The Value of Discipline

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Value Disciplines Model & Your Competitive Advantage

by Pat Ordenes, on Mar 8, 2020 9:04:12 PM

The Value Disciplines Model is one of my favorite strategy frameworks. It helps you better understand and execute on the one thing that you want your organization to be famous for.

There are countless strategy frameworks out there, and we have already covered a few key frameworks which we think are extremely flexible and battle-tested over the years:

The great thing about the Value Disciplines framework, it can be applied at any stage of your organization’s growth. Whether you’re just starting out, or an established multinational – Value Disciplines helps you get laser-focused on your business objectives.

So what are the Value Disciplines?

The Value Disciplines concept was solidified by Michael Treacy and Fred Wiersema in their book: The Discipline of Market Leaders. Having researched and observed trends in companies such as Wal-Mart, Dell, Southwest Airlines, Intel and Sony, the authors presented a business model with three key competitive areas:

  1. Customer Intimacy
  2. Product Leadership
  3. Operational Excellence

They propose that for a business to be competitive, they must do well in all three areas. However, organization’s that wish to become market leaders in their category, need not just do well, but excel in one of these. Let’s first break each one of these down and look at what they represent. Then, we’ll look at how they co-exist and why no organization can really excel at all three (as nice as that would be).

Customer Intimacy of Value Disciplines

The easiest way to explain the concept is to use this statement:

Your organization must become obsessed with understanding the individual customer in detail.

This will then help you to excel in customer service and customer attention.

Customer intimacy in the Value Disciplines goes beyond understanding your customer’s needs and wants. It means having a full range of services available to help serve your customers on demand. Think of it as a concierge for customer service. E.g. you know you’re in a good hotel when the concierge gets to know you to the point where they not only serve you IN the hotel but also outside. The concierge may do this by providing advice you wouldn’t normally get on a brochure or Googling. They may even arrange services for you well outside the scope of the hotel (arranging for a tailor to come to the hotel).

This level of intimacy with the customer gives your organization a unique opportunity to bring unparalleled value to your customers. That’s a huge deal, because it allows you to differentiate yourself against your competitors. Also, it helps you to compete on value, rather than price (and most likely charge a significant premium for your product or service).

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Customer no longer place the value on the product or service alone, but rather the familiarity in the process. A company that comes to mind when it comes to customer intimacy is Zappos. Zappos customer service team are known for going well above the call of duty. Zappos don’t just keep customers happy, but also surprise them along the way. Here are some great examples of Zappos stories online. More traditional examples of companies with a customer intimacy approach include Home Depot, Staples in office-supply retailing, Ciba-Geigy in pharmaceuticals, and Kraft.

The guiding principles for effective Customer Intimacy are:

  • Having a full range of services available to serve the customers on demand. This may involve having a wide range of services available from other suppliers at very short notice through contract arrangements.
  • A corporate philosophy and resulting business practices that encourage deep customer insight. This helps deliver breakthrough thinking about how to improve the customer’s situation.

How would you measure Customer Intimacy?

This can seem a little vague at first, since customer intimacy is not necessarily a tangible dimension. Also, it’s often hard to simply quantify the success of customer intimacy. When we look deeper though, there are certain areas we can measure to help understand customer intimacy success. These measures will help paint a picture of how effective a customer intimacy approach can be for an organization:

  • Reach and range – This involves the location of service access points, number of channels the product or service can be accessed and levels of self-service available
  • Cycle time – Measuring the time between awareness of customer need and delivery, and product or service development time
  • Product identification – The ability to identify new products or services required by customers.

Focusing on customer intimacy is a fantastic way to differentiate your business. It can take time and a significant amount of money to achieve. But if done well it can give you a nearly unassailable competitive advantage.

Product Leadership of Value Disciplines

This is simply about leading the charge in product development. Though a simple concept, it is often a difficult space to compete in. Your ability to compete in this space will often be dictated by the level of investment an organization can allocate to researching and developing a product so that it not only leads the market but also remains well ahead of any competitors (easier/cheaper said than done!).

To do this effectively, an organization needs to challenge itself in three specific ways:

Creatively – meaning that they often need to embrace ideas that are usually outside the company’s normal scope

Commercially – the ideas need to move through their due process quickly to reach the market first

Relentlessly – such a product leader must be relentless in their pursuit of new solutions to problems they may have just solved. In the tech space, for example, this means continuously rendering your latest product obsolete (better you do that than your competition).

Apple is probably the poster child in terms of product leadership. However, in recent times this has become increasingly debatable (I can already hear the screams of iPhone fanboys!). Regardless, Apple has always aimed to lead through developing a better product. Their drive for innovation is so embedded into the organization, that it became part of the marketing (“Think Different” campaign).

Guiding principles of an effective product leader are:

  • Encouragement of innovation – Maintain a company culture that allows experimentation and innovation and rewards product or service improvement
  • Risk-oriented management style – Having management team that allows the organization to take risks and reap the rewards of new ventures (of course this means an inevitable number of failures in the process)
  • Recognition that the organization’s current success and future prospects lie in its talented design people and those who support them
  • The drive to educate and lead the market in the use and benefits of new products or services.

How do you measure Product Leadership?

Though the initial measurable focus area would be market share, this does not immediately indicate product leadership in a particular product category. If we look at the smartphone market, for example, Apple is still seen as the market leader, although Samsung moves more units. Apple managed to position itself as the innovator at the early stages of the competition, so customer perception tends to lag. Some areas that can help identify product leadership include:

  • Capability maturity – The ability to maintain the level of capability to deliver products or services and the continuous improvement of those capabilities
  • Intellectual leverage – Being able to develop and use intellectual assets for improved product and service delivery
  • Responsiveness – minimizing the response and turnaround times for product and service design and delivery (getting to market quickly)

Operational Excellence of Value Disciplines

Operational excellence revolves around the principal of low or lowest price and hassle-free service. This is simplifying the concept somewhat, but essentially the organization aims to lead the market through price and convenience. The goal is not to simply be the cheapest (from a financial point of view, that can be a journey to the bottom), but to really create an environment for the customer where friction is minimized or completely eradicated.

Dell is a perfect example of this principle. While Compaq computers concentrated on making faster and cheaper machines than IBM, Michael Dell saw an opportunity from his college dorm. He still focused on the product (faster cheaper) like the competitors but decided to emphasize the delivery system.

Dell was able to compete by delivering products to order rather than to inventory (cutting out the middleman and reducing costs) and still maintain quality and service.

The guiding principles for operational excellence revolve around:

  • Efficient management of people – Developing a culture and training focused on efficient and low-cost ways of doing things
  • Management of efficient transactions – Being able to maximize the efficiency of all facets of a transaction, including the full supply chain
  • Dedication to measurement systems – Focus on quality AND cost control (with an emphasis on finding ways to reduce costs). Manage customer expectations by limiting products and services (avoid over-promising).

How do you measure operational excellence?

There are three key areas that can help measure how well an organization is performing in this space. These are:

  • Costs – By analyzing and adjusting processes and products to facilitate the most cost-effective delivery
  • Quality – By detecting, understanding and removing problems through processes, products, and services that have efficiency impacts both before and after delivery
  • Organisational performance – Maintain efficiency through improved processes and automation for speed and hassle-free delivery

If you are familiar with the concept of “Kaizen” from Japan, you will agree that the operational excellence concept borrows a lot from it. In fact, Toyota, is a brand know for its operational excellence.

Can’t I be great at all three?

The short answer is no. Like anything in business though, it depends. The initial reaction when I looked at this framework was to strive to excel in all areas. Alas, Treacy-Wiersema argues that an organization will find it very difficult to excel in all three disciplines. Treacy-Wiersema argues this since the organizational culture, structures, people, facilities, processes and business models that lead to excellence in one discipline are not compatible when attempting to achieve the same in the other two disciplines. For example, Dell would find it hard to break into the product leadership discipline. All Dells processes are geared to providing customized solutions at the lowest possible price. This is a very different business model from Apple who produce few products but with an intense attention to product detail.

Having said that, it doesn’t mean it is not possible. There are companies out there that have somewhat achieved this. Let’s take Staples, the office supply giant in the United States. They have adopted both operational excellence and customer intimacy. Staples achieves the lowest net-landed cost in the entire office stationery business. Recently though, Staples pushed for customer intimacy, by creating a Staples ‘club’ with membership and discounts. They now use the data they gather from the club members to serve better and deepen their relationship with these customers.

Indeed, if we look at the tech space and some of the companies that are disrupting the market, we see that a lot of them manage to excel at two of these areas effectively. If we look at Airbnb for example, the business offers operational excellence from a high level of customer intimacy. This could be said about Uber also.

How can you apply this framework to your business?

An organization looking to define it’s direction and quickly gain a competitive edge may use The Value Disciplines Framework as a tool. More than a discipline, once you ‘stake your claim’ in one of these areas, an organization can turn this into a philosophy that is embedded within the company. When that is achieved, employees resonate with the discipline and will aim to uphold it vigorously. It can almost become the WHY of the organization, and this can not only give you a competitive edge but a cultural one as well (watch the video below if you haven’t seen it before).

The trick is to not forget that simply because you focus on one discipline, there is no neglect of the other two. Remember, you MUST compete in all three disciplines – there is no choice in that. The choice is simply to make a conscious decision to excel in one.

Cascade’s Value Discipline

Here at Cascade, for example, we’ve made a conscious decision to excel in customer intimacy. We do this by going that extra mile for our customers. We don’t just provide Cascade as a strategy tool, but as something that integrates with an organization. The way we do that is by really understanding the needs of an organization and going well beyond the software to facilitate success. This doesn’t mean we don’t focus on our product (most of our team is comprised of developers). But, it is everyone’s responsibility to know, understand and better serve our customer. If our customer feedback and reviews is anything to go off, you can see that customer intimacy is a core strength for Cascade.

The Value Disciplines Model

Value Disciplines is a really powerful strategy framework. Value Disciplines can be quite flexible, but it is not for everyone. For example, if a business offers customer care as a service, trying to focus on a discipline other than customer intimacy will offer limited value. It pays to look at the concept and determine if it really is a good fit for your current structure. If you want to read more about this framework, I strongly suggest picking up the book: The Discipline of Market Leaders.

If you’re curious to see how this framework could work for you, why not use our platform to visualize it? Cascade Strategy allows you to quickly build your plan, along with organizational goals and tasks, to help you quickly determine how this type of strategy can help. Give it a try!

[UPDATE] : We’ve added an info-graphic that you can download for your reference or share.

Value Disciplines: Customer Intimacy, Product Leadership and Operational Excellence

In their book ‘The Discipline of Market Leaders‘ M. Treacy and F. Wiersema argue that no company can succeed today by trying to be all things to all people. It must instead find the unique value that it alone can deliver to a chosen market. This is quite in line with Porter’s Generic Strategies in which Porter describes how companies gain competitive advantage by either focusing on low cost (Cost Leadership is a type of competitive strategy with which a company aggressively seeks efficient facilities, cuts costs and employs tight cost controls to be more efficient than competitors. A low-cost position means that the company can undercut competitors’ prices while still offering comparable quality and earning a reasonable profit. Cost leadership is, just like Differentiation and Focus, part of Porter’s Generic Strategies.

” target=”_blank” >differentiation or a niche market. If a company tries to pursue all of these strategies, it is likely to end up somewhere ‘stuck in the middle’ offering average products for average prices. Similarly, Treacy and Wiersema suggest three ‘ Value Disciplines ‘ to choose from which should act as a central piece that shapes every subsequent plan and decision a company makes. These three value disciplines are: Operational Excellence, Product Leadership and Customer Intimacy. This article will go into what each value discipline stands for and how a company’s operating model should look like to best serve these value disciplines.

Value Disciplines Customer Intimacy, Operational Excellence, Product Leadership, Treacy and Wiersema

Figure 1: Value Disciplines Model

Define your customer, narrow your focus

Different customers buy different kinds of value. Some customer segments appreciate low prices, while others want the most superior and innovative products. Some customers expect the best of the best customer service, while others want to be able to quickly get a reliable product without much hassle. It is therefore important to clearly choose your customer and narrow the value you want to focus on. Market leaders choose to excel in delivering extraordinary levels of one particular value while maintaining a threshold standard on other dimensions of value. In other words: market leaders are extremely good at being the best at delivering one particular value without being bad at the other value disciplines. Consequently by focusing on one (and one only) particular value to excel at, they beat competitors who are dividing their attention and resources among more than one discipline. Customers know that to expect superior value in every dimenion from the same company is unreasonable. After all, you don’t go to Wal-Mart for the best personalized service and you don’t buy Nike sneakers because of the cheap prices they offer.

The Discipline of Market Leaders by Michael Treacy & Fred Wiersema

Value-driven operating model

The particular value that you decide to offer has the effect of defining your way of thinking about your business: it shapes the company’s operating model. Different value disciplines demand different operating models in order to best capture the value that is being pursued. Operating models are made up of core processes, organizational structures, management systems, information technologies and culture. All of these element have to be adapted and aligned with the value discipline that the company is focusing on. If a company focuses on superior quality and innovation, you need a culture where employees can challenge the status quo and try new things. If a company’s focus is on cutting costs and becoming as efficient as possible, you need a centralized organizational structure and a standarized production process. Down below we will go more into each value discipline and how the underlying operating model should look like.

Operational Excellence

The first value discipline we discuss is Operational Excellence: providing customers with reliable products or services at competitive prices, delivered with minimal difficulty or inconvenience. Operationally excellent companies deliver a combination of quality, price, and ease of purchase that no one else in their market can match. Their value proposition to customers is garantueed low price and/or hassle-free service. An operational excellent company has an operating model based four distinct features: 1. Its core processes are aimed at end-to-end product supply and basic service that are optimized and streamlined to minimze costs and hassle. Costs in this context does not merely mean the price that is paid for a product. It also includes costs in terms of time spent to purchase the product, product maintenance needed in the future and the ease of getting swift and dependable service. 2. Operations are standarized, simplified, tightly controlled, and centrally planned, leaving few decisions to the discretion of rank-and-file employees. 3. Management systems focus on integrated , reliable, high speed transactions and compliance to norms. 4. A culture that abominate waste and reward efficiency. Especially, efficiency is a key word in operational excellent companies. Variety kills efficiency because it burdens the business with cost. A narrow product line and standarized products are therefore central features in the operating model. Some great examples of operational excellent companies are McDonald’s, Southwest Airlines, Wal-Mart and IKEA.

Figure 2: Operational Excellence Operating Model

Product Leadership

Product Leadership is about consistently striving to provide your customers with leading-edge products or useful new applications of existing products or services. In order to do so, they must be creative, agile and fast. Their strenght lies in reacting to situations as they occur. Consequently, product leaders avoid bureacracy at all costs because it slows down the commercialization of their ideas. The operating model of a product leader is completely different from an operational excellent company and includes: 1. A focus on the core processes of invention, product development and market exploitation. 2. An organizational structure that is loosely knit, ad hoc and ever changing to adjust to the entrepreneurial initiatives and redirections that characterize working in unexplored territory. 3. A management system that is results-driven, measures and rewards new product success and that doesn’t punish the experimentation needed to get there. 4. A culture that encourages individual imagination, accomplishment, out-of-the-box thinking, and a mindset driven by the desire to create the future. Examples of product leaders are Apple, Nike, Rolex, Microsoft and Harley-Davidson.

Figure 3: Product Leadership Operating Model

Customer Intimacy

A company that delivers value via customer intimacy builds bonds with customers like those between good neighbours. Customer intimate companies don’t deliver what the market wants, but what a specific customer wants. It continually tailors its products and services to the customer in a way that it can offer the ‘best total solution’. Because of this approach, customer initmate companies’ greatest assets are their customer loyalty. Their operating model allows them to produce and deliver a much broader and deeper level of support. It features: 1. An obsession with the core processes of solution development, results management and relationship management. 2. A business structure that delegates decision-making to employees who are close to the customer. 3. Management systems that are geared toward creating results for carefully selected and nurtured clients. 4. A culture that embraces specific rather than general solutions and thrives on deep and lasting client relationships. Customer intimate companies know that their clients have a hierarchy of needs beyond their requirement for a product and instead have a broader, underlying problem that they are trying to solve. Examples of companies that show this level of understanding are Home Depot, Salesforce, Amazon and Nordstrom.

Figure 4: Customer Intimacy Operating Model

Value Disciplines In Sum

Treacy and Wiersema argue that companies need to make tough strategic choices in order to become market leaders. Market leaders choose to excel in delivering extraordinarily levels of one particular value to their customers. This way they can remain focused and become the absolute best in a certain value proposition. It also means that a company’s entire operating model should be adapted in a way that it is aligned with the chosen value discipline. This however doesn’t mean that a company should allow performance in other dimensions to slip so much that it impairs the attractiveness of the other ‘secondary’ value disciplines. Maintaining thresholds of performance on those secondary disciplines is therefore important as well. If a company has reached a leadership value in one discipline and threshold values in the other two, it is ready on its way up to become a market leader. If your company is not there yet, don’t wait longer and: choose your customers, narrow your focus, and dominate your market.

Customer Intimacy and Other Value Disciplines

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January–February 1993 Issue

How was Dell Computer able to charge out of nowhere and outmaneuver Compaq and other leaders of the personal computer industry? Why are Home Depot’s competitors losing market share to this fast-growing retailer of do-it-yourself supplies when they are all selling similar goods? How did Nike, a start-up company with no reputation behind it, manage to run past Adidas, a longtime solid performer in the sport-shoe market?

All three questions have the same three answers. First, Dell Computer, Home Depot, and Nike redefined value for customers in their respective markets. Second, they built powerful, cohesive business systems that could deliver more of that value than competitors. Third, by doing so they raised customers’ expectations beyond the competition’s reach. Put another way, these industry leaders changed what customers valued and how it was delivered, then boosted the level of value that customers expected.

The idea that companies succeed by selling value is not new. What is new is how customers define value in many markets. In the past, customers judged the value of a product or service on the basis of some combination of quality and price. Today’s customers, by contrast, have an expanded concept of value that includes convenience of purchase, after-sale service, dependability, and so on. One might assume, then, that to compete today, companies would have to meet all these different customer expectations. This, however, is not the case.

Companies that have taken leadership positions in their industries in the last decade typically have done so by narrowing their business focus, not broadening it. They have focused on delivering superior customer value in line with one of three value disciplines—operational excellence, customer intimacy, or product leadership. They have become champions in one of these disciplines while meeting industry standards in the other two. (For a discussion of companies that excel at more than one discipline, see the insert “Masters of Two.”)

Masters of Two

While market leaders typically excel at one value discipline, a few maverick companies have gone further by mastering two. In doing so, they have resolved the inherent tensions between the operating model that each value discipline demands. A decade ago, Toyota successfully pursued an operational excellence strategy; today, it retains its mastery in operational excellence, and, through its breakthroughs in automobile technology, it is moving ahead in product leadership as well.

USAA, a Texas-based insurer that caters mainly to people in the military, has mastered both customer intimacy and operational excellence. USAA is everything an operationally excellent company would want to be: centralized, highly automated, and incredibly disciplined. Its immense, state-of-the-art information system is an information technologist’s wish come true. By virtually eliminating paperwork, it allows the company to be quick and responsive. The information system at USAA is the process.

Other insurance companies—Northwestern Mutual and Allstate come to mind—have been building equally excellent operations. But USAA continues to set the pace by doing a better job of tailoring its services to customers’ particular needs. USAA segments its customer base by, among other characteristics, life stage—at what point a customer is in life—and develops products, services, and servicing approaches for each of those segments. In addition to execution, USAA has mastered customer intimacy.

Staples, the office supply giant, also has become adept at both operational excellence and customer intimacy. Staples achieves the lowest net-landed cost in the entire office stationery business, but it also has become intimate with a particular market: companies employing fewer than 50 people. To further the intimacy with that market segment, it has created a club. Customers join it at no cost and get at least a 5 % discount on the fastest moving items. But to get the discount, customers have to show their club card, which means Staples can track sales by customer, and that gives the company all kinds of data it can use in satisfying its market. Store managers now have incentives based on customer retention.

Toyota, USAA, and Staples are today’s rare exceptions. But mastery of one discipline will eventually become the minimum that a company will need to get itself into the game. Chances are that the big winners of the future will have mastered two.

By operational excellence, we mean providing customers with reliable products or services at competitive prices and delivered with minimal difficulty or inconvenience. Dell, for instance, is a master of operational excellence. Customer intimacy, the second value discipline, means segmenting and targeting markets precisely and then tailoring offerings to match exactly the demands of those niches. Companies that excel in customer intimacy combine detailed customer knowledge with operational flexibility so they can respond quickly to almost any need, from customizing a product to fulfilling special requests. As a consequence, these companies engender tremendous customer loyalty. Home Depot, for example, is better than any other company in its market at getting the customer precisely the product or information he or she wants. And product leadership, the third discipline, means offering customers leading-edge products and services that consistently enhance the customer’s use or application of the product, thereby making rivals’ goods obsolete. Nike excels in product leadership in the sport-shoe category.

Companies that push the boundaries of one value discipline while meeting industry standards in the other two gain such a lead that competitors find it hard to catch up. This is largely because the leaders have aligned their entire operating model—that is, the company’s culture, business processes, management systems, and computer platforms—to serve one value discipline. Knowing what they want to provide to customers, they have figured out what they must do to follow through. And with the hard work of transforming their organizations behind them, they can concentrate on smaller adjustments that produce incremental value. Less focused companies must do far more than simply tweak existing processes to gain this advantage.

Companies that pursue the same value discipline have remarkable similarities, regardless of their industry. The business systems at Federal Express, American Airlines, and Wal-Mart, for example, are strikingly similar because they all pursue operational excellence. An employee could transfer from FedEx to Wal-Mart and, after getting oriented, feel right at home. Likewise, the systems, structures, and cultures of product leaders such as Johnson & Johnson in health care and pharmaceuticals and Nike in sport shoes look much like one another. But across two disciplines, the similarities end. Send people from Wal-Mart to Nike, and they would think they were on a different planet. Moreover, homogeneity exists only among leaders in the same value discipline; mediocre performers are not distinctive enough to look like anything except other mediocre performers in their own industries.

The conclusions we’ve drawn about the value disciplines are based on a three-year study of 40 companies that have redefined performance expectations in their markets. Through this research, we have come to understand what each value discipline demands of an organization and why.

Operational Excellence

The term “operational excellence” describes a specific strategic approach to the production and delivery of products and services. The objective of a company following this strategy is to lead its industry in price and convenience. Companies pursuing operational excellence are indefatigable in seeking ways to minimize overhead costs, to eliminate intermediate production steps, to reduce transaction and other “friction” costs, and to optimize business processes across functional and organizational boundaries. They focus on delivering their products or services to customers at competitive prices and with minimal inconvenience. Because they build their entire businesses around these goals, these organizations do not look or operate like other companies pursuing other value disciplines.

Dell Computer is one company that has focused on such operational excellence and, in doing so, has shown PC buyers that they do not have to sacrifice quality or state-of-the-art technology in order to buy personal computers easily and inexpensively. In the mid-1980s, while Compaq concentrated on making its PCs less expensive and faster than IBM’s, college student Michael Dell saw the chance to outdo both IBM and Compaq by focusing not on the product but on the delivery system. Out of a dorm room in Austin, Texas, Dell burst onto the scene with a radically different and far more efficient operating model for operational excellence.

Dell realized that Compaq’s marketing strategy—selling PCs through dealers to novices—could be outperformed by a model that cut dealers out of the distribution process altogether.

By selling to customers directly, building to order rather than to inventory, and creating a disciplined, extremely low-cost culture, Dell has been able to undercut Compaq and other PC makers in price yet provide high-quality products and service. While Dell has risen to $ 1.7 billion in revenue in less than ten years, Compaq has been forced to cut prices and overhead.

Other leaders in operational excellence include Wal-Mart, American Airlines, and Federal Express. Yet another, less well-known example, is General Electric’s “white goods” business, which manufactures large household appliances. It has focused on operational excellence in serving the vast market of small, independent appliance retailers.

In the late 1980s, GE set out to transform itself into a low-cost, no-hassle supplier to dealers, and it designed its so-called Direct Connect program in pursuit of that objective. The Direct Connect program was ambitious. It required that GE reengineer several of its old business processes, redesign its systems, reconfigure information systems, reconfigure its management systems, create a new mind-set among employees. In effect, General Electric reinvented its white goods business to embody its operational excellence discipline. As a result, the company has lowered dealers’ net-landed cost of appliances and simplified its business transactions.

Historically the appliance industry had endorsed the theory that a loaded dealer is a loyal dealer. If a dealer’s warehouse were full of a manufacturer’s product, went the argument, the dealer would be committed to that company’s product line because there was no room for goods from anyone else. Manufacturers’ programs and pricing had been built around the idea that dealers got the best price when they bought a full truckload of appliances and were offered the best payment arrangements if they adhered to the manufacturer’s floor plan.

But changes in the retail end of the industry caused GE to question that assumption. For one, the loaded-dealer concept was costly for independent appliance dealers, whose very existence was being threatened by the growing clout of low-price, multibrand chains like Circuit City. Independent stores could hardly afford to carry a large stock of appliances, especially when faced with competition from multibrand chains. Moreover, the chains could put price pressure on manufacturers, causing makers’ margins to shrink.

Realizing that it had to supply high-quality products at competitive prices with little hassle, General Electric abandoned the loaded-dealer concept and reinvented its operating model—the way it made, sold, and distributed appliances. Under the company’s new Direct Connect system, retailers no longer maintain their own inventories of major appliances. They rely instead on General Electric’s “virtual inventory,” a computer-based logistics system that allows stores to operate as though they had hundreds of ranges and refrigerators in the back room when in fact they have none at all.

To make Direct Connect work, retailers acquire a computer package that gives them instantaneous access to GE’s on-line order-processing system 24 hours a day. They can use the system to check on model availability and to place orders for next-day delivery. The dealers get GE’s best price, regardless of order size or content. Direct Connect dealers also get, among other benefits, priority over other dealers in delivery scheduling plus consumer financing through GE Credit, with the first 90 days free of interest. In exchange, Direct Connect dealers make several commitments: to sell nine major GE product categories while stocking only carryout products, such as microwave ovens and air conditioners; to ensure that GE products generate 50 % of sales and to open their books for review; and to pay GE through electronic fund transfer on the 25th of the month after purchase.

Under the Direct Connect system, dealers have had to give up some float time in payables, the comfort of having their own back-room inventory, and some independence from the supplier. In return, they get GE’s best price while eliminating the hassle and cost of maintaining inventory and assembling full truckload orders—and their profit margins on GE products have soared.

Virtual inventory, it turns out, works better than real inventory for both dealers and customers. “Instead of telling a customer I have two units on order,” says one dealer, “I can now say that we have 2,500 in our warehouse. I can also tell a customer when a model is scheduled for production and when it will be shipped. If the schedule doesn’t suit the customer, the GE terminal will identify other available models and compare their features with competitive units.”

Meanwhile, GE gets half the dealers’ business and saves about 12 % of distribution and marketing costs. And since dealers serve themselves through the network, GE saves time and labor in order entry and in responding to inquiries. At GE, the new Direct Connect system is the order-entry process. Most important, GE has captured a valuable commodity from its dealers: data on the actual movement of its products. Most appliance manufacturers have been unable to track consumer sales accurately because they can’t tell whether dealers’ orders represent requests for additional inventory or actual customer purchases. With Direct Connect, GE knows that vendors’ orders are, in fact, actual sales to customers.

With Direct Connect, GE manufactures in response to customer demand—not inventory.

GE links its order-processing system to other systems involved in forecasting demand and planning production and distribution. The company now, in effect, manufactures in response to customer demand instead of to inventory. It has reduced and simplified a complex and expensive warehousing and distribution system down to ten strategically located warehouses that can deliver appliances to 90 % of the country within 24 hours.

Other businesses that vigorously pursue a strategy of operational excellence have reinvented their companies in similar fashion. They have reengineered the process that begins with order entry and ends with product or service delivery in a way that emphasizes efficiency and reliability. Specifically, they have adopted automated inventory replenishment and invoiceless payments and have integrated formerly disparate logistics systems. Companies that have adopted a strategy of operational excellence also have built their operations around information systems that emphasize integration and low-cost transaction processing.

Customer Intimacy

While companies pursuing operational excellence concentrate on making their operations lean and efficient, those pursuing a strategy of customer intimacy continually tailor and shape products and services to fit an increasingly fine definition of the customer. This can be expensive, but customer-intimate companies are willing to spend now to build customer loyalty for the long term. They typically look at the customer’s lifetime value to the company, not the value of any single transaction. This is why employees in these companies will do almost anything—with little regard for initial cost—to make sure that each customer gets exactly what he or she really wants. Nordstrom is one example of such a company; IBM in its heyday was another; Home Depot is a third.

Home Depot clerks spend whatever time is required with a customer to figure out which product will solve his or her home-repair problem. The company’s store personnel are not in a hurry. Their first priority is to make sure the customer gets the right product, whether its retail price comes to $ 59 or 59 cents.

Individual service is Home Depot’s forte. Clerks do not spend time with customers just to be nice. They do so because the company’s business strategy is built not just around selling home-repair and improvement items inexpensively but also around the customer’s needs for information and service. Consumers whose only concern is price fall outside Home Depot’s core market.

Other companies that have embraced a strategy of customer intimacy include Staples in office-supply retailing, Ciba-Geigy in pharmaceuticals, and Kraft and Frito-Lay in consumer packaged goods. These companies have designed operating models that allow them to address each customer or small subsegment of their market individually, as much for the sake of the company’s profitability as for the customer’s satisfaction. Their infrastructures facilitate multiple modes of producing and delivering products or services. They gladly split hairs when segmenting a market.

One principle that such companies understand well is the difference between profit or loss on a single transaction and profit over the lifetime of their relationship with a single customer. A leading financial brokerage firm, for instance, knows that not all customers require the same level of service or will generate the same revenues. The company’s profitability, then, depends in part on its maintaining a system that can differentiate quickly and accurately among customers based on both the degree of service they require and the revenues their patronage is likely to generate. The company recently installed a telephone-computer system capable of recognizing individual clients by their telephone numbers when they call. The system routes investors with large accounts and frequent transactions to their own senior account representative. Other customers—those who typically place only an occasional buy or sell order, for instance—may be routed to a trainee, junior rep, or whoever is available. In either case, the customer’s file appears on the rep’s screen before the phone is answered.

The new system, which embodies this company’s pursuit of customer intimacy, lets the firm segment its services with great efficiency. If the company has, say, just 400 clients around the country who are interested in trading in a particularly arcane financial instrument, it can group them under the one account rep who specializes in that instrument. It does not have to train every rep in every facet of financial services. Moreover, the company can direct certain value-added services or products to a specific group of clients whose interest it knows to be strong. It could, for instance, search its customer database for affluent retirees interested in minimizing inheritance taxes, customize a service or a product just for them, and train a rep in the new offering’s sale and use.

In its move toward customer intimacy, Kraft USA has created the capacity to tailor its advertising, merchandising, and operations in a single store or in several stores within a supermarket chain to the needs of those stores’ particular customers. Kraft has the information systems, analytical capability, and educated sales force to allow it to develop as many different so-called micro-merchandising programs for a chain that carries its products as the chain has stores. The program can be different for every neighborhood outlet. But to accomplish this, Kraft had to change itself first. It had to create the organization, build the information systems, and educate and motivate the people required to pursue a strategy of customer intimacy.

Like most companies that choose this strategy, Kraft decentralized its marketing operation in order to empower the people actually dealing with the customer. In Kraft’s case, this was the sales force. Instead of pushing one-size-fits-all sales promotion programs, Kraft salespeople now work with individual store managers and regional managers to create customized promotional programs from an extensive computerized menu of program models.

Kraft does not just give its salespeople permission to work with customers, it also is giving them the data they need to make intelligent recommendations that will actually work. To do so, Kraft has assembled a centralized information system that collects and integrates data from three sources. The data it collects from individual stores break out consumer purchases by store, category, and product and indicate how buying behavior is affected by displays, price reductions, and so forth. They also provide profiles of customers who have bought particular products over the past several years and their rates of purchase. A second database contains demographic and buying-habit information on the customers of 30,000 food stores nationwide. A third set of data, purchased from an outside vendor, contains geo-demographic data by nine-digit zip code.

At Kraft headquarters, its trade marketing team sorts and integrates the information from these three databases and uses the results to supply sales teams with a repertoire of usable programs, products, value-added ideas, and selling tools. For instance, the trade marketing team sorted all shoppers into six distinct groups, with names such as full-margin shoppers, planners and dine-outs, and commodity shoppers. Kraft then determined for its major accounts which shopper groups frequented each of their stores. A Kraft sales team even persuaded one chain to create a drive-through window in stores where planners and dine-outs—people who plan their shopping trips and dine out often—were a large segment, making it more convenient for them to pick up staples between big shopping trips.

Kraft is also able to develop promotion packages for store clusters for special events like the Super Bowl. It can design a product mix more likely to succeed in one cluster than another. Pinpointing which store gets which product reduces inventory and delivers the right product to the right place at the right time.

In reinventing itself, Kraft emulates other companies in different industries that also choose to pursue the strategy of customer intimacy. Its business processes stress flexibility and responsiveness. Its information systems collect, integrate, and analyze data from many sources. Its organizational structure emphasizes empowerment of people working close to customers, and its hiring and training programs stress the creative decision-making skills required to respond to individual customer needs. Its management systems recognize and utilize such concepts as customer lifetime value, and the rules and norms that management fosters among employees are consistent with the “have it your way” mind-set that must prevail in a company built on customer intimacy.

Product Leadership

Companies that pursue the third discipline, product leadership, strive to produce a continuous stream of state-of-the-art products and services. Reaching that goal requires them to challenge themselves in three ways. First, they must be creative. More than anything else, being creative means recognizing and embracing ideas that usually originate outside the company. Second, such innovative companies must commercialize their ideas quickly. To do so, all their business and management processes have to be engineered for speed. Third and most important, product leaders must relentlessly pursue new solutions to the problems that their own latest product or service has just solved. If anyone is going to render their technology obsolete, they prefer to do it themselves. Product leaders do not stop for self-congratulation; they are too busy raising the bar.

Johnson & Johnson, for example, meets all three of these challenges. J&J seems to attract new ideas, but it is not happenstance that brings good ideas in, develops them quickly, and then looks for ways to improve them. In 1983, the president of J&J’s Vistakon, Inc., a maker of specialty contact lenses, heard about a Copenhagen ophthalmologist who had conceived of a way of manufacturing disposable contact lenses inexpensively. At the time, the company’s Vistakon unit generated only $ 20 million each year in sales primarily from a single product, a contact lens for people who have astigmatism.

What was unusual was the way Vistakon’s president got his tip. It came from a J&J employee whom he had never met who worked in an entirely different subsidiary in Denmark. The employee, an executive for Janssen Pharmaceutica, a J&J European drug subsidiary, telephoned Vistakon’s president to pass along the news of the Danish innovation. Instead of dismissing the ophthalmologist as a mere tinkerer, these two executives speedily bought the rights to the technology, assembled a management team to oversee the product’s development, and built a state-of-the-art facility in Florida to manufacture disposable contact lenses called Acuvue.

Vistakon’s disposable lenses caught rivals off guard—and they never caught up.

In 1991 Vistakon’s sales topped $ 225 million worldwide, and it had captured a 25 % share of the U.S. contact-lens market. But Vistakon is not resting on its laurels. It continues to investigate new materials that would extend the wearability of the contact lenses and even some technologies that would make the lenses obsolete.

Product leaders avoid bureaucracy at all costs because it slows commercialization of their ideas. Managers make decisions quickly, since in a product leadership company, it is often better to make a wrong decision than to make one late or not all. That is why these companies are prepared to decide today, then implement tomorrow. Moreover, they continually look for new ways—such as concurrent engineering—to shorten their cycle times. Japanese companies, for example, succeed in automobile innovation because they use concurrent development processes to reduce time to market. They do not have to aim better than competitors to score more hits on the target because they can take more shots from a closer distance.

Companies excelling in product leadership do not plan for events that may never happen, nor do they spend much time on detailed analysis. Their strength lies in reacting to situations as they occur. Fast reaction times are an advantage when dealing with the unknown. Johnson & Johnson’s Vistakon managers, for example, were quick to order changes to the Acuvue marketing program when early market tests were not as successful as they had expected. They also responded quickly when competitors challenged the safety of Acuvue lenses. They distributed data combating the charges, via Federal Express, to some 17,000 eye-care professionals. Vistakon’s speedy response to the concerns raised by its competitors engendered goodwill in the marketplace.

Vistakon can move fast and take risks because it is organized like a small, entrepreneurial company. At the same time, it can call on the resources and capabilities of a multibillion-dollar corporation. This combination makes Vistakon—and J&J—a powerhouse competitor and strong product leader.

Product leaders have a vested interest in protecting the entrepreneurial environment that they have created. To that end, they hire, recruit, and train employees in their own mold. When it is time for Vistakon to hire new salespeople, for example, its managers do not look for people experienced in selling contact lenses; they look for people who will fit in with J&J’s culture. That means they do not first ask about a candidate’s related experience. Instead, they ask such questions as, “Could you work cooperatively in teams?” and “How open are you to criticism?”

Product leaders are their own fiercest competitors. They continually cross a frontier, then break more new ground. They have to be adept at rendering obsolete the products and services that they have created because they realize that if they do not develop a successor, another company will. J&J and other innovators are willing to take the long view of profitability, recognizing that whether they extract the full profit potential from an existing product or service is less important to the company’s future than maintaining its product leadership edge and momentum. These companies are never blinded by their own successes.

One final point about product leaders: they also possess the infrastructure and management systems needed to manage risk well. For example, each time J&J ventures into an untapped area, it risks millions of dollars as well as its reputation. It takes that chance, though, in part because its hybrid structure allows it to combine the economies of scale and resource advantages of a $ 12 billion corporation with the cultural characteristics of a startup company. In the case of Acuvue, J&J could manage the tremendous risk associated with developing and launching the lens because it represented only a small portion of the company’s outlays.

Sustaining the Lead

Becoming an industry leader requires a company to choose a value discipline that takes into account its capabilities and culture as well as competitors’ strengths. (For more on choosing a value discipline, see the insert “Choosing Disciplines or Choosing Customers?”) But the greater challenge is to sustain that focus, to drive that strategy relentlessly through the organization, to develop the internal consistency, and to confront radical change.

Choosing Disciplines or Choosing Customers?

When a company chooses to focus on a value discipline, it is at the same time selecting the category of customer that it will serve. In fact, the choice of business discipline and customer category is actually a single choice.

One set of potential customers defines value within a matrix of price, convenience, and quality, with price the dominant factor. These customers are less particular about what they buy than they are about getting it at the lowest possible price and with the least possible hassle. They are unwilling to sacrifice low price or high convenience to acquire a product with a particular label or to obtain a premium service. Whether they are consumers or industrial buyers, they want high-quality goods and services, but even more, they want to get them cheaply or easily or both.

These are the customers who shop for retail goods at discount and membership warehouse stores. They buy PC clones directly from manufacturers. They seek basic transportation when they buy a car and discount commissions when they buy or sell stocks and other investments. The business that succeeds by serving these customers focuses on operational excellence.

The second set of customers is more concerned with obtaining precisely what they want or need. They are willing to make some sacrifice—in price or delivery time, for instance—if the sacrifice helps them acquire something that meets their unique requirements. The specific characteristics of the product or the way the service is delivered is far more important to them than any reasonable price premium or purchase inconvenience they might incur.

Customers in this group ascribe value to a product or service according to how closely it appears to be designed just for them. Chain stores—whether in the food, book, or music business—that customize their inventories to match regional or even neighborhood tastes serve this category of customer. Other retailers and catalogers attract this customer type by offering the largest imaginable range of products. They won’t carry just standard Scrabble, for instance, but every version of the game. An industrial distributor we know carries 12 pages of water heaters in its catalog. Its breadth of inventory is a strategic asset in appealing to this second customer category. These customers require a company to focus on customer intimacy.

To the third category of customers, new, different, and unusual products count most. These are customers who, as clothing buyers, are primarily interested in fashion and trends. In an industrial context, they are buyers who value state-of-the-art products or components because their own customers demand the latest technology from them. If they are service companies, they want suppliers that help them seize breakthrough opportunities in their own markets. For a company to succeed in serving these customers, it has to focus on product leadership.

One point to bear in mind: the same people can be found in all three customer categories, depending on what they are buying. An individual might buy office supplies primarily on price, groceries strictly on the basis of personal taste, and clothes as fashion dictates. The same people will define value differently as it applies to different goods and services.

Many companies falter simply because they lose sight of their value discipline. Reacting to marketplace and competitive pressures, they pursue initiatives that have merit on their own but are inconsistent with the company’s value discipline. These companies often appear to be aggressively responding to change. In reality, however, they are diverting energy and resources away from advancing their operating model.

Sears is a good example. Under enormous pressure from Wal-Mart and other competitors, Sears’s retailing division in the late 1980s launched a number of initiatives aimed at winning back customers and boosting its sagging bottom line. First came “everyday low prices,” a component of an operational excellence discipline. For that gambit to pay off, Sears needed to cut costs—which it did to some extent by eliminating many in-store employees and slashing front-office expenses. But the cost cutting did not go nearly far enough, in part because Sears had not consciously focused on the discipline of operational excellence. Had it done so, it would have scrutinized each part of its organization, including the order-fulfillment process, to see where it could realize savings. The consequence of not focusing meant, among other things, that Sears failed to restructure its end-to-end distribution costs, as Wal-Mart, for instance, has done.

In another attempt to regain market share, Sears inaugurated “Brand Central,” whereby the retailer would carry branded products in addition to its house brands, Kenmore and Craftsman. Creating more product variety in an attempt to meet the needs of different market segments is a component of a customer intimacy discipline. But again, Sears did not go far enough. By just plucking Brand Central from a quiver of random ideas, Sears shot wide of the target. Brand Central only confused existing customers, who did not know which brand to buy. Sears’s strategy also cut into sales of its own brands. And since the move did not give Sears any more product variety than competitors had, it did little to boost sales.

Sears’s third initiative, meant to give the retailer a trendy image, was to have models and actresses endorse its fashion line. This tack, which corresponds to a product leadership discipline, also had little impact on profits. One problem was that Sears struck just one deal, with model Cheryl Tiegs. The second problem: J.C. Penney was following the same strategy but was outdoing Sears with more endorsements, slicker advertising, better catalogs, more sophisticated marketing, and better product design. In trying to be all things to all people, Sears pursued strategies that steered it away from its chosen value discipline and into unproductive dead ends. It tried to fuse together incompatible philosophies and practices and got predictable results. In its time, Sears was a value leader, but to regain that distinction in today’s competitive market, the company will have to pick one value discipline and vigorously pursue it while meeting industry standards in the other two.

The key to gaining and sustaining value leadership is focus, but the management of a company that’s a value leader must stay alert. The operating model that elevated a company to value leadership—Compaq’s model, for instance—is superior and worth exploiting only until a better one—Dell’s distribution model, say—comes along.

Companies that sustain value leadership within their industries will be run by executives who not only understand the importance of focusing the business on its value discipline but also push relentlessly to advance the organization’s operating model. They will personally lead the company’s drive to develop new capabilities and to change the imbedded work habits, processes, and attitudes that prevent them from achieving excellence in the discipline they have chosen. By leading the effort to transform their organizations, these individuals will be preparing their companies to set new industry standards, to redefine what is possible, and to forever change the terms of competition.

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