value core

November 15, 2017

Peter Drucker, probably the best management thinker of the 20th century, provided two unique perspectives on business. First, the purpose of business is to create and retain customers. This was a novel idea because most corporations and their boards were organized and guided by the corporate governance responsibility to only shareholders and investors. In other words, according to the fiduciary responsibility, the purpose of business is to create wealth for the owners. Drucker challenged that thinking. While today customer centricity and customer engagement are taken as table stakes, it was a radical thought in the fifties.

Drucker also stated that there are only two real functions of business: innovation and marketing. The rest are all costs. Again, it was a unique perspective on how to create value. He felt that innovation and marketing created value while most corporations, and business in general, considered both innovation and marketing as cost centers to cut back in tough times and chronically underinvest. This is especially true in Indian enterprises except for the FMCG sector. Now the Indian enterprises, including the State enterprises, have realized that the real competitive advantage comes through inventions and discoveries and from advertising, publicity, and promotion. In the License Raj era, it was easy to make money as a monopolist with an attitude of ‘customer be damned’, and ‘ let me milk the product or the license’. However, it is simply not sustainable in today’s competitive world. In fact, after the privatization and liberalization of the Indian economy in the early nineties, we have seen many legacy products and companies unable to compete because they did not embrace customer centricity and innovation. Examples include the Ambassador car, landline telephones, and many great companies such as Metal Box, Indian Airlines, and Crompton-Greaves.

why customer centricity matters

Customer centricity, like religion, is very intuitive and easy to understand but hard to practice on a daily basis. This is because most businesses are organized by functions, products, and processes. For example, one presumes that it is the responsibility of the marketing and sales functions to be in charge of customers. This results in turf wars between sales and production (or procurement if you are a retailer or distributor), and sales and customer support functions. It also generates conflicts between sales and marketing.

A second and more critical issue in implementing customer centricity is the present accounting system which is organized around products and functions and not around customers and market segments. Until the financial and managerial accounting embrace customer-centric activity-based costing, it will be difficult to implement customer centricity in any business.

competitive advantage through customer centricity

This is unfortunate because customer centricity generates several competitive advantages with respect to both top line growth and bottom line cost reduction.

First, customers buy the product (or service) for life. Therefore, it is important to calculate a customer’s life time value (CLV) to fully appreciate his or her value. In the US, my estimate of average CLV for a super market is about $500,000 over the 25-year life of a family. CLV in India is much higher because of multiple generation-relationship between the customer and the supplier, especially in business-to-business markets. This means we must treat marketing expenses as investments to be amortized over time. However, GAAP does not allow this.

Second, customer centricity often enables a business to redefine and reposition itself over time. It enables to enlarge the scope of the business and results in continued growth, as well as reduction of average cost by the amortization of fixed costs (including corporate overheads) across a broader range of products under the same brand or company name. Examples include: Nike Shoes to Nike Lifestyle, Sony Radio to Sony Entertainment, and IBM Computers to IBM Services. Several Indian enterprises have also repositioned themselves for future growth. This includes Jaipur Rugs to Jaipur Living, Marico Parachute Brand Coconut oil to Marico Health, and Wipro Vanaspati to Wipro Consumer Care, which includes not only soaps but also light bulbs and personal care. Probably the most dramatic example is the success of Patanjali Ayurveda. It offers a very wide range of products and far more than just a chyawanprash. And of course, online retailers such as Amazon and Flipkart offer millions of products.

The third advantage of customer centricity is internal cooperation, coordination, and integration. While no department or function wants to be subordinated by any other department or function, they all rally around being customer centric. This includes both line and staff functions, and it extends from procurement to R&D to manufacturing to sales to service. This is what Lou Gerstner did when he became the first outside CEO and Chairman of IBM. Coming from the outside and despite having no knowledge of computers and computing, Gerstner was able to get the R&D, manufacturing, and sales departments to be on the same page. Similarly, Procter and Gamble (P&G) learned to organize around its customers such as Walmart, K-Mart, Kroger, and Target across more than twenty different product divisions.

the 4 A’s of marketing

In our book, The 4 A’s of Marketing (Routledge 2006), my colleague Rajendra Sisoda and I documented (based on more than five hundred case studies) why so many new products fail (Concorde Plane, Iridium Phone) or succeed (iPod, iPhone). We found that customers’ acceptability, affordability, accessibility, and awareness were key. In most emerging markets, the biggest growth opportunities are making products or services more affordable and accessible. In my recent book, Breakout Strategies for Emerging Markets (with Mona Sinha and Reshma Shah), our research documented that the biggest opportunities for growth in emerging markets are converting unbranded products to branded products such as street foods, and the use of smartphones and the ecommerce distribution through Amazon or Flipkart in India.

why innovation matters

As Drucker emphasized, innovation is also key to business success, especially for top line growth. Innovation culture, by definition, welcomes change and challenges complacency or status quo management. It constantly strives to improve on existing products and services and provides a deferential advantage.

product, process, and integration innovation

Innovation is not just product innovation but also process innovation and end-to-end integration innovation.

Many disruptive innovations are process and integration oriented. For example, generic drugs in which India is a major global player, were through process innovation. This is also true of online taxi services such as Ola and Uber. Mapping the customer journey and taking out friction at each step of the journey as well as integrating them with ICT technologies, such as digital apps and machine learning, are all user-centric processes and has generated more wealth for the founders and their businesses than what the Industrial Revolution was able to do in the last century. Examples of companies such as Google (for library), Amazon (for procurement), Facebook (for social media communication), and WhatsApp are striking examples. In my research, I have found that the most successful process or integration innovators tend to be customer centric. And they can be scaled up with practically no upper limit. Who would have thought that Facebook would have two billion users globally?

why product innovation is difficult

On the other hand, product innovation is more difficult for several reasons.

First, most successful companies have world-class R&D departments with highly specialized scientists. While they are exceptional in what they do, they are not capable of doing anything else. For example, mechanical engineers are incapable of chemical engineering and vice versa. I call this a competency trap. The more specialized the expertise, the less the capability to do something else. It is the opposite of core competence as a competitive advantage. Companies that were analog based such as Tektonics have not been able to switch to digital products, for example. Similarly, Kodak was unable to transition to digital camera in consumer markets because their core competency in film and chemicals became a trap. Similarly, Sears Rocback was the best, and largest, department store in the last century. It knew how to build shopping centers and bet on the growth of automobiles and highways. Today, it is struggling to build and operate on the information highways and mobile devices (smart phones).

The most successful product innovations are those that smoothly upgrade from one generation to the next without much interruption to the customer ecosystem. IBM was master of product migration from the IBM 650 to IBM 7070/7090 to IBM 360/370 to IBM 3300 Series over the last two generations. This is also true of equipment makers such as Caterpillar or John Deere. And, of course, Boeing has added a whole fleet of aircraft ranging from 737 to 757 to 747 to 767 and now, 787 (Dreamliner).

Finally, product innovations which create and promote relative advantage to existing alternatives usually succeed. These can be both functional as well as non-functional advantages. Functional advantages are reliability, durability, and economic [value]. This is how Toyota became the number one car-maker, and only recently it was surpassed by the Volkswagen Group. The non-functional relative advantages are often through design, status, and emotional connections. Examples include designer clothing and accessories (bags) and office furniture such as what Michael Kors, Gucci, and Steelcase have achieved. Similarly, Patagonia has successfully linked its brand to environmental sustainability.

Recently many companies, especially in the FMCG space, have linked their brands to some purpose or cause, making consumption not just pleasurable but also meaningful. These include such giants as Unilever, Procter & Gamble, and Coca-Cola.

Peter Drucker was the ‘Einstein of management’. His belief that the purpose of business is to create and retain customers is now widely accepted. And the best way to create and retain customers is to create value for them through innovation and marketing.