Understanding how value is created across a business system can yield breakthrough ideas and improved performance

As companies grapple with this challenge, the burning question in many boardrooms is: What can top management do to accelerate growth of both the top and bottom lines of existing businesses?

We believe that the answer lies in pursuing strategies that simultaneously create value for all customers – both end-use consumers and channel partners – and for the company itself. Strategies that benefit all participants in the activity chain tend to be highly distinctive and difficult to copy. As such, they have the best chance of increasing not only near-term revenue and profitability, but also long-term, sustainable growth in intrinsic value.

Before getting into how these winning strategies can be developed, let me start by offering a bit of background on how we define both customer and company value. I will then illustrate how these values can be increased simultaneously once you understand how they are linked together to form an integrated business system.

When the customer is the consumer (e.g., a shopper at a retail store), customer value is defined by the benefits that the end user gets from consuming the product or service. The dollar value of these benefits can be thought of as the customers’ willingness to pay for the product/service offer. From a strategic standpoint, it’s not absolute consumer value that matters, but relative consumer value – that is, the benefits of an offer relative to the benefits of competing offers. This is fortunate because measuring relative customer value is far easier than measuring absolute customer value. Advancements in marketing science can now generate highly detailed information that can inform management about which consumers they should target, whether their current product/service offer is advantaged or disadvantaged versus the competition and by what amount.

When the customer is a channel partner, or intermediary, customer value is also defined by the dollar value of the benefits received from the company. Since each channel partner – whether a retailer, a value-added reseller, an agent or a franchisee – wants to create value for its own enterprise, the key driver of the relationship benefits is the economic profit (EP)¹ over time that the channel partners capture from the product/service sale to the end user. Note that the EP earned from the relationship must include both the EP from direct channel activities, such as reselling or advising, and any advantages or disadvantages in dealing with the company that impact the customer’s EP (e.g., invoicing or shipping errors).

Similarly, company value is driven by the economic profit that the company captures for its owners over time. This value, also known as intrinsic value, is explicitly defined as the present value of the EP stream from each business, plus the amount of invested capital on its books. Numerous studies have shown that a company’s market value tracks its intrinsic value over time.

Taken together, the various customer and company values form an end-to-end business system whereby value created for the end user is captured through the pricing mechanism in differing degrees by all participants in the activity chain. From the company’s standpoint, the strategic challenge is to manage this system in a way that produces the right mix of customer/consumer values and pricing so that the company’s own intrinsic value growth can outpace that of its competitors.

Building a Profitable Organic Growth Platform
Developing profitable organic growth strategies requires not only a clear understanding of the economic definitions explained above, but also of how customer and company values are linked in each business unit’s activity chain. We think of this as gaining "line of sight" on how changes in the value created anywhere in the end-to-end business system impacts every other value in the system. The best way to illustrate the power of this line-of-sight model is through examples.

One of our clients, a global consumer goods company, recently used this approach to increase organic growth in one of its largest business units. The BU management team began by segmenting its consumers in two dimensions (see Figure 1). The first dimension was defined by the consumers’ propensity to purchase, as revealed by a detailed analysis of brand switching behavior (how consumer loyalty is distributed across brands) and the consumer decision hierarchy (which attributes products compete on). The second dimension was the profitability of the consumer to the BU (the amount of economic profit each consumer generated for the business).

Using this new view on consumer segments, management tailored both the tangible product offer – by improving a key element of the product’s performance and changing the packaging – and the advertising and promotion strategies to get better alignment with the needs of the most desirable consumers. In addition, a new in-store promotion was co-developed with the BU’s biggest customer which produced a substantial increase in the retailer’s economic profit margin on each unit sold. These increases in consumer and customer value caused an immediate surge in demand for the product, enabling the supplier to gain several points of market share. To further exploit the rise in demand, management raised prices slightly to offset the increase in economic cost of the new strategy. The result: a jump in the business unit’s economic profit of nearly 30%, which increased the BU’s intrinsic value by roughly 20%.

In another example, an industrial client used the line-of-sight model to create more customer and company value, in part, by overhauling its cost structure. Initially, the company enhanced customer value by integrating several key activities in the joint supply chain between itself and its largest retail customer. Then it used a "customer-back" view of its cost/asset structure to develop a highly advantaged economic cost position. This was accomplished by first calculating the maximum economic cost per unit necessary to hit an ambitious EP target, given the pricing required to capture most of the customer’s orders. Top managers then used this maximum economic cost number to develop alternative operating configurations, approaching the task with a "zero-base" mindset (if we didn’t own the operations we now have, what would we buy?).

In this instance, the targets could only be reached through outsourcing most of their legacy manufacturing assets, an option that would never have been seriously considered under their traditional approach to strategy development. As a result, management turned a negative EP business into a positive one while continuing to grow its revenue base.

Getting Organizational Alignment
Our experience with companies that have used this platform has been uniformly successful. Getting a clear line of sight into how value is created across a business system has yielded increases in near-term economic profit of 20% or more for most clients. Sustaining improvements of this magnitude, however, typically requires changes in the company’s management model. Since most companies are organized around products or technologies, customer-centric strategies will almost always cross existing organizational boundaries, creating implementation barriers. For example, a highly innovative customer strategy for a financial services client was delayed for months by a disagreement among the heads of several product "verticals" over who would manage the strategy and how the internal economic gains would be distributed. Ultimately, management’s ability to sustain profitable growth will depend on how well it can identify the organizational barriers and then develop the necessary structure and management process options to minimize them.