By George F. Brown, Jr. and David G. Hartman, Special for US Daily Review.
In the first part of this article, we described the situation faced by suppliers in which their direct customers are battling for every last nickel at contract negotiation time despite the fact that their own customers focus on factors other than price. Such suppliers see their direct customer’s healthy margins, and contrast them with their own always-under-pressure margins. The question that such suppliers constantly ask is “How did we get into a situation where the only thing that seems to matter to our customers is price?” It’s an important question, and one where the unfortunate answer often is, in the words of Jimmy Buffett, “It’s my own damn fault”. In the following sections, we will present several case studies of firms facing such challenges, and draw some conclusions about how such unhappy situations can be avoided in the future.
Understand the Real Competition along the Customer Chain
One of the most surprising examples of a firm that created an environment in which their direct customers were focused almost exclusively on price involved an electrical products manufacturer that made quite a few products that were viewed by all as the best the industry had to offer. They sold through electrical distributors (their direct customer) who in turn served contractors and industrial firms (the end customers). This manufacturer’s products were used primarily in industrial and commercial applications where performance mattered and in applications where the products made a real difference in terms of the life-cycle costs of operation. All of the ingredients were there for this firm to enjoy the benefits of differentiation and to capture the value that it was creating for customers at all stages of the customer chain.
How did this firm undermine its own success and shift the focus to price? It did so by excessive authorizations of distributors and other sales channel organizations. In every territory, they acted as if “more is better” and signed up distributor after distributor. What the sharp buyers at the later stages of the customer chain learned was that they could create a fierce price-based competition among the many authorized distributors in each territory, and get to low price points without ever having to consider any products other than those made by this manufacturer. And, of course, these end customers did exactly that and quickly got price concessions from the competing distributors. In turn, the distributors, seeing their margins dropping, began to place every pressure they could on the manufacturer. They were convincing, with sales data to back them up, that they couldn’t sell the product unless prices were lowered considerably. The results, in financial terms, evolved to look more like those of the manufacturer of the salt for the parking lot described above than those of a firm that manufactured best-in-class, highly-sought-after products. And it was their own damn fault.
The mistake made by this manufacturer was failing to understand the business environment at each stage of their customer chain. Rather, they implicitly assumed that their own situation carried forward to the other customer chain participants. From their perspective as a manufacturer, the competition was the other manufacturers making similar electric products. And they had largely won the battle against those competitors, with their products ranked as superior by almost everyone. But for their distributors, the competition did not involve those other manufacturers. Rather, it was the other distributors that the manufacturer had given authorizations to. As a result, the distributors resorted to the only strategy they could identify, naming that of participating in a vicious cycle of price-based competition.
The lesson is clear: make the effort to understand the business environment of every participant along the customer chain (especially focusing on who is seen as the competition) and make sure your strategy is contributing to alignment, rather than fostering the opposite.
Build Relationships Centered on Your Ability to Create Value
The second situation in which a supplier fails to thwart a lack of alignment and gets into a price-focused situation is far more common than the one presented above. One illustration involves a firm that builds a significant component of the infrastructure for power plants. Although each installation was unique, this firm brought technology and design capabilities that it could document were worth millions of dollars in operating savings over the decades during which such plants were operated. Unfortunately, the decisions on whether this firm won a job or it went to a competitor were made by third-party Engineering, Procurement, and Construction (EPC) firms that had a short-term perspective. Those EPC firms primarily cared about meeting the schedule, passing inspections, and coming in at or under budget. Their focus during the procurement process was on getting bids that helped them stay under budget, and an innovation that paid off later in the life cycle got little attention, and could even be viewed negatively if it had a higher first cost. As a result, while the electric utility firms who were the end customers had the potential of a huge benefit from superior technology and design, the EPCs who were this manufacturer’s direct customers made purchase decisions largely on price. The result was once again an unaligned customer chain, with the supplier facing a skilled price buyer who used every tool available to avoid leaving even a dollar on the table. And it was their own damn fault.
The mistake made by this supplier was failing to develop end customer relationships and sell their advantages to those end customers at a point in time early enough to matter. Had they done so, the end customers might have either identified this supplier as the preferred one, or at minimum provided the EPCs with spec’s that reflected the potential that this supplier could provide. Instead, this supplier had accepted this situation as a fact of life, devoting resources to building a team that was excellent at responding to Requests for Proposals and figuring out how to shave costs from their bids. In many instances, they first heard of a bid opportunity when the RFP was released by the EPC, a point in time at which it was far too late to make their case or influence the spec’s. Within this firm, there was constant friction, as the bid team red-lined solid engineering ideas to keep bids low, knowing that such ideas weren’t ones required by the spec’s provided by the EPC.
The lesson is clear: make sure you understand the factors driving purchase decisions at every stage of the customer chain, focus relationship development and information delivery on those stages where you have the ability to create value, and work to enlist the customers at those stages as allies who will help to create alignment along the full customer chain.
Many firms face this situation even when all the decisions are made within the direct customer organization, in situations in which there is a lack of alignment between the purchasing organization and with the “actual” end customers who use the supplier’s product as an ingredient or in operations. There can be many causes for such internal misalignment within a customer organization, and sometimes they can’t be overcome, but far too many situations like this reflect a failure on the part of the supplier to effectively make their case to the people and departments within the customer organization who can recognize value and insist on procurement processes that deliver it. Like the case of the supplier responding to RFPs issued by EPCs, failing to develop the right relationships can relegate a supplier to a situation in which their communications are always too late and to the wrong audience.
Understand the Business Models of Your Customers
The third example of customer chains that are not aligned is also quite common, and it again leads to situations in which price becomes the only factor of consequence. A case study involves a technology provider that makes equipment that is important in the data center environment. This firm sells through customer chains that involve VARs and integrators as direct customers, who in turn serve firms in industries like financial services, telecommunications, and government as end customers. The data center environment is one in which reliability is critical, with the goal of most data center owners and operators being that of ensuring “many 9s of reliability”. These end customers are indeed not price buyers. The VARs and integrators similarly voice messages about their own abilities to deliver on reliability goals, but in an example of “watch what we do rather than what we say”, they aggressively shop across technology suppliers to find offers of lower prices and do everything they can think of to reduce the equipment component of their bids. The equipment supplier thus faces a price buyer in their direct customer, even though the end customer’s orientation is centered on performance. And it was their own damn fault.
The mistake the data center equipment supplier made was failing to understand the business models of the participants along the customer chain. The VARs and integrators make most of their money on the skilled professional services that they brought to their end customers, and winning jobs and keeping their staff fully utilized was what drove their bottom lines. Selling the equipment at even a loss makes economic sense to these direct customers in many instances, as long as it allows them to keep their money-making service offerings going and their key relationships intact.
The lesson is clear: make sure you understand the business models of the participants at every stage of the customer chain, and address situations in which there is misalignment between what makes sense for your firm and what makes sense in the context of the business models of the other customer chain participants.
Solutions in situations like this are a challenge to identify and implement. Like tigers, the VARs and integrators through which this data center equipment supplier goes to market aren’t going to change their stripes. They will continue to understand that their business success is centered on their ability to win jobs and keep their professional staffs busy. For the equipment supplier to avoid misalignment with those direct customers, it had to contribute to one or both of those goals.
One Final Lesson and a Summary
The three lessons we’ve presented here share one common element. If your contract negotiations start tomorrow, or if your customer calls you in next Tuesday for a discussion as to why your prices are out of line with the market, none of them will help at all. On those occasions, the outcome will be determined by other factors – your ability to negotiate and the options available to your customer. Your firm may sometimes be successful, but over the longer term, it is quite likely that pricing pressures will persist and eventually result in a deterioration of your margins.
Best-in-class firms recognize that pricing must be an element of longer-term strategy, centered on the challenge of identifying how to create value for your customers as the route to capturing it for your shareholders. The lessons drawn from the three case studies are ones that must be part of such longer-term strategy, providing insights as to what will be required to be successful in the eyes of all of the participants along the customer chains that your firm serves. In all three cases, the “own damn fault” involved a decision that was inconsistent with the success of at least one customer on the customer chain. And in all three cases, the solution involved identifying and implementing actions that created a “win” for all of the customer chain participants.
As we noted at the beginning of this paper, there are many situations in which firms must face the reality of customers whose purchase decisions are largely driven by price. For those firms where that reality is unavoidable, there is no choice but to face it and implement a strategy that responds to the needs of their customers. But for those firms that unnecessarily place themselves into that situation, it’s a sad situation, one that is costing their shareholders rewards that could have been achieved through a longer-term perspective that is focused on understanding what is of value to each of the customers along the customer chain.
Taking steps to avoid unnecessary instances in which your direct customer is a price buyer is thus hard work and work that can’t be undertaken at the last minute. As the three examples provided above suggest, success requires considerable attention to understanding the business environment at each stage of the customer chain, the competitors that each participant faces, the goals that drive decisions for each participant, the business models through which each is creating value, and many other factors.
With an understanding of these factors, it is often possible to identify actions to avoid because they will motivate price-based purchase decisions and actions to take that will create alignment and shared successes along with your customers. Doing this successfully can allow a supplier to boast of strong earnings and point out proudly that “It’s our own damn fault”.
George F. Brown, Jr. is the CEO and cofounder of Blue Canyon Partners, Inc., a strategy consulting firm working with leading business suppliers on growth strategy. Along with Atlee Valentine Pope, he is also the author of CoDestiny: Overcome Your Growth Challenges by Helping Your Customers Overcome Theirs, published by Greenleaf Book Group Press of Austin, TX.
David G. Hartman is Blue Canyon Partners’ China Practice Director. He has previously served on the faculty of Harvard University and as executive director of the National Bureau of Economic Research. He has been an active participant in China’s markets for over twenty years, speaks Mandarin, and resides in Beijing. His clients include a roster of Fortune 500 firms and Chinese companies.