5 crucial parameters of the Value Equation.

5 crucial parameters of the Value Equation.

Some time ago I wrote a post that listed the 4 questions every business owner should ask themselves:

How do we create value?

How do we deliver value?

How do we capture value?

Will it be the same tomorrow?

In a recent workshop I was asked to expand on the rather brief notes in the original post. Following is a summary of the comments I made.

How do you create Value?

This is the one question every successful business on earth has in common. Success depends on them creating value for someone in excess of the cost to create that value.

There are several parameters to consider.

First: What is value?  Value can be relative, as in the situation where you stick a premium brand on a pair of ordinary sunglasses, and some people who value the cachet and assurance of the brand will pay several times the cost of the identical pair unbranded. The value is in the brand rather than the physical pair of sunglasses.

Value can also be contextual. I have been considering the option of upgrading my computer recently, looking at the costs, brands, and technical performance of the available options that suit my needs. Two weeks ago, my existing computer took a powder,  at which time the context in which I was considering a purchase changed radically, and the value of time became the over-riding factor. As the context of the consideration changed, so did the value, and so defining value at any time needs to consider these two differing sets of relative and contextual factors.

Second: Value to whom? Everyone defines what value means to them differently. In the sunglasses example above, there are groups who will pay significantly for a brand, and differing amounts of premium for differing brands.  For some, a brand like Ray Ban might add 5 times the commodity value, for others, who would not buy Ray Ban to save themselves, Pierre Cardin might add 8 times the commodity value to their choice of sunglasses. The marketing challenge is to define the groups to whom your brand adds the value, and target your marketing and brand building activity towards them.

Third: What is your niche? The definition of a niche is always a critical but often overlooked component of your marketing planning. Without adequate definition, you are unable to find the degree of definition of customers necessary to discriminate sufficiently closely to refine your messages to a point where they resonate with the most likely primary customer without wasting resources on those less likely to buy.  Often the creation of value evolves when an unrecognised or under-serviced niche is identified. Back to the sunglasses. 10 years ago there were no brands (that I can recall) targeted at sports people, who valued a light tint, polarisation, and a ‘wrap-around’ style that ensured a frame did not impede peripheral vision, and a very close fit. Oakley jumped into this unrecognised niche and built a brand based on delivering value previously unrecognised to a closely defined niche in the sun glasses market.

How do you deliver value?

It is of little use having something someone else would value without the means by which to deliver it. Your ‘Business Model’ is the means by which you deliver, a factor that is again often not considered in any real depth by small and medium sized businesses.  There are a pile of questions that need answering, but are mostly left to chance, habit, and the way it is always done in that market, which is hardly the way to differentiate yourself. Are you a retailer, wholesaler, operate in a double sided market (such as EBay), fee for service, franchise operator or franchisee, and so on.  While we are all sick to death of Airbnb and Uber being held up as examples, they are simply great examples of delivering an existing service via an entirely different business model making their owners rich in the process.

A great tool to use is the business model canvas articulated a few years ago  in a book of the  same name, and described in this post.

How do you capture value?

A business model offers some of the story about the means by which you capture value. Every model approaches the task differently. However, there are some common elements irrespective of your model that face every business.

Firstly, and most obviously, your costs must be less than your revenue, numbers captured well in traditional accounting models of the Profit and Loss account. However, what the P&L usually fails to do is clearly articulate all the costs that are incurred, particularly the last two in this following list.

Direct or marginal costs are those incurred directly to produce another unit of sale. Usually this is referred to as the cost of goods sold.

Overhead costs are incurred in every  business to keep the doors open. Communication costs, rates and taxes, management wages and salaries, utilities, and so on. Many accountants use a ‘fully absorbed’ cost method that divides the total of all costs incurred except perhaps discretionary trading costs such as advertising and promotion, into the number of units sold and allocates a cost to each unit to ‘absorb’ the overhead. This is logically flawed as the less you sell the more you must sell it for to absorb the costs, so the march towards commercial oblivion proceeds.

Opportunity costs. I have never seen these captured in a P&L, indeed, am not sure of how you would go about doing it,  but nevertheless, it is a cost of choosing a less than optimised allocation of resources. Consideration of the opportunity costs of resource allocation decisions should be a topic in every serious strategic discussion.

Transaction costs are the costs of managing transactions inside a business. A business with one supplier for an ingredient has less transaction costs associated with the purchase of  that ingredient than  if they had 50 suppliers. Obviously they also have greater risk, but transaction costs are the great hidden cost in most businesses.

The answer to the dilemma of capturing value is twofold:

You just have to understand, really understand your numbers, what drives them, and how you can influence them. Secondly, the number that counts above all else is cash. How much cash is coming in, from where, and going out, to where, and what are the timing factors that will influence that flow of cash. Every business should be forecasting their cash flow at least weekly in a rolling periodic forecasts that suits their business, but usually 13 weeks is a good number, and be watching the ebbs and flows daily.

Will it be the same tomorrow?

While a literal tomorrow may see little change, but what about next month, next year, the answer is a clear and resounding No!

The answer to this dilemma of managing for short term profitability while ensuring commercial sustainability is complex. On the one hand you have to have stable processes to optimise the productivity of resources allocated to a task, at the same time as you experiment in order to see the next thing coming, which is usually messy and risky, but absolutely necessary to survive. The classic case is Kodak who invented the digital camera and did not do anything with it, enabling the seeds of its own destruction to be sown. Most good businesses manage what they can control, and accommodate the changes necessary to moderate risk or leverage the opportunities as they  emerge.

It is a cliché but time has to be spent ‘on the business’ rather than in it by at least some of those responsible for the commercial sustainability of the business.

People.

Most will tell you that people are their greatest asset, then go off an do something that demonstrates the hypocrisy in the statement. It remains the truth however, that in all but the markets for non-critical purchases, people do business with people, not corporations, and people still do business with people they know like and trust.

Since I was a boy, I have heard the expression ‘Beauty is in the eye of the beholder’. It holds absolutely true for value as well. Value is always in the eye of the beholder, and is the net outcome of the complex set of unconscious and unseen mental gymnastics we all go through as we make assessments of options open to us. In a supermarket that may be hundreds of times in a few seconds, in a significant B2B purchase decision the considerations may be entirely different, but the processes are identical.

What is Intellectual Osmosis?

What is Intellectual Osmosis?

Definition: ‘The process by which a great product is conceived and  ‘launched’ to the market, with the developer believing that its greatness will be so obvious that the world will beat a path to his door’.

Never happens.

That bloke with the better mousetrap is still waiting.

 Nobody will become aware, understand, and be motivated to take some action if they know nothing about your great idea, and the solution to their specific problem that it can deliver, by some form of Intellectual Osmosis.

At some point you have to undertake the hard graft of developing a strategy, and translating it into the necessary marketing, sales, operational and commercial processes in order to turn the great idea into a business.

Most stop at the idea stage, as that is the easy bit. They then sit back and get disappointed and even angry when they see ‘their’ idea turned into a successful venture by someone else.

Intellectual Osmosis simply does not work, but does feel seductively good, as it is totally risk free.

The future of FMCG research has arrived

The future of FMCG research has arrived

My 30 year old son, a ‘gamer’ from way back, bought himself one of the new Playstation Virtual Reality units last week.

We have all heard about VR for ages, or it seems that way, always just about to be commercialised, then suddenly, a consumer retail level product that is just astonishing, for a few hundred bucks.

Fiddling with it during the week, moving through the scenarios, in between being amazed, and gobsmacked, it occurred to me that this was the future of consumer research.

Over the last 40 years I have commissioned enough consumer research to keep several firms in business,  both as an employee and more recently as an advisor. Almost all of it has been aimed at identifying the choices consumers will make between various options, price, packaging, shelf positioning, value add offers, and all the other things in the marketers toolbox.

Here is a tool that will do it all, and give a much higher degree of reliability than the methods to date.

Consider being a marketing person in a big FMCG supplier selling to the supermarkets.

Instead of the techniques used to date, gear up a virtual supermarket, and get people representing your target markets to wander the isles, making their choices as they would on a Thursday evening for their families.

This is real research in real time, and is right there to be used, right now.

 

3 things advertising cannot do, despite the claims.

3 things advertising cannot do, despite the claims.

Many small and medium sized businesses I interact with seem to have the view that advertising and marketing are synonyms, and if they had a bit more money in their marketing budgets, it would best be spent on advertising.

Rarely is that the case.

Advertising is just a part of a marketing menu, often crucial and a voracious consumer of dollars, but nevertheless often a small part.

Advertising is a great tool, a device to achieve all sorts of commercial ends, but like any tool, there are limits.

The babble that usually  accompanies the sales pitch for advertising is often long on superlatives and short on specifics.

Here is what advertising cannot do:

Advertising weight is no substitute for creativity.

Messages only really get absorbed when they appeal to our hearts, and most advertising appeals to our brains. Like all rules, there are exceptions, such as the advertising of a once only limited time price deal. No heart in that, all head, and it may be seen, and it may also be destructive of the brand, as it is commoditising it.

Advertising cannot make people care about something that has no relevance to them.

Look at all the advertising done for starving kids in Africa, soliciting 10 bucks a month to save a life. If we really cared, rather than felt guilty, the coffers would be running over. It is not that we do not abhor the fact that kids die of malnutrition, it is just that it is removed from us, has no personal impact, and we are cynical about how much of our 10 bucks is actually getting to the people who need it.  Advertising  is best when it defines the WIFM to those seeing it. The best copywriters are usually the direct response writers, they know immediately when their adverting works, and they are always appealing to the prospects top of mind self interest.

Advertising rarely increases the size of a market in the short term.

The purpose of advertising is to attract your competitors existing users, lapsed users, or light users to your products or service. From time to time advertising latches onto a latent need and does create a market, such as the great Apple advertising for the first macs or even better, DeBeers programs to create the tradition of a diamond engagement ring, but those take bucket loads of money, beyond the capacity of any medium advertiser, as well as great timing and a level of creativity rarely seen. Most advertising is aimed at nicking your competitors customers, in one way or another. When I had to turn around Ski yogurt, the target was Yoplait. There was no mistaking what we set out to do by offering a product that was distinctly different, had a different value proposition, but it was still yoghurt. Over time the combined activity increased the size of the market considerably, but our advertising target was Yoplait users and we got them by taking a stance on yogurt that had discernible pieces of fruit in it, rather than being a homogeneous product, and the taste was distinctly different, so there was a choice to be made once we persuaded consumers to trial.

The question of which channel to use for your advertising is a whole set of different questions.

Digital or analogue, is usually the first step, and the logical answer is ‘both’ as there is no one right answer. Each channel and each platform within the channel plays a different role, and has different costs and outcome expectations. It can get very complicated, and the only sensible way to sort out the mess, and conflicting claims is to be very clear about the objectives you have, then assess each advertising option against the objectives, and the value they deliver.

Digital impotence and the Black Knight

Digital impotence and the Black Knight

I am in the middle of a device free week.

Not by choice, my PC took a powder, and is in the ‘hospital’ for surgery. Now, at the close of day 5 I feel like the Black Knight, still kicking, but no arms.

The term digital impotence springs to mind.

It is interesting to reflect at such a time on the dependence we have developed to these things. This post is being done on one of my kids computers, a bit like the Black Knight landing a feeble kick on his opponent. Might make him feel better but is effectively useless.

Ages ago in an effort to retain some control of my time, I decided that I would not connect my phone to my email. Clients who might need me at short notice all have my mobile, so I do not need the constant email alerts going off, they are nothing but an unwelcome distraction, and kill battery life.  However, being disconnected since Wednesday morning is starting to have psychological effects.

Sweating, worrying that I just might have missed a return communication from someone not yet a client, but who is keen to be, a link to something that I would have liked the time to consider, the list drags on, and on, as does the time.

Nir Eyal writes about the habits we form, with some focus on digital products, his book ‘Hooked” is a disturbing, enlightening and fascinating read, but I thought I was largely immune.

No so.

Please give me back my PC before I lose my legs as well.

Where now for the two big supermarket retailers?

Where now for the two big supermarket retailers?

What a fascinating time to be an observer of FMCG.

The speed of strategic evolution is ramping up, and the risks to the investors in the two retail gorillas must be increasing as a result.

15 years ago FMCG retailing in Australia  was a two horse race. Coles or Woolies, there seemed to be no other options. While there were other options, independent retailers of varying types, particularly in SA and WA, their profile and strategic relevance was generally lower than a dwarf in a game of basketball. They could be annoying, and occasionally useful, but would never change the outcome of a game.

The net result is that Coles and Woolies concentrated on their short term game, with Woolies winning hands down in the shareholder returns stakes until recently. However, in the process, they lost sight of those who made a difference to their strategic numbers as distinct from their immediate financial ones: Customers.

They used their power to belt suppliers, and ignore customers beyond the land grab to put stores in every place where more than a footy team could congregate.

They ignored the opportunity to innovate beyond optimising what was already there, in other words they ensured innovation could not happen, or at least, ensure they carried absolutely no risk in the process.

The world has evolved since then, and panic has set in.

Woolworths botched Hardware in spades, demonstrating an astonishing lack of strategic insight, closed down Thomas Dux after strategically emasculating it just as it was gaining traction, is closing the Metro stores, and now it has been reported over the weekend, that they are considering selling the petrol retailing business. All that and declaring a $1.2 Billion loss for the 2015-6 year.

Meanwhile Coles has renewed itself, and announced a $1.86 billion profit for the year amongst some large write-downs in other parts of the Westfarmers group, particularly worryingly, Target.

Relative newcomer Aldi has upset the comfortable duopoly by grabbing market share and shopper penetration at a rapid and continuing rate. On top of all that you have alternative and web enabled retailers taking an increasing share of mind and attention that will over time convert to sales share. 15 years ago you could not find a Farmers Market, now they seem to be everywhere, and doing great business, and the net retailers seem to be able to actually deliver, sometimes.

For Woolies and Coles to fight each other, and invader Aldi on price makes no sense at all. The logical outcome of a battle on price is that Aldi will win simply because their business model is aligned to accommodate low margins and the gorillas are not, but if they do win that race to the bottom, the real risk is that they will go broke in the process.

No joy there.

So Woolies and Coles are left with where supermarkets started back in the thirties, delivering value to customers.

What an interesting notion for the gorillas, to be competing on the basis of the total value they deliver to customers, not just on price.  They might even have to collaborate in a meaningful way with suppliers, invoking  Joy’s Law, named after  Sun Microsystems co-founder Bill Joy who noted ‘No matter who you are, most of the smartest people work for someone else’.

Clearly, very few of the smartest people work for the gorillas, although there are some more left in their supplier base. However, those suppliers of any real scale who remain locally owned could together just about fill a phone box.

There is plenty of room in the demand chain left for innovation. The first step is to recognise the necessary change from a retail optimised supply chain that implies screwing suppliers for margin in any way you can dream up, while maximising margins at the checkout, to one that puts the consumer front and centre.

A demand chain.

This change requires recognition that the consumer has a reasonably certain amount of money to spend on groceries and household supplies, and will allocate those dollars in the ways  that best suits them and their circumstances.  Economists will call this phenomenon ‘Customer demand”. The name of the game then is to share out those consumer dollars in the best way that serves the whole supply chain based on that actual and latent demand.

Plenty of room for collaboration through the chain, enabling innovation and sustainable profitability. You just have to see the competitive game completely differently. I wonder if the gorillas are capable of that sort of strategic renewal or if I should sell my (very few) shares ASAP.