The Bottom Line

Amazon Moving Out of the Driver's Seat

2010-02-01T16:45:00.002-05:00

Amazon had to knuckle under to the pressure provided by book publishers, now that a viable alternative e-book product exists. With the announcements last week that Apple had built the iPad, in part as an alternative to the Kindle, book publishers began to apply pressure to Amazon. Oddly enough for consumers, this competition means that prices will rise in the near term. How did this happen?

Well it appears that Amazon used their initial control of the burgeoning e-book market to keep prices at an attractive $9.99. From a pricing perspective, doesn't this seem like an odd way to use monopoly powers? Well, Amazon wasn't doing us all a favor; they were looking to guarantee that this new device would reach the tipping point as quickly as possible, ensuring its success.

So what of the future? Well, I can imagine that Amazon will take advantage of the cover provided by Apple. That is, they should allow Apple to take the lead in pushing e-book prices up to the consumer, allowing the publishers to reap some rewards. But if played correctly, they should also be able to increase their margins. After all, we're in the second or third period of a product that will have a steep adoption curve. Now that the product had a clear role in the future of the book industry, and consumers actually see additional benefits (such as convenience), Amazon and Apple should both be seeing margins expand as a result of that value.

Growth is a challenge

2010-01-27T10:19:00.003-05:00

We are in the midst of earnings season right now and I would recommend that people listen/read carefully as companies are reporting better-than-expected earnings in many cases. Always remember than business finance is really easy: Units time Price equals Revenue, and Revenue minus Expenses equals Profits.

Caterpillar is a good example, having released fourth-quarter and full-year earnings yesterday. The headlines that the financial press wants us to focus on is "higher revenues and profits"... unfortunately the company's press release says ("in 2010"). This is hardly the way to start a positive earnings announcement about 2009. For the year, Cat saw revenues decline 37% and profits were down 75%. And we know that pricing creates leverage on earnings, so it's easy to deduce that they were having problems across all three levers: price, volume and expenses.

The WSJ wants to talk about the "bullwhip" effect, which will pull companies like Cat quickly up during a recovery. However, even their own interviews with executives confirm that their expectations for 2010 focus on rebuilding their inventories within their channel, not demand-pull sales from customers. Companies need to be careful to avoid the temptation to stuff their channel. Rather, they should be looking to remain lean and allow customer demand to show up in price improvements first and units improvements later. This will also allow them to maintain expense improvements they've gained in the downturn.

Sales Strategies in Financial Institutions

2009-10-15T11:22:00.006-04:00

Financial Institutions, particularly banks, struggle to manage the diverse customer types and channel options available to them. As in many other industries, this can lead to a great deal of confusion, overlap and inefficiency. And that's to say nothing of the poor impression that it leaves with customers.

In a recent white paper, we explore banking as an example in a broad approach to creating sales strategies. We cover the importance of analytics to the development of the strategy; in fact, how those analytics will suggest the strategy. We also discuss the breadth of topics that must be considered: culture, the importance of coaching, differences between B2B and B2C situations and many other topics.

One of the most interesting issues in the banking example, particularly in today's climate, are the very real tradeoffs between building for the long term and executing tactically.

Access the white paper via our website: www.TheProfitGroup.com/media

or, launch it directly from our media host:

http://www.screencast.com/t/mVdKtP3Vk

and, click on "Download this Media"

Apparently beer can lead to rational behavior

2009-08-26T09:53:00.003-04:00

Let me set the stage for you: flat volumes, consumer prices falling generally (down 2.1% in July, the most in a half-century), industry consolidation. Each of these is supposed to portend lower prices, right? Well if you are pricing rationally, that's not necessarily the case. The two largest US beer producers, Anheuser-Busch InBev and MillerCoors have seen their profits rise 29% and 27%, respectively, over the first-half of this year. In fact, their making so much money, they're going to do it again - raise prices that is.

In a WSJ story today, the companies are getting widespread coverage of their rational behavior. Last Fall, they both announced price increases. The increases happened, they stuck and the profits have been flowing ever since, like from a pressurized tap. So they have both announced another increase for this Fall, on the same day, very publicly. In fact the Journal then did their market research for them, checking with retailers on the ability of this increase to stick.

So while volumes in the US are down 0.9% in 1H09 - the largest decline since they were down 0.3% in 2003 - prices are up 4.6% from a year earlier. Sounds like beer makers understand elasticity in their markets and will continue to get paid off for that intelligence.

Using Products to Build a Customer Segmentation - The Starbucks Example

2009-08-24T11:29:00.002-04:00

Last week, Starbucks announced that it will more carefully tailor prices of certain products. In effect, it is using its product lineup to help with its customer segmentation. It believes that certain combinations of (i) product category, (ii) size (volume) and (iii) add-ons will predict a customer segmentation. It will test whether this is true, and if true, do these segments have unique price elasticity.

For example, the Wall Street Journal reported that larger and more complex drinks will command as much as 10% more in price. At the same time, they will lower prices on some drinks by 2-5%, roughly. Further, they are teaching their salespeople ("baristas" sounds better), how to explain the price changes when they encounter sensitivity.

One of the things that Starbucks will need to start worrying about is the long-term effect on the brand. They have done an excellent job over the years of cultivating a high-end image. Worrying too much about volume growth, and store growth, can lead quality brands to worry about share. They need to remain consistent with the brand, looking to maintain price premiums in the market, rather than trying to "remain below competitors' prices." Doing otherwise will dilute the brand. Frankly, the irony is that they would be fighting a losing battle to try and undercut price, precisely because of the money they've invested in the brand over the years - no matter how real the discounts, it's just not a credible story.

Can Penske Remake The Auto Value Chain?

2009-06-10T16:58:00.006-04:00

Roger Penske is one of those guys that seems to get it. So when he announced that he was buying Saturn and looking to fold it into his Penske Automotive Group, I think that we should all take notice. We should also ask ourselves, "what lessons can we learn ... what does he believe that makes him place such a bet?"

I will hazard a guess about what he believes - that the auto value chain has been a bit off balance. In addition to being bloated (see my 5/15 post), the dealer network has disconnected the brand ownership from the customer. Translated: too many brand decisions are dictated by manufacturing constraints (real and imagined); and by extension, the insulation from tough decisions has made the evolution of the manufacturing process too slow.

If we look at the value chain in the auto industry, we see that what Penske is doing is moving the brand ownership closer to the customer. Historically being owned by the assembly company, rather than the customer-facing network, helped to give rise to a vulnerable product. Because of the power of the unions inside the company, manufacturing short-cuts were inevitable. With management at GM so preoccupied with managing a broken business model, it was too compelling to think the business was evolving slowly.

So what's Penske's brave new world look like? Well, he is apparently buying the brands, service, parts and distribution, but plans to outsource manufacturing. Initially, this will involve buying the historic Saturn product from GM, as they phase it out and Penske strikes new deals with other assembly companies. Speculation is that this will involve a number of German and Asian producers. It's logical to assume in this configuration, that Penske will soon be dictating design criteria and manufacturing specifications ... going shopping to all good assemblers and leveraging a very powerful position in the process.

Wall Street Journal - 6/6/09

US Companies Are Posting Profits ... Is Yours?

2009-05-30T15:01:00.002-04:00

The Wall Street Journal reported on Friday that profits at US corporations increased 3.25% in for first quarter. What they failed to note was the most important detail. The US Commerce Department report makes clear that all of the improvement was due to accounting adjustments, not real productivity, at financial firms (i.e. banks trying to look good to get out from under TARP restrictions). Non-financial companies saw overall and per-unit profit declines. And so, I've used the same sort of fancy "reporting" in my headline to get your attention.

But let's assume for the moment that we are in the early days of the US recovery. This headline will be true someday - hopefully soon. The question you should ask yourself is, "why is my profit not accelerating like the broader economy?" In most cases, the answer will be a lack of proactive customer management.

The discipline that we refer to as Strategic Customer Management has many facets. But one of the core practices is "culling the herd." Companies need to be very proactive about which customers they wish to serve, to protect or to fire. To many sales forces, that last bit is anathema. The most typical measure of sales we see monitored and rewarded is volume. However, a detailed look at per-client, per-segment or per-product profitability will often reveal loss-making activities. In most clients, between 20% and 40% of your clients are losing you money and their combined losses are responsible for destroying several margin points.

In a complete account planning cycle, we would typically divide the clients into segments, which definitions imply our broad course of action. Think of the typical police slogan - "To Protect and To Serve." (We'll add a couple of twists.) A scatter plot of customer profitability will often form a funnel shape: many low-volume customers representing a wide variety of profitability; and a few large customers hovering close to zero net margin. In this hypothetical example, I've drawn a segment called "To Protect" because they represent the bulk of our business. Job One for the sales person is to keep these customers' orders coming. Even Customer A, with slightly negative margin, might represent strategic volume for our factory. Our "To Serve" segment are the customers that we need to encourage to make us a bigger vendor and move to the right of the chart. The "To Nurture" segment are those customers that represent the large volume of our time and energy, but little order volume or profits.

The key segment to manage in this type of difficult economy is the "To Fire" segment. The sales action here is really "Up or Out," meaning that if they will pay a fair price, we would certainly keep them. In businesses where factory through-put is an important issue, there are ways to do this in a very methodical and calculated way. But it's important to pay attention to the important benefits of getting rid of these types of customers:

Sending difficult and low-profit customers to our competitors helps to fill their capacity with problems - which will free our capacity for good customers in an upturn
We can use our dry powder to defend our better segments - for example, offering discounts to customers that typically pay high prices, to get more of their business
Using the time dividend for the sales force to spend with segments we need To Nurture and To Serve - giving us a chance to build more durable relationships
Use fallow capacity to upgrade equipment, reconfigure for more efficiency or to strategically attack customers we want to grow with or have always wanted to add

Thinking long-term about where we want to be demonstrates the important strategic moves that we can make in any market ... even a difficult market.

Wall Street Journal - 5/30/09

Goodyear Makes Rational Production Choices

2009-05-27T17:50:00.010-04:00

Crain's covered an interesting release today on the choice Goodyear made to shutter a tire plant in France. I thought that it would be worth a comment or two on how global companies make these choices, as it is a good example of how global pricing analysis can lead to production decisions.

GT apparently made the decision to close one of

two tire plants in Amiens, France. It cited "its strategy to reduce high-cost manufacturing capacity" and "weak industry demand." The news release went on to detail employee cuts, unit volume reduction and it's strategy to remove 15-25 million units of capacity over the next two years. I point this out because these are all responsible actions from a major producer in a global market.

The broadest level of pricing analysis is referred to as Industry pricing - it's typically considered the Economist's view of price dynamics, but I argue that it should also be the Manufacturer's view (as in the case of Goodyear). [See our website for details.] In Industry analysis, it is important to understand cost structure of competitors, their intentions towards the market, geographic preferences, as well as the locations of production versus demand. Does this all sound familiar?

Just as it is important to provide good price leadership as a major producer, so too is it important to manage the supply side of the equation with the same discipline. Producers with the largest and highest-cost production bear the greatest responsibility to the industry to manage output, because they realize the greatest benefit. Price leadership is not something ominous; it simply means that the inverse (price wars) is not on the horizon. It means that one will rationally pick their market, produce close to their market and manage cost to stay price competitive. Does this all sound familiar?

Now, one of the wild cards in all of this for an Industry Strategist is the timing; and GT can using timing to its advantage. Because the closing of the plant will take 4-5 quarters, there is plenty of time to slow or alter the announced plans. While this may be a simple union negotiating tactic, it could be something much more strategic. I would look for another major producer to permanently idle capacity over the next few months. In most cases this should be in a Goodyear stronghold territory. This move would help to confirm GT's intention to focus on a core market, where it has production cost advantages; and both players benefit by producing more cheaply and closer to their customers. This is what drives prices down over time, while margins can remain strong.

Crain's Cleveland Business - 5/27/09

Professional Services Are Businesses Too

2009-05-20T20:58:00.007-04:00

In an interesting pair of articles today, the WSJ picks on lawyers and their poor business skills. Apparently there are a number of new programs designed to help lawyers do a better job of marketing themselves. They tend to be geared toward the individual; and no one would argue that leaders of any substantial business like a law firm shouldn't be familiar with the basic finance and accounting concepts. Perhaps that's enough of a sea change in the staid practice of law, where in generations past being a "rainmaker" was sufficient to make senior partner.

But, let's stop picking on poor lawyers and recognize that the same traditions exist in most professions: medicine, architecture, consulting, etc. Two decades ago, a wave swept the medical field with MBA programs popping up that were geared toward doctors and practice managers. This may simply be an evolution of those programs.

We would argue that to dive right in to a discussion of individual skills is premature. It ignores the role of the firm in setting strategy and perpetuates the inclination in the professions to have autonomous producers. In our construct of Strategic Customer Management (SCM), we argue that there is a stepwise process to managing revenue in a business; and our experience is that most companies skip important steps. When firms send novices or leaders to camps to learn how to "sell better," they are picking at the splinter in their peoples' eyes, while ignoring the plank in the organization's.

Professional firms historically grow and shrink by adding whole practices and geographies. These are key Market Strategy decisions. But much of the rest of the process is left to the discretion of the individual. While the management of the case/project must rest with the partner in charge, there are broader Sales Planning and Account Planning tasks that firms could direct. Without these micro views of the business, the sole role of the firm in success comes down to the hiring decision. With a more methodical approach, the firm would collaborate on segment/product strategy. The end result could be a much more accurate growth model, leading to greater stability.

Wall Street Journal - 5/20/09 - B5

Oil Drillers Feeling Commodity Economics

2009-05-19T20:17:00.009-04:00

Oil producers have been pinched lately between declining oil prices and sticky costs of production. Labor costs had not flowed through the oil services businesses while pricing power remained strong, which was due to tight supplies and these providers trying to hold margins until an actual turnaround materialized. Likewise, steel pipe prices and diesel fuel had remained firm - both being downstream products, with adjustments taking a while to work their way through the value chain.

Only recently have input costs completed a 10-20% retrenchment. The sharp decline in oil prices rippled through contracts for drilling rigs, which have now seen their demand cut in half since last Fall. The following chart shows a typical costs curve that can illustrate what's going on here:

As oil prices declined from P1

to P2, some producers/fields could not be profitably drilled unless the bars (cost) were shrunk sufficiently to produce a positive margin. This gives the producers a strong bargaining position with services firms and other input providers. Eventually, the demand for drilling activity will decrease by X barrels and services firms will begin to fight over customers and jobs. This is where the strong relationships and contracts allow certain producers to resist the call for price cuts on Y barrels.

Because cost curves are global in markets like oil, it is critical to include several other factors in the analysis: deliver costs, transport time, regional downstream demand, co-product supplies/demand, etc. Understanding these factors can spell the difference between giving in to a negotiating ploy or not.

Wall Street Journal - 5/19/09 - B1

Best Buy Has Strong Reasons To Clarify Its Position

2009-05-18T16:31:00.004-04:00

Best Buy probably shouldn't be scared today, with Wal-Mart's announcement that it is upping its game in the electronics space ... but, it should probably be getting laser focused on what it wants to be in 3-5 years. It is a good bet that Wal-Mart will take (perhaps significant) share in this market over the next 6-12 months and standing still is not a good strategy.

For context, Best Buy has slightly more than 1,000 US stores, to Wal-Mart's 3,500. Best Buy's sales of $45 billion is impressive in any industry, while Wal-Mart is nearly 10 times the size. It is safe to say that Wal-Mart has proven that a core competency of a low-cost retailer is its buying operation and the ability to bully suppliers - all of which makes it particularly odd for consumer marketing gods like Apple to get in to bed with them. Be that as it may, Circuit City's closing left $11 billion on the table - clearly enough to entice Wal-Mart to double-down. Best Buy has roughly $18 billion in sales in the consumer electronics space, giving it by some estimates a 22% share.

In the current recession, Wal-Mart has actually seen traffic increase and has been apparently taking share in a variety of categories from a variety of mid-priced retailers. What Best Buy has going for it is more than just a reputation for low prices. Arguably, it has invested in differentiated service (Geek Squad, associate training, etc.). If you think, even for a minute, that Wal-Mart is capable of taking share in this space, you would have to start thinking about a differentiation strategy rather than a low-price strategy. I would argue strongly that Best Buy should think about that for more than a minute.

Best Buy needs to think about customers in a very segmented manner. I believe that their investments (noted above) are proof that they do. What I would argue however, is that they need to start making those tough decisions: cutting segments loose, focusing spending on profitable segments and managing margins at the segment/channel level. This is generally a disconnect in culture for volume sellers (retails in particular) - to be comfortable with lower volumes in exchange for higher margin dollars per customer. The more they focus on these types of metrics, the more justification in the business model for investments in capabilities, the more comfort in letting pure price shoppers go.

Wall Street Journal - 5/18/09 - B1

Big Three Learn About Channel Management

2009-05-15T09:55:00.003-04:00

The U.S. auto makers are learning a very important lesson in channel management. They are taking back control of a dealer network that had grown bloated and counter-productive in the process. To listen to some of their own dealers interviewed is to recognize that the knowledge was there all along, for the taking, if only the manufacturers had listened. The dealers will say, "I have no pricing power ... there are too many of us in the area ... I can't get a foreign franchise, because they won't add any." All of these are lessons in scarcity and channel management.

What is interesting, but not at all surprising, is that these same dealers say, "why are they closing me, when I'm the biggest and the highest volume?" What the Big Three might be realizing is that true channel management involves very tough decisions. In one case in particular, we worked with a client that had let one of its wholesalers come to dominate the channel. Their "partner" was attempting to take share with low price, which was causing damage to partners who also offered service. In the long-run, the client would become more beholden to the channel and customers would see a notable degradation in service.

The only way the client was going to regain control of its own destiny was to have an old fashioned revival. Channel partners were going to have to get religion or leave the tent. By their nature channel partners will try to dominate competitors and suppliers alike - it's the way capitalism plays itself out. So someone in the ecosystem has to regulate the behavior.

If a company wants to succeed as well as survive, it will have to manage channels the same way it manages direct customers. Segmentation is important. Service discrimination is a tool. Having a concrete and comprehensive strategy for channel management is the only antidote for becoming dominated by "partners."

The Wall Street Journal - 5/15/09 - A1

The Initials Gang-Up On Intel

2009-05-14T17:26:00.002-04:00

AMD convinced the EU to put Intel in a box. The regulators levied nearly a $1.5 billion fine on the chip maker for various misdeeds. The short explanation of the findings is that Intel was abusing its monopoly power and its rebate program to disadvantage AMD with certain chip buyers. (Remember, it's not illegal to BE a monopoly, only to abuse the position). Intel claims to only use volume-based rebates and AMD claims that the rebate terms discourage buyers from using rival products.

The broader issue at stake however is how others interpret their ability to use rebates, which are a critical component to many pricing structures. It is quite common for manufacturers to use rebate schemes to reward customers; and in fact, it's quite common for those agreements to stipulate a minimum share of the buyer's wallet. It is a bit disconcerting to think of this through the reverse lens - that if share-of-wallet (SOW) declines, rebates are reduced. That starts to look (at least to the EU) as though a manufacturer is charging a premium to buyers who use competitive products.

The value to manufacturers is in rewarding buyers for actual performance under pricing guidelines, rather than having to proactively enforce volume breakpoints. In the latter, the producer would have to true-up contracts that had been delivered and paid for, through some sort of right of set off on future invoices. This is very difficult to administer; and many sales managers will find their own account managers revolting under some of those conditions, because of the sensitive nature of frequent renegotiations.

It will be important for large, global companies to follow the evolution of this story carefully. In its original summary ruling, the EU didn't specify the remediation and policy changes that are required for Intel to behave appropriately in the future. It's within these details that others will be able to parse the good and bad of rebate schemes.

Wall Street Journal - 5/14/09 - A1

Consumer Product Giants Know Their Price Elasticity

2009-05-01T18:31:00.003-04:00

Colgate and Proctor and Gamble understand how to use pricing as a tool to manage margin. They saw broad trends in the first quarter, indicating consumers were moving down-market. Some in fact were defecting all the way to private-label brands. But these master marketers know from experience that price moves would overcome defections, if done correctly.

They also have to deal with the complex channel issues of consumer products companies. In soft markets, retailers' typical reaction is to preserve volumes by cutting price. The big two knew that when they resisted retailers' calls for lower prices, they would be at a significant disadvantage to the private-labels on the adjoining shelves.

The marketing teams at these two companies knew that this was the right thing to do, in both the the short- and long-run. Today, it protects margins by trading volume for price. They were confident that the loss in volume would be less than most would expect (i.e. elasticity was lower). The brands have real value that consumers would pay an increasing spread for (remember, the bargain brands that retailers control would cut price in this environment).

In the long-run, this is an important test in the ever-evolving relationships with their channel. It's a bit like gasoline pricing - we understand that supply/demand has forced gas prices to triple over the last 10-15 years. But when feedstock prices go down, retail prices move slower. In the consumer product case, if retailers had won concessions, it's unlikely the producers would have seen those margins re-expand later.

Wall Street Journal - 5/1/09 - B1