1. © Kenneth B. Wong, May 2006 1 Competing for a Profitable Future by: Ken Wong Queen’s School of Business

2. © Kenneth B. Wong, May 2006 2 2 TO DETECT… TO DESTROY… TO AVOID… MARGIN-SUCKING MAGGOTS The Objectives of All Great Innovations

3. © Kenneth B. Wong, May 2006 3 3 The Challenge is NOT to Innovate, It IS to MAKE MONEY Price Cost Minus Net Income Assets Managed Divided By Market Share Market Size Times Unit Margins Unit Volumes Times Return On Investment

4. © Kenneth B. Wong, May 2006 4 4 The REAL Questions What kinds of innovations will get PRICES UP? What kinds of innovations will get COSTS DOWN? What kinds of innovations will give us the BEST SOURCES OF VOLUME GAIN? Should I be more worried about prices, costs or volume?

5. © Kenneth B. Wong, May 2006 5 5 A Comparison of Profit Levers Volume Variable Cost Price 3.3% 7.8% 11.1% (Average economics of 2,463 businesses in Compustat) A 1% change in... Creates a change in operating profit of... KW-210

6. © Kenneth B. Wong, May 2006 6 GETTING PRICES UP Competing FOR price versus ON price

7. © Kenneth B. Wong, May 2006 7 7 Understanding Pricing Challenge WHICH PRODUCT IS CHEAPEST? A: $1.01 B: $1.00 C: $0.999,999,999,999,999,999,999,999,999,999,999,999,999 WHICH PRODUCT HAS THE BEST QUALITY? A:“Wonderful Quality” B:“Great Quality” C: “Smokin’ Good Quality”

8. © Kenneth B. Wong, May 2006 8 8 Pricing Challenge 1: Raise Your Price Ceiling THE VIAGRA RULE: People DON’T buy products or services, they buy solutions to problems Customer willingness to pay a premium price increases:  with the importance of the problem being solved  the complexity of the work  the number of alternative suppliers DON’T TELL PEOPLE WHAT YOU DO – TELL THEM WHY THEY SHOULD CARE ABOUT WHAT YOU DO

9. © Kenneth B. Wong, May 2006 9 9 THE COLA RULE: Show customers why they SHOULD care Interest expenses Opportunity costs Storage/handling Installation Quality control (of your product on installation) Tax and insurance Shrinkage Obsolescence Training User's labour costs (especially if re-engineered) Longevity Replacement/ repair costs Disposal costs Regulatory Cost-in-Use Price = Acquisition Costs + Possession Costs + Usage Costs Paperwork Shipping time Expediting orders Cost of errors in ordering Pre-purchase activities Purchase evaluation © Kenneth B. Wong (2005)

10. © Kenneth B. Wong, May 2006 10 10 Pricing Challenge 2: Don’t Commoditize Yourself THE TELEPHONE RULE People are creatures of habit and convenience – your task is to make it their habit to think of doing business with you KEY QUESTION: What is the problem the customer is looking to solve when they pick up the phone and choose to call you? IF THE NEED IS GENERIC, YOUR PRICES WILL BE TOO! Do you “build an association” with distinctive problems OR are you trying to be all things to all people?

11. © Kenneth B. Wong, May 2006 11 11 Pricing Challenge 3: Understand REAL Quality Improving the Retail Experience (Sample Advice)  Personalize/localize the experience  Help the customer find their way  Explain product differences  Show them you care  Show them why they “get what they pay for”  EDI, E-tailing, etc. etc.

12. © Kenneth B. Wong, May 2006 12 12 Pricing Challenge 4: Understand PERCEIVED Quality THE CHINESE FOOD RULE (3 Parts) (Part 1): “Quality” is in the eye of a beholder - Different buyers will use different measures (Part 1): “Quality” is in the eye of a beholder - Different buyers will use different measures (Part 2): Buyers may lack 20/20 vision... - They may lack the technical competence to make rational valuations - They may lack the time to make rational valuations - They may lack the interest to make rational valuations (Part 3): Uninformed or uninvolved buyers will use certain cues or “proxies” to infer the presence or absence of desired qualities - Managing “perceived quality” requires us to distinguish between how the buyer defines quality versus how they measure quality

13. © Kenneth B. Wong, May 2006 13 13 Putting It All Together If customers think your prices are too high… 1. Are you spending too much time talking about what you do instead of why it matters? (VIAGRA & COLA RULE) 2. Are you focusing too much time talking generic needs instead of your specialized talents? (TELEPONE RULE) 3. Are you defining quality in too narrowly based on your craft instead of thinking about what quality REALLY means to different customers? (LINGERIE RULE) 4. Are you confusing how the buyer DEFINES quality versus how they MEASURE the presence of quality? (CHINESE FOOD RULE)

14. © Kenneth B. Wong, May 2006 14 One Last Thing

15. © Kenneth B. Wong, May 2006 15 15 Can You Say It All in 60 Seconds or Less? Part One: What We Do  Forthe target market  Who wantthe "consumption problem" (what "need" do you serve?)  Our product is aour portion of the "solution" (how do you help satisfy that need?)  That featureskey benefit provided (what are the one or two things you want them to remember about you?)  As measured byhow the customer infers quality (how can you convince them you are for real) Part Two: Why We Will Win  Unlikeour main competitors  Our product provideskey point(s) of difference  As supported bywhat makes our difference possible (why they should believe us… TODAY)  And protected bywhy the competition cannot easily overcome it (why they should believe us… TOMORROW)

16. © Kenneth B. Wong, May 2006 16 COMPETING ON COST How to reduce cost WITHOUT destroying quality in the process

17. © Kenneth B. Wong, May 2006 17 17 The Four Key Determinants of Cost How you think What you do How much you do it Who your “friends” are

18. © Kenneth B. Wong, May 2006 18 18 THINKING ABOUT COSTS Do you THINK about MARKETING as an EXPENSE or INVESTMENT?

19. © Kenneth B. Wong, May 2006 19 19 Pick A ONE DIGIT Number from this list… 1351283980846664123429858 1902514090365828948425390 0859533045691110489313480 5299045203666662491358209 0501372541684986314215928 8324580132466668953124808 1351283980846664123429858 1902514090365828948425390 0859533045691110489313480 5299045203666662491358209 0501372541684986314215928 8324580132466668953124808

20. © Kenneth B. Wong, May 2006 20 20 Now Pick a Number… This is the power of a great Ad 1351283980846664123429858 1902514090365828948425390 0859533045691110489313480 5299045203666662491358209 0501372541684986314215928 8324580132466668953124808 1351283980846664123429858 1902514090365828948425390 0859533045691110489313480 5299045203666662491358209 0501372541684986314215928 8324580132466668953124808

21. © Kenneth B. Wong, May 2006 21 21 Now? This is the power of a great BRAND 1351283980846664123429858 1902514090365828948425390 0859533045691110489313480 5299045203666662491358209 0501372541684986314215928 8324508132466668953124808 1351283980846664123429858 1902514090365828948425390 0859533045691110489313480 5299045203666662491358209 0501372541684986314215928 8324508132466668953124808

22. © Kenneth B. Wong, May 2006 22 22 OR Maybe this is…. 2468050137254138498931421592814215928 2468050137254138498931421592814215928 8324257650813242468095312480883245081 8324257650813242468095312480883245081 1353429128398084666412342985819025140 1353429128398084666412342985819025140 6684190251409036582894842539048425390 6684190251409036582894842539048425390 0370885953304569111048931348023429858 0370885953304569111048931348023429858 2304529904520366666249135820953124808 2304529904520366666249135820953124808 0430750137254168498631421592835128392 0430750137254168498631421592835128392 8967132450813246666895312480808595397 8967132450813246666895312480808595397 1351222888398084123412342985853904842 1351222888398084123412342985853904842 4508110251409035582894842539012839809 4508110251409035582894842539012839809 1592834123405013725494842539049484253 1592834123405013725494842539049484253

23. © Kenneth B. Wong, May 2006 23 23 Still not convinced? Describe this product… What if it carried the logo… How much would FP need to spend on EACH product to convince you it had those traits IF IT HAD NO BRAND? © Kenneth B. Wong (2005)

24. © Kenneth B. Wong, May 2006 24 WHAT YOU DO Do You See All Costs As Bad?

25. © Kenneth B. Wong, May 2006 25 25 Lower Costs Higher Prices and Sales Increase “Value” Reduce “Waste” Add “Good” Costs Reduce “Bad” Costs WHAT YOU DO: How Great Businesses Spend “More” Total Costs Higher Profits

26. © Kenneth B. Wong, May 2006 26 HOW MUCH YOU DO Are You WINNING or BUYING Market Share?

27. © Kenneth B. Wong, May 2006 27 27 HOW MUCH YOU DO: Why Everyone Wants Market Share 100 1 502 12.508 254 Unit cost Vol The Large Firm’s PROFIT TheSmallFirm’sLOSS

28. © Kenneth B. Wong, May 2006 28 28 Via experience effects, economies of scale, market power, etc. MORESCALE LOWER COSTS HOW GREAT BUSINESSES USE SCALE Via business planning LOWERPRICES

29. © Kenneth B. Wong, May 2006 29 29 Volume-Based Price Reductions 100 1 502 12.508 254 Unit cost Vol COST PRICE CUSTOMERS ARE WILLING TO PAY InitialVolume New Volume PRICE NEW PROFIT A’s PROFIT WHAT A DEAL!!!

30. © Kenneth B. Wong, May 2006 30 30 Why Price isn’t the Best Way to Add Value Short strategic window Inefficiency relative to quality enhancement

31. © Kenneth B. Wong, May 2006 31 31 Via experience effects, economies of scale, market power, etc. MORESCALE LOWER COSTS HOW GREAT BUSINESSES USE SCALE Via business planning BETTERQUALITY

32. © Kenneth B. Wong, May 2006 32 32254 1 ? SPEND TO ADD NEW CAPABILITIES & FEATURES NEW PROFIT Volume-based Value-Added 100502 12.508 Unit cost Vol Initial PROFIT COST PRICE CUSTOMERS ARE WILLING TO PAY INITIAL VOLUME NEW VOLUME NEW FEATURES NEW PROFIT LOWER PRICE

33. © Kenneth B. Wong, May 2006 33 33 Via experience effects, economies of scale, market power, etc. HIGHERSALES Via sales and marketing MORESCALE LOWER COSTS HOW GREAT BUSINESSES USE SCALE Via business planning LOWERPRICES SUPERIORVALUE Via execution and implementation BETTERQUALITY AND/OR

34. © Kenneth B. Wong, May 2006 34 How WHO YOU KNOW Effects Costs

35. © Kenneth B. Wong, May 2006 35 35 The BRAUN Rule FILTER CARAFE STAND BASE - On/off FILTER CARAFE STAND BASE - On/off - Timer FILTER CARAFE STAND BASE - On/off - Timer - Flavour controls © Kenneth B. Wong (2005)

36. © Kenneth B. Wong, May 2006 36 36 MODEL A MODEL A SALES MODELB MODEL B SALES MODEL C MODEL C SALES How Common Components and Modules Create Value 100 1 Unit cost Vol COST IF COMMON COMPONETS USED IN MODELS A+B+C ADDED PROFIT FOR MODEL A ADDED PROFIT FOR MODEL B ADDED PROFIT FOR MODEL C COMBINED SALES OF A+B+C © Kenneth B. Wong (2005)

37. © Kenneth B. Wong, May 2006 37 THE KEY TRADE-OFF Differentiation versus Integration You can’t get scale economies without STANDARDIZATION You don’t get sales by being only SOMEWHAT RIGHT

38. © Kenneth B. Wong, May 2006 38 38 Why the Model Sometimes Fails – The Blue Jean Rule Which size would you use? How would the customers react? How much of the blame for heavy promotional spending lies in inappropriate attempts to use a one- size-fits-all approach? PAT MIKE

39. © Kenneth B. Wong, May 2006 39 39 Segmentation – The Most Important Thing We Do Segmentation is the equivalent of off-the- rack sizes: we identify the average requirements of a group of customers based on some characteristic. The BIG Issue:  What indicator(s) work best to discriminate the needs, wants and behaviors of different customers?

40. © Kenneth B. Wong, May 2006 40 40 When Should Independents Worry Most? When everyone wants basically the same thing  Limited assortment and standardized practices (i.e. little customization) serves to reduce costs WITHOUT reducing quality to inadequate levels  Ability to leverage information and other technology to provide customer service and distributive services transforms scale-insensitive variable costs in scale-sensitive fixed costs When you need “critical mass” to access the “instruments of scale”  There are some practices you have to be big to be able to afford When smaller competitors cannot respond  buyers CANNOT be convinced their needs are unique  smaller competitors CANNOT form marketing, buying or administrative consortia to counter your advantage

41. © Kenneth B. Wong, May 2006 41 COMPETING FOR THE RIGHT VOLUME

42. © Kenneth B. Wong, May 2006 42 42 The Profitability of a Transaction Focus Profit contributed by: Time Profit Base profit Cost of new customer Source: Bain & Company (Frederick Reicheld) KW-153

43. © Kenneth B. Wong, May 2006 43 43 The Value of Customer Loyalty Price premium Referrals Lower costs Increased volume Profit contributed by: 01 234567 Year Profit Base profit Cost of new customer Source: Bain & Company (Frederick Reicheld)

44. © Kenneth B. Wong, May 2006 44 Profit Impact of a 1 Percent Increase in Customer Loyalty 0481216 20202020 7 9 15 16 17 17 1719Software Industrial distribution Credit cards Auto service Auto/Home insurance Publishing Bank branch deposits Advertising agency Percentage Increase in Profits per Customer Source: Bain & Company (Frederick Reicheld) Volume 3.3% 3.3%Cost 7.8% 7.8%Price 11.1% 11.1%

45. © Kenneth B. Wong, May 2006 45 45 What the “Great Ones” Know About Customer Relationships No one ever switched suppliers for an offer that is only “just as good”  Loyalty is a source of marketing-based cost advantage Every business needs a “franchise”  But you can’t grow a relationship by doing the “same old things” Not everyone wants or needs a “relationship” – they’ll take it but ONLY IF YOU GIVE IT TO THEM FOR FREE

46. © Kenneth B. Wong, May 2006 46 CLOSING THE LOOP

47. © Kenneth B. Wong, May 2006 47 47 Marketing Services is Fundamentally Different The distinctive character of service offerings means you cannot sell what your staff doesn’t understand The distinctive character of service offerings means you cannot sell what your staff doesn’t understand * Intangible * Inseparable * Variable * Perishable The Five Step “Service Profit Chain” The Five Step “Service Profit Chain”  Profits grow from satisfied customers who receive service value due to satisfied and loyal employees who had proper training, coaching and support COMPANYEMPLOYEES CUSTOMERS Interactive Marketing ExternalMarketingInternalMarketing

48. © Kenneth B. Wong, May 2006 48 48 What the Great Ones Know About Marketing to Employees Employees often cite DIFFERENT value propositions Employees often cite DIFFERENT value propositions Employees frequently lack knowledge of how they impact on the value proposition in their day-to-day operations? Employees frequently lack knowledge of how they impact on the value proposition in their day-to-day operations? Employee training and development must be aligned with the value proposition Employee training and development must be aligned with the value proposition Employees’ “performance review” must be aligned with the value proposition? (i.e. Management by Objectives”) Employees’ “performance review” must be aligned with the value proposition? (i.e. Management by Objectives”) You cannot have customer loyalty without employee loyalty. You cannot have customer loyalty without employee loyalty. KW-055

49. © Kenneth B. Wong, May 2006 49 49 How to Survive the “Margin Sucking Maggots” 1. Know the Arithmetic of Profitability 2. Think of Price as an OBJECTIVE, not as a TACTIC 3. Discriminate “good costs” from “bad costs” 4. Know when to “go big” and when to “go small” 5. Know Your Employees…and be certain THEY KNOW WHAT YOU WANT AND WHY

50. © Kenneth B. Wong, May 2006 50 50 FOCUS ON “EXECUTION” The EXECUTION of the MARGIN-SUCKING MAGGOTS

51. © Kenneth B. Wong, May 2006 51 Ken Wong c/o Queen’s School of Business Kingston Ontario K7L 3N6 tel: 613-533-2367 fax: 613-533-2321 email: kwong@business.queensu.ca kwong@business.queensu.ca