing - 2
How do you find the processes to analyse?
Organisations are managed vertically, however: Work gets done horizontally via business processes Processes cut across functions and layers of the organisation Processes consume all types of the resources of an organisation Process measures help resolve friction and take out costs Processes provide feedback for continuous improvement
Process measures enable customers of the processes to be served more effectively and efficiently
Processes consist of activities– measure through activity-based costing
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The Logic of Activity Costing
Products and Services are consumed by customers Activities are consumed by products and services Resources are consumed by activities
It is the Customers
That buy our Services
Which makes us conduct ActivitiesThat consume
ourResources
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Basic Activity Cost Allocation
The costing process is simple in theory:
FundamentalCost Objects
Activities
Costs of Activities
Assignment to OtherCost Objects
Product Lines Individual Products
Customers Distribution Channels
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Implementing Activity Costing
Follow four stages to assign overhead costs to products:
Calculate a cost-driver rate for each activity. Assign activity costs to customer value packages using the cost-driver rate.
Identify and classify cost objects (activities).
Customer Value Package 1Customer Value Package 2
Identify cost drivers relevant to each activity in a whole product value
package: Marketing & Sales
Corporate Services Lifecycle Support
Step 1 Step 2
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Activity-Based Costing
The logic of ABC is simple: It is a methodology to calculate the cost of activities (such as
train employees), and cost objects (such as products and services)
It assumes that services create needs for outputs which create the demand for activities which, in turn, consume resources.
By tracing costs to services/outputs according to the activities required to provide them, ABC provides a more accurate picture of costs and performance.
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Cost Drivers
Knowing the cost drivers is an integral part of ABC
Drivers apply to activities or factors that cause costs to be incurred
There are volume-based drivers and non-volume-based:
Volume-based cost drivers– Assumes all costs are driven, or caused, by the volume of
production (or sales) Non-volume-based cost drivers
– Costs are not directly related to production volume
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Activity–Based Costing - 1
The key principles are that:
Cost are assigned to activities Costs driven by volume are at ‘unit level’ Cost drivers are identified for batch-level and product-level
costs, but not for facility-level costs Unit, batch and product-level costs vary proportionally with their
cost drivers
Managers need to see “whole product” costs as an integral part of the firm’s effort to create value for customers.
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Activity-Based Costing - 2
The ABC process relates activities to the resources they consume Classifies costs into four levels: Unit level
– Activities performed for each service-product unit Batch level
– Activities performed for a group of service-product units Product level
– Activities performed for service-product families Facility level
– Costs incurred to support the whole enterprise
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Activity-Based Costing - 3
Other costing factors to consider are:
Customer Lifecycle Costs – Customer-level costs -- things like preparing bids, processing
orders, answering questions, expediting rush orders, designing products, providing support
Net Margin Realized– Difference between the revenue and unit and batch level
costs of manufacturing the item. The profit on the actual goods sold, without consideration of the specific costs to selling them to the customer
– Influenced by the price demanded by the customer (related to their bargaining power) as well as the inherent profitability of the item
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When to Use ABC - 1
An option when one or more of the following conditions exist:
Indirect costs are significant in proportion to direct costs and use only one or two cost-drivers
Goods are complex, requiring many inputs and processes. Simple, high-volume products perform more poorly than
complex, low-volume products Different departments believe costs are assigned inaccurately. The company loses bids it thought were low, and wins bids it
thought were high Operations have changed significantly, but the costing system
has not changed
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When to Use ABC - 2
When organizations find themselves on a crisis course:
Selling (funding) the wrong products or services Serving the wrong customers Designing costly products Instituting cost cutting programs that fail, and/or Obtaining the wrong (unnecessary) parts from outside suppliers
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Strategic Cost Analysis Benefits
ABC benefits will be greatest where:
Overhead costs are a significant proportion of total cost, and a large part of overhead is not directly related to production volume
The business has a diverse product range, and individual product’s use of support resources differs from their use of volume-based cost drivers
Production activity involves diverse batch sizes and product complexity
There are likely to be high ‘costs’ associated with making inappropriate decisions, based on inaccurate product costs
The cost of designing, implementing and maintaining the ABC system is relatively low due to sophisticated IT support
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Typical Revelations
The application of strategic cost analysis typically reveals:
Higher-volume products/services are overcosted Lower-volume products/services are undercosted Unexpected differences in customer profitability Opportunities to improve processes 25-35% of activities don’t contribute to organizational goals 80% of costs are consumed by 20% of the activities
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Limitations
However, ABC can be difficult to implement in service firms:
High levels of facility costs cause problems with costing services Individual activities are difficult to identify because they are non-
repetitive A non-repetitive production environment makes it difficult to
identify service outputs
Challenge:
ABC systems require management to estimate costs of activity pools and to identify and measure cost drivers for these pools.
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The Service-Profit Model
Improving Margins through the Service Value Chain
Customer Lifecycle and ProfitabilityLifecycle Sales Approach
Increasing Net Value
1 3 4 5
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Customer Lifecycle Costs
The lifecycle incurs costs in delivering through the value chain
The Customer Lifecycle
Phase 1 Pre-sale
Phase 5 Value
Creation
Phase 9Disposing & Upgrading
Phase 2 Value
Identification
Phase 7Customer
Value Gain
Phase 8 Value
Improvement
Phase 3 Meeting Needs
Phase 4 Obtaining
Commitment
Phase 6 Customer Learning
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Whole Product Value Chain
The Customer Value Package offer is a value chain
Is each extension feasible, achievable, sustainable?– Investment and resource allocation?– Market competitiveness and positioning?– Ability to make a profit?
Value/Cost DValue/Cost CValue/Cost BGeneric Product
Value/Cost A
Expected Product
Total Solution
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Value Chain Analysis
Value chain analysis helps to understand (at a high level) how each of your business activities adds value to your company
The objective of value chain analysis is to maximise the profitability of your business activities in a sustainable manner
Value chain analysis can also be applied to the Whole Product offer to understand the value offered to the customer and your costs associated with each element of that offer
The chain comprises the activities and functions performed by a company to deliver value to its customers.
Are you profitably delivering value to your customers?
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Value Chain
Consider a value chain for the "Recruitment" business activityThe links in the value chain could be:
Identify - a list of all of the candidates that applied Select - those candidates that meet the basic criteria Screen - identify the best two/three for the vacancy Interview - determine who should be offered the job Offer - the job to the best candidate Train - the new employee when they join the company
Each step in the chain adds value and adds costs
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Value Chain Analysis - 1
A Value Chain Analysis:
Summarises your customer value package activities as distinct value chains - one for each package
Outlines and analyses the key links in each of your customer value packages
Defines the metrics you will measure to determine performance of your customer value packages
Identifies opportunities to improve the profitability of your customer value packages
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Value Chain Analysis - 2
Distributors’ and forward channels partners’ value chains:
Change costs and margins of distributors and forward channel partners influence price paid by ultimate consumers
Therefore these activities must be analyzed as part of the chain: The quality of activities performed by distributors and forward
channel partners influence the quality of products/services of the company to the end-user
The activities have a direct impact on the profitability of the customer value packages and the lifetime customer value
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Growing the Bottom Line
Value chain analysis and activity-based costing are tools to grow the bottom line and the quality of earnings:
Activities
Costs of Activities
Product Lines Individual Products
Customers Distribution Channels
Value/Cost DValue/Cost CValue/Cost BGeneric Product
Value/Cost A
Expected Product
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Increasing Net Value
Reduce resource expenditure at each stage of the value chain Minimize interpersonal blockages Optimize informational sharing and transfer Decrease intra-enterprise engagement friction Understand the Whole Product cost and value chain!
Share a common intent about the customer value package
Value/Cost DValue/Cost CValue/Cost BGeneric Product
Value/Cost A
Expected Product
Total Solution
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Margin Improvement
Margins can be improved through process improvement: Time and motion studies (1940s) Workflow analysis (1960s) Technology-based approaches (1970s) Business process reengineering (1980s) Process mapping (late 1980s)
Differences between activity-based and processed-based approach: The activity-based view reveals how resources have been
consumed The process-oriented view cuts across the entire organization
and reveals all resources and costs expended on producing a process output e.g. a customer value package
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Service Process Chain - 1
The CVP is delivered by a “process” chain, or value chain:
xxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxx
Service Product
Marketing & Sales Support
Customer Value & Your Profit
xxxxxProcess
Activity
A Customer Value
Package
DeterminingService-Product
Mix
DeterminingMarketing & Sales Effort
Support & Lifecycle Effort
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Service Process Chain - 2
There is a different chain for each part of the customer lifecycle:
xxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxx
Service Product
Marketing & Sales Support
1
5
9 2
7
8 3
4
6
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What To Measure
Process improvement uses many measures: Activity-Based Cost – the cost of resources consumed by each
activity performed Rework – the cost of non value-added activities to correct things
not done right the first time Cycle Time – length of time it takes to get an outcome for a
process Touch Points – number of times an item is touched as it moved
through a process Cost per Process Output – process cost divided by a volume of
items produced by a process Customer Satisfaction – the degree to which customers are
satisfied with the performance of the process
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Service Process Improvement - 1
A methodical approach is required, focused on processes:
Firstly, identify the activities behind the customer value package Determine the cost of resources used to perform each activity -
some allocation may be required using resource drivers (labor, capital, materials, energy)
Allocate secondary activity costs to primary activities if needed Combine activities with similar drivers/behavior into cost pools
based on process, activity level, consumption ratio Identify a cost driver for activities Calculate the budgeted cost per unit of the cost driver for each
activity Collect information about cost driver usage for value package Allocate costs to customer value package
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Service Process Improvement - 2
Analyze the process chain for the total Customer Value Package:
Post-Sales
Support
Life-Cycle Support
Pre-Sales Support
Integration
Services
Software
Consulting
Hardware
TheProduct
1. Marketing & Sales Logic
2. Service Product Design
3. Delivery & Customer Support
4. Revenue Model
5. Branding & Reputation
6. Informational
7. Interpersonal
The Whole Product
plus
Enterprise CapabilitiesValue Chain - Processes
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Customer Profitability - 1
The most common problem in determining customer profitability:
Selling, marketing, distribution and administrative costs are not assigned to products or customers
This is not necessary for financial reporting Management considers them ‘fixed’ It is considered too expensive to do so
As a result, the behavior of these costs is not well-understood and cannot be easily managed
Value-chain analysis identifies and allocates these costs
Costs are allocated to each customer value package
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Customer Profitability - 2
Knowing the customer-profit profile determines value packages
A mismatch between the value package and customer profile:
Erodes profits Misses the chance to capture extra profits Consumes resources managing the mismatch
The matching of value packages and customers is step one
Value chain analysis, and profitability analysis are step two
From there margins can be improved
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Customer Profitability - 3
Types of Customer-Profit Profiles
Aggressive Leverage their buying power
Low price and lots of customized service and
features
SensitivePrice-sensitive and few special
demands
ImpressiveCostly to service, but pay top
dollar
Passive Product is crucial
Good supplier relationship
Net
Mar
gin
Rea
lized
Low
High
Low HighCost to Serve
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Gaining Internal Balance
There are often significant disagreements between staff about the costs and profitability of products and services.
Products& R&D Delivery Consulting Sales
CEO & Finance
Technology
Quality
Top-line
Profit 1
3
2
4
1
1
1
12
2
2 3
3
3
4 4
4
43
2
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Summary – Improving Margins
By following the value chain analysis process:
The profitability of each Customer Value Package is known The Value Packages are matched to the customer profiles Margins will be improved for each value package Alignment will be gained between all parties to the value chain
and service product about its contribution to profit
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Profitably Serving Customers
Contact:
Walter Adamson
Digital Investor Pty ltd5/45 William St, Melbourne 3000
Office: 0500-500-321, Cell: 0403 345 [email protected]
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