How Do YOU Treat Your BEST
When you think of your best customers, how do you define 'best'? Do you treat them better than you do other customers? Do you generate more profit from them than you do from others?
Think about your relationship from the customer's perspective. Do they perceive that you provide outstanding service? Do they see you as an essential partner in generating profit for them? How does it compare to the way you view your own vendors?
Let's consider some examples. In these examples, we are less concerned with the specific facts behind each situation than we are with perceptions of behavior in the various cases.
Almost everyone in business does some airline travel. Many of us concentrate our flying on one or a few airlines with which we have love/hate relationships. We appreciate the benefits of their loyalty programs (upgrades, award travel, etc.), but we resent having to pay hundreds or thousands of dollars more for our seats than do other travelers in the same aircraft. We perceive that the other travelers enjoy almost the same experience for a fraction of the cost we pay. Airlines are widely perceived as gouging their most frequent and highest profit customers.
Southwest and Midwest Express both contrast sharply with others in the industry. Southwest leads with low fares. Midwest Express provides a distinguishing level of service. Both lead in customer satisfaction, but for different reasons. Also, both are more profitable than their peers.
Other than the two preceding counter-examples, airlines exhibit what many customers perceive to be low levels of trustworthiness and service while charging all they can. It is as if they view each transaction as a zero-sum game. For the most frequent travelers, they create some modest benefits. However, in many cases the benefits accrue to the traveler, not whomever is paying for the trip.
The Auto Industry
The U.S. press had a field day with the purchasing practices that Ingacio Lopez brought to General Motors a dozen years ago. Under his purchasing leadership, GM unilaterally canceled long term contracts and sought commitments to annual price reductions. While GM and Lopez got the attention, the same practices were and still are widespread in the U.S. auto industry.
In this part of the industry, relations between customers and suppliers can be characterized as a zero-sum game. Which side plays the game better allocates the profit between them. Unfortunately, in an environment lacking cooperative behavior, often the combined profit is less than it otherwise could be. On average, the industry suffers from higher costs and lower quality than its best Japanese rivals. In addition, at both the U.S. OEMs and their suppliers, employee satisfaction and trust of their employers is often poor.
In contrast, the most successful Japanese auto companies have a reputation for helping their suppliers improve while expecting them to meet high standards for quality. In this context, quality is broadly defined - not simply quality of conformance to parts specifications, but quality of design and consistently meeting business relationship expectations (such as on-time delivery).
Some of the Japanese firms exhibit a willingness to share gains between customer and supplier. The customer is usually not as dependent on the supplier as the supplier is on the customer, though.
Microsoft and PC OEMs
A federal judge recently ruled that Microsoft has a monopoly in operating systems for personal computers and that it abused its monopoly power. Several OEMs of PCs revealed during the trial that Microsoft engaged in threats, bullying of its largest customers, and price discrimination. Microsoft was (and still is) widely feared because it controls the supply of a required element for a system to function and its practices are very aggressive.
As a thought experiment, if Microsoft's control of the operating system were to weaken, how loyal would the PC OEM's be in the future?
Microsoft and its OEM customers have a critical dependence on each other, but in many of the transactions, the bulk of the value created accrues to Microsoft. Despite their mutual dependence, Microsoft pursues a zero-sum game, taking full advantage of its pricing power.
Many job shops make the bulk of their profit on repeat production of parts they have manufactured before. They often hesitate to pass on increases in costs, though, out of fear that the customer will seek to qualify new vendors. At the same time, job shops infrequently pass on cost savings, whether they achieve them through productivity improvement or reduction in materials costs.
Yet today, in some industries, job shops and their customers are working together with open books to identify savings, share the gains, and improve the profits of both entities. Since many job shops are much smaller than their customers, the customers are of strategic importance to the job shop though the reverse is rarely true.
Electronics Manufacturing Services
Electronics Manufacturing Services such as Solectron and Flextronics do much of the physical manufacturing for firms such as Cisco Systems, Hewlett Packard, and Motorola. The subcontract manufacturers and their customers have truly symbiotic relationships.
The manufacturing arms depend critically on the owners of brands for work while the latter depend on the subcontractors for rapid scaling up and down of production. They must share product life cycle plans and significant work flow data. Each fulfills a strategic role for the other.
WalMart and Procter and Gamble have a similar collaboration.
Which of these examples characterize your relationship with your customers and suppliers? Does one example apply to some situations while another one applies to others? Can you improve your business results by changing how you approach certain types of situations? In which examples do you think the returns on capital employed are highest?
The Relationship Continuum
Several factors influence your range of strategic options and the relative attractiveness of each.
Where are you on the Relationship Continuum?
The simplest business relationship is a one-time event such as purchasing a car from a car dealer. The relationship becomes richer if multiple transactions take place over time. Many business relationships are limited to one of these contexts.
In certain situations, both parties reveal private information in an effort to improve their combined effectiveness, which we characterize as "gain sharing". The parties seek to improve their individual business results in a "win-win" approach, rather than a "zero-sum" approach. This relationship stops short of both parties developing a critical dependence on each other.
A Strategic Relationship goes far beyond the Gain Sharing model. In this approach, the parties not only seek the "win-win", but they actually change their business models in ways that increase their dependence on each other but unlock the potential for substantially greater improvement in shared results. Many firms with genuine Strategic Relationships exhibit "virtual integration". For a true Strategic Relationship to be present, both parties must view the relationship as strategic to their future success.
Many businesses have no Strategic Relationships and limited Gain Sharing Relationships. Can you benefit from either with your key customers? Remember, you are limited to Gain Sharing unless the other party is willing to accept the mutual Strategic Relationship. Is your industry limited by values or historical behaviors to the transactional, Hobbesian world, in which life is nasty, brutish, and short?
Who has the pricing power?
Pricing power is usually, but not always determined by concentration of buyers and sellers. In a market with few sellers and lots of buyers, typically pricing power lies with the sellers. In contrast, when there are more sellers than buyers, the opposite is true. Exceptions exist. There are industries that exhibit fierce price competition even with a small number of sellers.
For simplicity, identify pricing power as strongest in one of the following four areas:
Determining where pricing power lies, enables you to evaluate how conditions might change suddenly to change the pricing power equilibrium. For example, if you look at Microsoft or the airlines, the way they treat their customers today limits their options in the future if the conditions that let them establish their current levels of pricing power erode.
Culture affects the extent to which businesses and individuals are willing to consider Gain Sharing and Strategic Relationships. In general, have you and your customers developed trust? In your industry do the powerful players always take advantage of pricing power? Is moral hazard present?
For example, many business travelers choose the airline on which they fly, but it might not minimize travel cost. And the airlines provide benefits (such as free vacation travel) to the traveler, who is often the buying decision maker. An employer might experience higher costs while the employee builds up the miles to go to Hawaii.
Where employees and customers observe price gouging and moral hazard, it is very difficult to establish the culture that supports Gain Sharing or Strategic Relationships.
Implications For Strategy
Gain Sharing and Strategic Relationships offer outstanding potential for improving business results in a sustainable manner. However, reaping the fruits requires sincere commitment to the principles, hard work, and the existence of appropriate conditions - both within and outside your firm.
Paul Minton is a consultant for Center for Simplified Strategic Planning, Inc., a consulting firm with a strict focus on strategic planning services for the small to mid-sized company. For more information, call 203-255-2080 or visit www.cssp.com . Paul can be reached via e-mail at email@example.com.