business marketing: understand what customers value

Business Marketing:Understand What Customers Value

by James C. Anderson and James A. Narus

Harvard Business Review Reprint 98601

NOVEMBER – DECEMBER 1998

Reprint Number

HarvardBusinessReviewCLUSTERS AND THE NEW ECONOMICS OF COMPETITION 98609

WHAT MAKES A LEADER? 98606

VERSIONING: THE SMART WAY 98610TO SELL INFORMATION

WORK AND LIFE: THE END OF 98605THE ZERO-SUM GAME

HOW VENTURE CAPITAL WORKS 98611

COVERT LEADERSHIP: NOTES ON 98608MANAGING PROFESSIONALS

HBR CASE STUDYTHE CASE OF THE PROFITLESS PC 98603

ideas at workBUSINESS MARKETING: UNDERSTAND 98601WHAT CUSTOMERS VALUE

first personTHE NEW MATH OF OWNERSHIP 98607

hbr classicTHE DISCIPLINE OF INNOVATION 98604

books in reviewARE NETWORKS DRIVING THE NEW ECONOMY? 98602

Michael e. porter

daniel goleman

carl shapiro and hal r . varian

stewart d. friedman, perry christensen, and jessica degroot

bob zider

henry mintzberg

andy blackburn, matt halprin, and ruth veloria

james c. anderson and james a. narus

bill gross

PETER F. DRUCKER

peter l . bernstein

Copyright © 1998 by the President and Fellows of Harvard College. All rights reserved. 5

I D E A S AT W O R K

ow do you define value? can you measure it?What are your products and services actually worth to

customers? Remarkably few suppliers in business marketsare able to answer those questions. And yet the ability topinpoint the value of a product or service for one’s customerhas never been more important. Customers – especiallythose whose costs are driven by what they purchase – in-creasingly look to purchasing as a way to increase profits andtherefore pressure suppliers to reduce prices. To persuadecustomers to focus on total costs rather than simply on ac-quisition price, a supplier must have an accurate under-standing of what its customers value, and would value.

Put yourself, for a moment, in the role of a commercialgrower. Two suppliers are trying to sell you mulch film: thinplastic sheets that are placed on the ground to hold in mois-ture, prevent weed growth, and allow melons and vegetablesto be planted closer together. The first supplier comes to youwith this proposition: “Trust us – our mulch film will loweryour costs. We’ll provide superior value for your money.” Thesecond supplier says, “We can lower the cost of your mulchfilm by $16.83 per acre,” and offers to show you exactly how.Which proposition would you find more convincing?

James C. Anderson is the William L. Ford DistinguishedProfessor of Marketing and Wholesale Distribution and a professor of behavioral science in management at North-western University’s J.L. Kellogg Graduate School of Man-agement in Evanston, Illinois. He is also the AT&T ISBMResearch Fellow at the Institute for the Study of BusinessMarkets, located at Pennsylvania State University. JamesA. Narus is an associate professor of management at theBabcock Graduate School of Management at Wake ForestUniversity in Charlotte, North Carolina. Their book, Busi-ness Market Management: Understanding, Creating, andDelivering Value, has just been published by Prentice Hall.

by James C. Anderson andJames A. Narus

Gauging – and communicating –

what your products and services

are worth to customers has

never been more important.

HBusiness

Marketing:Understand

WhatCustomers

Value

“Everything is worth what its purchaser will pay for it.”Publilius Syrus, first century b.c.

some context. Even when no compa-rable market offerings exist, there isalways a competitive alternative. Inbusiness markets, one competitivealternative may be that the customerdecides to make the product itselfrather than purchase it.

We can capture the essence of thisdefinition of value in the followingequation:

(Values 2 Prices) > (Valuea 2 Pricea)

Values and Prices are the value andprice of the supplier’s market offer-ing, and Valuea and Pricea are thevalue and price of the next best alter-native. The difference between valueand price equals the customer’s in-

Many customers, like the com-mercial grower, understand theirown requirements but do not neces-sarily know what fulfilling those requirements is worth to them. Tosuppliers, this lack of understandingis an opportunity to demonstratepersuasively the value of what theyprovide and to help customers makesmarter purchasing decisions.

A small but growing number ofsuppliers in business markets drawon their knowledge of what cus-tomers value, and would value, togain marketplace advantages overtheir less knowledgeable competi-tors. These suppliers have developedwhat we call customer value models,which are data-driven representationsof the worth, in monetary terms, ofwhat the supplier is doing or coulddo for its customers.

Customer value models are basedon assessments of the costs and ben-efits of a given market offering in aparticular customer application. De-pending on circumstances, such asavailability of data and a customer’scooperation, a supplier might build a value model for an individual cus-tomer or for a market segment, draw-ing on data gathered from severalcustomers in that segment.

Customer value models are noteasy to develop. But the experiencesof suppliers that have built and usedthem successfully suggest severalguidelines that we believe will beuseful to any company attemptingto define and measure value for itscustomers.

A Common Definition of ValueTo measure value in practice, it iscrucial to have a shared understand-ing of exactly what value is in busi-ness markets. Before we go into anydetail about building value models,we need to provide a brief explana-tion of what we mean by value. Valuein business markets is the worth inmonetary terms of the technical, eco-nomic, service, and social benefits acustomer company receives in ex-change for the price it pays for a mar-ket offering. We will elaborate onsome aspects of this definition.

First, we express value in monetaryterms, such as dollars per unit, guildersper liter, or kroner per hour. Econo-

mists may care about “utils,” but wehave never met a manager who did!Second, by benefits, we mean netbenefits, in which any costs a cus-tomer incurs in obtaining the de-sired benefits, except for purchaseprice, are included. Third, value iswhat a customer gets in exchange forthe price it pays. We see a market of-fering as having two elemental char-acteristics: its value and its price.Thus raising or lowering the price ofa market offering does not change thevalue that such an offering providesto a customer. Rather, it changes thecustomer’s incentive to purchasethat market offering. Finally, consid-erations of value take place within

6 harvard business review November–December 1998

understand what customers valueI D E A S AT W O R K

Using Customer Focus Groupsto Assess ValueAlthough field value assess-ment – gathering data firsthandwhenever possible – is the mostcommon way to build customervalue models, not all situationslend themselves to it. Indeed,in some cases, the only way toobtain information for a valuemodel is to rely on customer per-ceptions. The results of such as-sessments may not be as preciseas those calculated from fieldvalue assessments; nonetheless,they can be quite effective. Con-sider a telecommunicationscompany that used focus groupsto gain a better understanding of the worth of an advanced in-telligent network service calledsingle-number reach.

Single-number reach is de-signed for people who wantcallers to reach them easily,even if they are not at a singlelocation or phone number dur-ing the course of a day. Providedfrom a central office switch, theservice allows a caller to seekthe buyer of the service via a se-quence of programmed tele-phone numbers. To determinethe target market segment, the

company conducted four focusgroups with itinerant Genera-tion X professionals, some ofwhom had six telephone num-bers on their business cards.

At the beginning of each focusgroup, the moderator demon-strated the service using a spe-cially arranged prototype andthen asked focus-group partici-pants to write down their firstimpressions of the service andhow much they would be will-ing to pay for it per month. Theparticipants then engaged in adiscussion of the service, howthey would most likely use it,and so on. At the conclusion ofthe approximately hour-longdiscussion, the moderator askedthe participants to write downtheir interest in the service us-ing a ten-point scale and again,how much they would be will-ing to pay for it per month.

Although the company wasinterested in the actual mone-tary amounts given at the begin-ning and at the end, it was moreinterested in any pattern of dif-ferences between the amounts.An ominous pattern would be

steep declines from the initialamounts to the ending amounts,indicating that the participantswere initially intrigued with theservice but, upon further con-sideration, concluded that itwould not offer them muchvalue. No significant change be-tween the initial amounts andending amounts would be apreferable pattern, provided thespecified amounts were suffi-ciently large. The final pattern,considerable increases from theinitial amounts to the endingamounts, would indicate thatwhen the participants thoughtabout the service, they recog-nized a greater potential value.That pattern would suggest thecrucial role of business market-ing communications in convey-ing the value of using the ser-vice to prospective customers.

The company used the resultsof the research to provide esti-mates of the service’s worth tolocal telephone-service providersand to show those providers anapproach for segmenting themarket, targeting customers,and positioning the offering.

provide the resources to gather thedata at no charge to the customerand guarantee to share all findings.For most companies, the promise ofshared research findings among par-ticipating customers in an aggregatedor disguised manner is an irresistibleincentive because it allows them tobenchmark. W.W. Grainger, a majordistributor of maintenance, repair,and operating supplies in NorthAmerica, offered both incentives forthe 15 companies that participatedin its initial model-building effort.

Generate a comprehensive list ofvalue elements. Value elements areanything that affect the costs andbenefits of the offering in the cus-tomer’s business. These elementsmay be technical, economic, service,or social in nature and will vary intheir tangibility. How well a pigmentdisperses in a coating, for example,would be a technical element; provid-ing a consolidated monthly invoicerather than a separate invoice foreach purchase would be an econom-ic element; design assistance wouldfall under the service heading; andease of doing business with the sup-plier would be social. As it is generat-ing the list, the team should considerthe entire life cycle of the offeringin question, from how the customeracquires and uses it to how the cus-tomer disposes of it when it is nolonger needed. The list should cap-ture all the potential effects that do-ing business with a supplier mighthave on the customer’s business.

It’s important to be as inclusive aspossible. Leaving out elements, par-ticularly those that might make thesupplier’s market offering look unfa-vorable next to the incumbent ornext-best-alternative offering, willundermine the project’s credibility.

By identifying as many elementsas possible, the team will be ableto gauge more accurately the differ-ences in functionality and perfor-mance its offering provides relativeto the next best alternative. Broadlystated categories, such as the cost ofan hour of downtime in a customer’splant, may be easier to identify. Butthey tend to leave out cost elements,producing less valid estimates ofworth. A bottle breaking in a filling

harvard business review November–December 1998 7

understand what customers value I D E A S AT W O R K

centive to purchase. Simply put, theequation conveys that the customer’sincentive to purchase a supplier’soffering must exceed its incentive topursue the next best alternative.

Building Customer Value ModelsField value assessments (also knownby other names, such as value-in-useor cost-in-use studies) are the mostcommonly used – and, we believe, themost accurate – method for buildingcustomer value models. Field valueassessments call for suppliers togather data about their customersfirsthand whenever possible. Clearly,however, conducting such direct research isn’t always an option. In

cases where field value assessmentsare not feasible, it is possible to gaina worthwhile understanding of value through such methods as di-rect and indirect survey questions,conjoint analysis, and focus groups,all of which rely primarily on cus-tomers’ perceptions of the function-ality, performance, and worth of asupplier’s offering. (See the insert“Using Customer Focus Groups toAssess Value.”) Below, we describe aprocess for building a value modelusing field value assessments.

Get started. Without a doubt, themost difficult customer value modelthat a supplier will build is its firstone. Indeed, gaining a comprehen-sive understanding of the value of a market offering in a particular cus-tomer setting may appear monu-mentally difficult. But it can be done.The first step is putting together theright kind of value research team.The team should include peoplewith product, field engineering, andmarketing experience, and two orthree forward-thinking salespeople.Having salespeople involved at thestart is particularly important. Theyknow the customer and how theoffering is used; they also knowwhich customers might be willingto cooperate in value research. Sales-people who are part of a value assess-ment initiative from the outset arealso more likely to understand andappreciate it. They will, therefore,support the approach and can thenpersuasively relate their experiencesto others in the sales force.

Selecting the right market segmentto target is the next step. Because the supplier will need to conductvalue assessments with at least twoand perhaps up to a dozen customersto build an initial value model, it’s a good idea to start with a segmentin which the supplier has particu-larly close, collaborative relation-ships with customers, extraordinaryknowledge of how customers usethe offering in question, or relativelysimple offerings.

Before approaching a customer,the team should think through whatit will need from the customer andwhat the customer will gain, and beprepared to offer an incentive. Forexample, the supplier might offer to

line causes downtime, certainly, butit also generates costs in scrap, dis-cards, disposal, maintenance labor,cleaning and sanitizing chemicals,and so on, many of which tend tobe buried in various plant-overheadaccounts.

Often, the value research teamwill have to make trade-offs betweenrelying on a customer’s perception of

what all the relevant elements areand actually observing firsthand theways in which the supplier’s offeringaffects the customer. The customer’smanagement may not have an accu-rate understanding of all the value elements associated with a particu-lar offering. Believing that this wasfrequently the case, Alcoa Aerospacedeveloped a program in which thecompany trained its salespeople infield-value-assessment methods andthen gave them an assignment inwhich they had to comprehensivelychart all the steps a customer took inacquiring, converting, and disposingof an Alcoa offering. Interestingly,the program gave salespeople a rea-son to approach customers: to askthem to cooperate in letting them do their assignments. The promise of enhanced knowledge of their ownbusinesses provided an incentive forthose customers.

Alcoa’s initiative paid off. At theend of a two-month period, the sales-people got together and presentedtheir findings to one another. Thepresentations allowed participants tolearn from others’ experiences andto exchange ideas about various cus-tomers’ situations and the potentialfor future sales. The customers bene-fited because they learned about costand benefit elements they had previ-ously been unaware of – elementsthey could now factor into their ownassessments of suppliers’ proposals.

Gather data. With a comprehen-sive list of value elements in hand,

the next step is obtaining initial esti-mates for each element and findingout what each one is worth in mone-tary terms. Sometimes, suppliersfind it useful to gather data by plac-ing a team member in a key func-tional area of the customer’s organi-zation for a week or two in order togain a better understanding of whatis actually being done and where

things can go wrong dur-ing the day. For example,a supplier might have ateam member work inthe customer’s receivingdepartment. To allay anyconcerns on the part ofthe employee, customermanagement should tellthem that the person is

there to help out and to learn.Frequently, the customer doesn’t

know that it has the data or informa-tion the supplier is looking for. Thecustomer may think the informationdoes not exist. In fact, the kind ofdata that needs to be pulled togetherin the analysis may reside on six orseven databases or systems in differ-ent functional areas.

Sometimes, the only way to findthe data is for team members to askaround until they come across theindividual who knows where the in-formation is.

Focus groups made up of represen-tatives from each functional areain a company can also be an effectivemechanism for uncovering data. TheProaction Group, a Chicago-basedconsulting and strategy implemen-tation company, recently conductedfour internal focus groups at a cus-tomer company for exactly that pur-pose. To prepare themselves and theprospective focus-group participants,Proaction consultants met individu-ally with each prospective partici-pant before the session, learningwhat the issues might be and gather-ing some initial data. During the ses-sion, participants were asked whatkinds of information they thoughtshould be used in a value model andthen where in the organization tolook for that information. The con-sultants discovered sources of datain places that neither they nor thecustomer’s management had previ-ously identified.

The value research team alsoneeds to be creative in finding othersources of information. Indepen-dent industry consultants or knowl-edgeable personnel within the sup-plier company can be good sources of initial estimates. San Diego-basedQualcomm, a supplier of satellite-based mobile communications sys-tems for truck fleets, for example,drew on the American TruckingAssociation’s research studies toprovide ranges for some of the ele-ments in the value model it devel-oped for its OmniTRACS mobilecommunications system.When asupplier provides a service that miti-gates the customer’s risk, it can beuseful to tap actuarial consultants toestimate what the cost of the poten-tial difficulty would be.

The ease with which the team canestablish monetary estimates for itsvalue elements will vary. The valueof social elements such as greaterpeace of mind, for example, is gener-ally very difficult to express in mon-etary terms. In fact, most suppliersdo not even attempt to assign mone-tary amounts to social elements. In-stead, they put those elements asideand discuss them with the customerin a qualitative way after presentingquantitative results. Qualcomm doesnot assign monetary amounts tomany less-tangible elements butstill includes them in its analysis as“value placeholders.” In this way,Qualcomm conveys to its customersthat those elements are worth some-thing and leaves open the possibilitythat a specific monetary amountmight be ascertained in the future.

In any field value assessment, sup-pliers will find that some assump-tions must be made in order to com-plete an analysis. These assumptionsmight be about the functionalityor performance a market offeringactually provides in the customer’sspecific setting, particularly for ele-ments that are extraordinarily diffi-cult or costly to measure. Or theymight be about the monetary worthof perceived or measured differencesin functionality or performance thatan offering provides in the customer’ssetting. It is critical for the supplierto be explicit about any assumptionsit makes. If the customer doesn’t



Frequently, the customerdoesn’t know that it has thedata or information thesupplier is looking for.

know how or why the team assigneda certain value to an element – or isnot encouraged to offer its own ratio-nale if it disagrees with the suppli-er’s estimates and then to join thesupplier in researching a mutuallyacceptable solution – the supplier’scredibility will be compromised.

Validate the model and under-stand variance in the estimates. Af-ter building the initial value model,the supplier should validate it byconducting additional assessmentswith other customers or potentialcustomers in the market segment.Conducting further assessments en-ables the supplier to refine its valueestimates and to understand betterhow the value of its market offeringvaries across customers’ applica-tions, capabilities, and usage.

What’s more, as the supplier con-ducts additional value assessments,it will develop a greater understand-ing of where it needs to use firsthanddata and where it can rely on cus-tomers’ perceptions. (In solicitingperceptions, the supplier should re-member that people are generallybetter at making comparative judg-ments [more or less than] than ab-solute judgments [it’s worth X]. Inother words, the supplier should pro-vide the initial estimate and ask theinformants whether that element ismore or less valuable to them thanthe estimate.)

In conducting additional assess-ments, the supplier will also learnhow the value its offerings providevaries across kinds of customers. Thesupplier can then build a databasethat contains value estimates – andthe individual customer characteris-tics, which we call descriptors, thatmight affect those estimates– from allparticipating companies. Looking atall of the data together, the suppliercan then determine which descrip-tors have more impact than otherson the value customers receive fromthe offering in question. As a result,the supplier can choose to pursuethose customers and prospectivecustomers for which its offering willprovide superior value.

Create value-based sales tools.Suppliers can not only use valuemodels to inform and guide theirown decision making but also to

create persuasive sales tools. Onecommon sales tool is a value casehistory. Value case histories are writ-ten accounts that document the costsavings or added value that a cus-tomer receives from its use of asupplier’s market offering. SonocoProducts Company’s protectivepackaging division, for example,tracks the savings its customers gainfrom implementing an offering itcalls total packaging solutions.Rather than selling customers themore commonly marketed corrugat-ed-cardboard packaging materials,Sonoco offers packaging systemsthat, it maintains, are stronger,lighter, and smaller. The major ele-ments in Sonoco’s value model thusinclude savings from reduced prod-uct damage, packaging costs, ship-ping costs, and storage costs. When acustomer has used these “solutions”for a year, Sonoco constructs a casestudy about the cost savings and re-ports the findings to the customer.Sonoco maintains a file of these casestudies, which its salespeople drawon when making proposals to otherprospects. The studies persuasivelyconvey the cost savings that theprospects themselves would likelyrealize.

Value assessment can also becomea service that suppliers offer as partof a consultative selling approach.For example, a supplier can developa spreadsheet software applicationthat salespeople can use on-sitewith a laptop computer to evaluatethe potential value of the offering to aparticular customer. (For an illustra-tion of how such a tool can be used,see the insert “How BT ProductsUses Value Models as Sales Tools.”)

Putting an Understanding ofValue to Use Suppliers can use their understand-ing of value to strengthen perfor-mance and create competitive advan-tage in several ways. For example, asupplier can use its knowledge totailor supplementary services, pro-grams, and systems in its currentmarket offerings and to guide the development of new offerings. Inte-grating everything it has learnedabout value into its marketing ef-forts, it can also gain new customers.

Finally, it can better sustain cus-tomer relationships by documentingits delivery of superior value overtime and by discovering new waysto update and reinvigorate thoserelationships.

Managing Market Offerings. In thearticle “Capturing the Value of Sup-plementary Services” (HBR January–February 1995), we argued that suppli-ers can capitalize on the inevitablevariation in customers’ requirementswithin market segments and in-crease their profitability by provid-ing flexible market offerings. Doingso entails constructing what we call naked solutions with options.Naked solutions consist of justthose product and service elementsthat all customers within a marketsegment value. We said that suppli-ers should strive to sell naked solu-tions at the lowest possible pricethat will yield a profit. Then suppli-ers should “wrap” those solutionswith options-specific product andservice elements that some, but notall, customers value.

A company’s ability to manageflexible market offerings successfullyrests on its understanding of thevalue each component of an offeringcreates as well as its associated cost.An understanding of how customersvalue those components – and whatthey cost the supplier to deliver – en-ables suppliers to identify and elimi-nate what we call value drains. Theseare services that cost the suppliermore to provide than they are worthto the customers receiving them andthat have no strategic significance.

Consider this: A producer ofchemicals used in extracting oilfrom wells routinely performed afield analytic monitoring service forits customers to determine when,and in what amounts, they shouldapply its products. A salesperson vis-iting one of the company’s small,less sophisticated customers noticedthe reports stacked in a corner of theproduction shed. When asked abouttheir usefulness, the customerreplied that he was not using the in-formation at all and instead just hadthe producer’s truck driver pump afew gallons of the chemicals intoeach well whenever the truck cameby. Learning this, the supplier offered



How BT Products Uses Value Models as Sales Tools

to discontinue the service and, inexchange, give the customer a 7%per-gallon price reduction. The cus-tomer readily agreed, and the profit-ability of that account jumped fromminus 6% to 32%!

Rather than finding value drains bychance, as in the example, supplierscan set out to detect them by usingfield value assessment in conjunctionwith activity-based-costing analysis.Identifying and eliminating valuedrains results in better allocation ofresources and improved profitability.Virtually always, the results morethan pay for the cost of doing the

field-value-assessment research.Guiding the Development of New

or Improved Products and Services.Most market research that is con-ducted to provide an understandingof a customer’s requirements andpreferences does not address thequestion: “If we do X, what is itworth to that customer?” Knowingthat an improvement in some func-tionality is important does not tell a supplier if the customer is willingto pay for it. Value models providethat information.

In cases where the supplier’s newoffering will introduce technology

into the market, for example, avalue model can demonstrate toprospective customers how the tech-nology can provide greater value forthem. That’s an especially criticalpoint when the new technologymakes the market offering itselfhigher priced than the alternativechoices, which may use more estab-lished and familiar technologies.At the same time, a model allowsthe supplier to see how the value ofits new technology varies acrossapplications, customer capabilities,and usage situations.

When a supplier is developing a



BT Products, a subsidiary of BT Industries Group, which is basedin Sweden, is a worldwide producerof warehouse trucks for inventoryhandling. In 1993, the companycreated BT Compass, a logistics-planning software system, to helpits customers improve their prof-itability by lowering the total costof the inventory-handling process.The BT Compass system providesthe following:n a full analysis of the customer’s

operational requirements,n a fast comparison of different

pallet handling and order-picking solutions,

n optimum warehouse layout,n accurate calculations of

handling capacities,n complete analysis of projected

life-cycle costs.The BT Compass system has beendeveloped to work in seven lan-guages, and all inputs and outputscan be translated into any languagewith a single keystroke. It displaysdifferent layout options by usinghigh-quality color graphics, and allplans can be printed quickly usinga printer or plotter.

BT Products uses the Compasssystem when a customer is con-templating a change in materialshandling or is adding a new facil-

ity. The system helps the cus-tomer figure out, for example, theoptimal aisle width that will ac-commodate the dimensions of acounterbalance lift truck, and itcalculates the layout and equip-ment requirements to meet peak-hour needs.

BT Products measures the actualperformance of its competitors’equipment, often buying the equip-ment to test it. Thus it knows thecritical performance measures thatcustomers use to judge lift trucks.BT Products also gathers informa-tion about the customers’ individ-ual systems. Customers sometimesprovide functional specificationsand ask the lift truck supplier totell them the number and types oftrucks required. If the performanceis not met, the selected supplierhas to provide additional trucks atno cost to the customer.

The data the customer must enter into Compass requires somecompetence on their part. To helpthe customer gather the requireddata, BT Products has developed aone-page worksheet that pulls to-gether the necessary input data.(See the worksheet “The Informa-tion BT Products Gathers to BuildCustomer Value Models.”) Somecustomers know the required data

very well; others do not. BT Prod-ucts’ most senior salespeople workwith the customers in doing theanalysis. They even provide hands-on data collection as needed at thecustomer’s facility.

One of the advantages of usingCompass is that it combines ware-house planning with an analysis ofthe kind and number of trucksneeded to optimize warehouse per-formance. Recently, Birkenstock,the German shoe manufacturer,decided to build a new warehousein Asbach, Germany. An in-houseconsultant responsible for the pro-curement process for this newwarehouse had proposed a layoutthat required three lift trucks tohandle the pallet movements. Byusing Compass, BT Products wasable to demonstrate how an alter-native layout in conjunction withits high-performance trucks re-quired only two trucks – one lesstruck and one less operator. Accord-ing to BT Products’ managers, with-out Compass, they would not havebeen able to find this new solutionand provide the detailed perfor-mance results for their trucks. Inaddition, they believed that theywould not have been able to con-vince Birkenstock managementthat their solution was correct.

PallethandlingPallet movement/dayNumber of shifts/dayWorking time/shiftDouble cycles in %Max. utilization in %No. of cycles/transferNo. of cycles/channel changeAdmin. time/cycle in sec

P and D located outside store, in %Dist. in meters to that positionNo. of 90 degree curvesBattery capacity in AhRelocations in % (cranes)

new offering in response to cus-tomers’ requests or demands, it canuse value assessments to determinewhat improvements are worthwhileand which ones have the highestpriority. For example, the suppliercould ask managers in different func-tional areas of customer companiesto evaluate potential improvements.One chemical pigment supplierasked managers in its customer’sproduction and R&D areas to performa conjoint analysis for potentialchanges in its offering. Specifically,the supplier wanted to know howthe customer would value some near-

term-achievable changes in technicalattributes, such as gloss or dis-persibility. At the same time, thesupplier asked the customer’s gen-eral managers and purchasing man-agers to consider the potential valueof changes in the products’ commer-cial attributes, such as the supplier’sdelivery service and payment terms.Although the findings largely con-formed to the supplier’s managementexpectations, there was at least oneimportant discovery: the relativelyhigh value the customers placed onimproved dispersibility. Subsequentfield investigation confirmed that



the supplier’s customers were in-deed having many troubles with“flocking,” the clumping that cansometimes occur as a dry pigment isdispersed into a liquid solution.

Gaining Customers. Knowledgeof how their market offerings specif-ically deliver value to customersenables suppliers to craft persuasivevalue propositions. Consider thecase of Greif Brothers Corporation,which produces fiber drums, plasticdrums, and intermediate bulk con-tainers for food products and chemi-cals manufacturers. Rather thancompeting on a price-per-container

This chart represents the BT Compass value-assessment

worksheet. It shows the parameters that affect the costs and

benefits of the supplier ’s offering. Clearly, many of the

elements listed won’t be relevant in other industries, but

they are central to assessing value for this company.

The Information BT Products Gathersto Build Customer Value Models

Pallet handlingPallet movement/dayNumber of shifts/dayWorking time/shiftDouble cycles in %Max. utilization in %No. of cycles/transferNo. of cycles/channel changeAdmin. time/cycle in secP and D located outside store, in %Dist. in meters to that positionNo. of 90 degree curvesBattery capacity in AhRelocations in % (cranes)No. of relocations/cycle (cranes)

Order PickingNo. of orders/dayNo. of orderlines/orderNo. of items/orderlineNo. of orders/picking roundNo. of shifts/dayWorking time/shift in hoursPrep. time/pick. round in sec.Prep. time/orderline in sec.Picking time/item in sec.ReplenishmentPos. time/orderline 1st levelPos. time/orderline 2nd level% of picking 2nd levelPicking from 2nd levelEffective working time in %Picking height in mmNo. of picking aislesBattery capacity in AhBuilding

RackingTrucksCranesConveyorsOthersInterest in %

Heating/m3 and yearPersonnel incl. social/year

Commercial overviewDepreciation time in years

Operational cost

Capacity:

Customize

Type of high level picking truckType of low level picking truck

Rear transfer aisle for order pickingLow order picking truck

Building Building Number Sprinkler Aisle width if Pallet per Upright Verticalheight length of aisles not standard channel width pitch

Load dimensionNumber of different Number of different unitunit widths heights for selected unit width

Unit no. Width Depth No./bay Height No. of units Weight in kg.1.2.3.4.

Wire guidance Radio shuttle Select conveyer

Machinery Alternative 1 Alternative 2 Alternative 3Type of truck/crane

Customer: Date:Comments:

BT Compass data collection



Understanding Value: How W.W. Grainger and Its Customers BenefitW.W. Grainger distributes maintenance, repair, andoperating (MRO) supplies and related information tothe commercial, industrial, contractor, and institu-tional markets in North America. Grainger’s missionis to provide the lowest total-cost distribution for173,000 MRO supply items, such as claw hammers,replacement motors, safety eyewear, and lubricants.In the early 1990s, Grainger’s managers realized thatto reach their ambitious goals for growth, the companywould have to help its customers better understandthe total cost of MRO supplies acquisition and man-agement. At the same time, a growing number ofGrainger’s large customers were becoming concernedabout the money they were spending – beyond theactual purchase prices – for MRO supplies. Recognizingan opportunity, Grainger’s managers formed GraingerConsulting Services (GCS) to help customers under-stand the total cost of MRO supplies management.

GCS began by performing a benchmark study free ofcharge for 15 of Grainger’s large customers. At eachcompany, GCS detailed the steps involved in acquiringan MRO item and outlined the estimated costs associ-ated with each step. Since the original studies, GCShas gained extensive experience and knowledge inbuilding customer value models, which it calls totalcost models. And as its reputation has grown, it hasincreasingly offered its consulting services on a for-feebasis to clients.

GCS’s experience with Pharma Labs (a disguisedname) provides a good illustration of how it builds anduses customer value models.

Pharma Labs is a rapidly growing pharmaceuticalsmanufacturer. At one of its largest plants – a facilitywith 380 employees – purchasing managers werequestioning whether to outsource their MRO procure-ment and inventory management processes. During a routine sales call, the Grainger account managerlearned of the managers’ concerns and arranged a half-day meeting with the vice president of operations, thepurchasing manager, and the maintenance manager atthat facility.

During the meeting, two GCS managers toured thefacility to gain an overview of its MRO-supplies-man-agement processes. Also during this meeting, GCSconsultants showed Pharma managers how GCS de-fines cost savings and outlined the sometimes hiddencosts of MRO supplies management. The consultants

told the Pharma managers, for instance, that somecompanies do not account for MRO supplies inventoryand associated carrying costs.

Following the meeting, GCS proposed that it per-form what it calls a baseline assessment, which docu-ments the total costs of MRO supplies managementand then, following that assessment, offer Pharmamanagers some strategic recommendations abouthow they could improve their operations. GCS toldPharma Labs that the assessment and the strategy de-velopment would take 6 to 12 weeks to complete andwould cost $45,000. Pharma Labs management agreedto the proposal, hiring GCS in January 1997.

To begin, GCS put together a case team, which con-sisted of a consulting manager, a consultant, and abusiness analyst. Pharma Labs formed a steering com-mittee and a project team. The steering committeecomprised the relevant department heads, such asmaintenance, purchasing, manufacturing, inventorymanagement, management information systems, andfinance, and was responsible for project oversight and strategy development. The project team was asmaller cross-functional group with representativesfrom each of the departments on the steering commit-tee and was responsible for working with the GCScase team.

Generally, GCS looks for the elements of its cus-tomer value models in four primary areas: processes(from how the need for items is identified to paymentof invoices), products (product price, usage factors,brand standardization and application), inventory (on-hand value and carrying costs), and suppliers (per-formance, consolidation and value-adding servicesprovided). In each area, GCS defines value and cost-saving elements (such as freight and courier chargesand the cost of overtime), specifies the measures forthe elements (such as procurement cost per purchaseorder, number of suppliers, and inventory accuracy),collects the data and analyzes them, and specifiesmeasures for monitoring performance. At PharmaLabs, the measures for monitoring performance in-cluded supply expenditures, number of suppliers, andtransaction volume.

In a baseline assessment, GCS uses process mappingand activity-based costing to build customer valuemodels, drawing on proprietary databases that thecompany has built from its findings in past engage-

ments. At Pharma Labs, GCS applied an activity-based-costing approach to identify procurement costsacross all typical functional areas – purchasing, main-tenance, receiving, and accounts payable. These iden-tified costs were generally in line with costs trackedin the GCS databases.

In any analysis, GCS attempts to use the customer’selectronic data whenever possible. The team usuallyattempts to get one year’s worth of data. Early on, thecase team makes a site visit to examine the customer’sdata and to assess how accurate and complete theyare. In the case of Pharma Labs, GCS analyzed twoyears’ worth of purchasing and accounts payable data,as well as six months of procurement card data. Thedata provided GCS and Pharma with insights aboutthe potential for consolidating the number of productsPharma purchased regularly from various suppliers.It also suggested how Pharma might consolidate itspurchases in return for lower prices and greater value-adding services from its remaining suppliers.

At Pharma Labs, as in most GCS engagements, thecase team also had to do an invoice analysis – actuallyinspecting past invoices to gather usable data – to vali-date the electronic data and to provide additional line-item product detail when available. The level of detailthat the customer has is usually not adequate. Thecustomer’s system may contain only aggregated pur-chase-order information, showing only how much waspaid in total. Complicating the task further, invoicesthemselves often have incomplete item descriptionsthat make it difficult to determine exactly what waspurchased.

The GCS team also found from its inventory analy-sis that Pharma Labs had no records of the amountof inventory on hand or its usage. Inventory levelswere extremely high – the team later found that Phar-ma had more than $1 million worth of slow-movinginventory – but no actual record of this inventorywas maintained in a system to track and managethe items.

The GCS case team supplemented its analyses byinterviewing the Pharma project team members. Inthese interviews, GCS shared its preliminary findings,tried to uncover anything that they might have over-looked, and learned what the Pharma managers them-selves perceived to be potential areas of improvement.The interviews were, in fact, fruitful, alerting GCS and

Pharma managers to at least one significant finding inthe procurement area. It turned out that Pharma labtechnicians played an unusually large role in theprocurement process, handling some routine purchas-ing, maintaining detailed, handwritten logs of alltransactions, receiving the items into inventory, andmanaging that inventory. The GCS value modelshowed that Pharma Labs was spending 30% of itsprocurement costs – or the equivalent of nearly threefull-time positions – on lab technicians who could beredeployed from this purchasing function to morevalue-adding activities in their intended function.Pharma Labs eventually signed a supply agreementwith another company, which, in return, put one of itspeople on site to manage this procurement process.

After GCS completes a baseline assessment, it thentries to specify improvements that the customer canmake in 6 to 12 months. It also works with the cus-tomer to formulate changes in the MRO-supplies-management strategy.

At Pharma, GCS identified at least $327,000 in totalcost savings on the $6.1 million Pharma was spend-ing yearly on MRO supplies, including the costs ofacquiring and managing them. These projected costsavings came about through consolidation of suppli-ers and product-spending reductions ($165,000), in-ventory reduction ($72,000), and process improve-ments ($90,000). For example, GCS recommendedthat Pharma Labs dramatically consolidate its MROsupplies purchases. Pharma Labs agreed and initiateda national account agreement with Grainger in June1997. In return, Grainger provided Pharma Labs withan on-site Grainger representative to manage thepurchase and inventory processes at the company.This allowed a Pharma Labs maintenance technicianwho had been spending 100% of his time purchasingMRO supplies to return to performing value-addingmaintenance activities.

What were the ultimate results of Grainger’s workwith Pharma Labs? In December 1997, GCS and Phar-ma Labs jointly conducted an audit of achieved costsavings, which were found to be $387,000 during thefirst six months. What’s more, for the whole of 1997,W.W. Grainger sales to Pharma Labs increased seven-fold, from $50,000 to $350,000. Clearly, a better un-derstanding of value created substantial benefits foreach company.



basis, Greif markets complete pack-aging systems. That is, Greif staysinvolved with its customers through-out the life cycle of the containers –monitoring how the customer usesthe container, following the contain-er’s path to the end user and retriev-ing it when it is empty, and disposingof it or reconditioning it. Greif’s valueproposition – total-cost-based pack-aging – promises that its systems can

significantly reduce a customer’stotal packaging costs.

How does Greif develop its propo-sitions? First, a Greif strategic ac-count manager, together with arepresentative from the customer,builds a value model to understandtotal costs. (Greif developed its cur-rent model based on informationfrom 20 major customers.) Key ele-ments include the costs associatedwith tracking and retrieving thedrums, cleaning and maintainingthem, testing and recertifying recy-cled drums, and all the associatedpaperwork.

Greif has found that customers –both existing and potential – canreadily assign monetary values tosome elements but that other ele-ments are more difficult to pin down.For those elements that are harder to quantify, Greif takes its analysis toa deeper level. Consider the benefitof environmental stewardship. Toget a handle on the value of thatelement, Greif determines what per-centage of its customers’ customers’locations (that is, the end users’ loca-tions) are in landfill-restricted areas,where the cost of disposing of thecontainers is higher than at other locations. Greif’s service – which, aswe said, includes retrieving the con-tainers – not only eliminates this costbut also indemnifies its customersagainst improper disposal by the endusers, protecting them from fineslevied by the Environmental Protec-

tion Agency. While these analyses donot account for all the reasons thatenvironmental stewardship wouldbe worth something to a customer,such as the value added to the cus-tomer’s reputation, they nonethelessmake environmental stewardshipworth something to the customer inmonetary terms.

Using the value model to constructseveral viable total-cost-based pack-

aging solutions,Greif’s strategicaccount manag-er and a team ofGreif expertsfrom logistics,handling sys-tems, and com-puter servicesthen give a com-

prehensive presentation to theprospective customer’s senior man-agers. During the presentation, theydiscuss the merits and prices of eachsolution.

Sustaining Customer Relation-ships. At the core of all successfulworking relationships are two es-sential characteristics: trust andcommitment. To demonstrate theirtrustworthiness and commitment to customers, progressive suppliersperiodically provide evidence to cus-tomers of their accomplishments.Sales managers at Greif, for exam-ple, give customers quarterly re-views that document actual costsavings. Applied Industrial Tech-nologies (AIT), a major distributor of specialty replacement bearings,power transmission components,and fluid power products in theUnited States and Canada, providesanother good example.

AIT primarily serves maintenance,repair, and operating (MRO) suppliesmarkets within the primary metals,mining, pulp and paper, utilities,chemical processing, textiles, foodprocessing, and agricultural indus-tries. It operates more than 337branch locations across the UnitedStates. In 1990, the company beganto market a value proposition promis-ing to help its customers improveproductivity rather than simplyselling them parts at a low price.Through value assessment, the com-pany began to work with its cus-

tomers to help them save money inareas such as maintenance, inven-tory, and energy consumption – anymeasurable area other than purchas-ing. The results were collected inwhat AIT calls documented value-added savings, which is now thecornerstone of the company’s part-nering efforts.

AIT trains all of its employees –from branch managers to field asso-ciates to delivery drivers – to look forways to improve customers’ opera-tions, and the company rewardsthem for their successes. And to sup-port their efforts, the company hasdeveloped a customized softwareprogram that calculates cost savings.Sales representatives can run theprogram on laptops while visitingcustomers. Working with customers’managers, representatives inputdata for potential value-adding andcost-reduction variables – variablesthat AIT and the customer have pre-viously agreed on. Then, either on aquarterly or a semiannual basis, AITpresents each customer with a re-port that documents the savings, al-lowing customers to assess firsthandthe value AIT has delivered.

In order to establish credibility forits reports, AIT asks customers tosign and return a copy. The companykeeps track of the performance ofeach cost-savings initiative and ag-gregates the totals. AIT calculatesthat last year it provided more than$100 million in cost savings to itscustomers.

Delivering Superior Valueand Getting an EquitableReturnUnderstanding value in businessmarkets and doing business basedon value delivered gives suppliersthe means to get an equitable returnfor their efforts. The essence ofcustomer value management is todeliver superior value and get an eq-uitable return for it, both of whichdepend on value assessment. W.W.Grainger, the MRO supplies distrib-utor, is an excellent example of acompany that has realized the bene-fits of measuring and monitoringvalue for its customers. The companyhas even established a consultingarm, Grainger Consulting Services,



Knowing that an improvement in some functionality is importantdoes not tell a supplier if acustomer is willing to pay for it.

specifically to help customers un-derstand the total cost of MROsupplies management. (See the in-sert “Understanding Value: HowW.W. Grainger and Its CustomersBenefit.”)

Perhaps equally compelling,though, is an observation made by a

senior manager at one company thatdoes business based on value: “Sell-ing only on price – where’s the fun inthat?” This manager recognized thatwhen there is market pressure onprice, his business unit needs to re-spond by demonstrating that it hassomething different to offer – some-

thing that will provide superiorvalue. Assessing and truly under-standing value in business marketsis the beginning of the path to prof-itable fun.

Reprint 98601To place an order, call 1-800-988-0886.



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