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Plugging Drains, Sealing Leaks: Stop Caving to Customer Pressure
March 28, 2008
Excerpted from Value Merchants: Demonstrating and Documenting
Superior Value in Business Markets
By James C. Anderson, Nirmalya Kumar and James A. Narus
Purchasing managers in business markets are becoming increasingly sophisticated in their strategies and tactics. Increasingly held accountable for reducing costs, purchasing and other customer managers don't have the luxury of simply believing suppliers' claims of cost savings.
A relatively easy and quick way to obtain savings is for purchasing managers to focus on price and obtain price concessions from suppliers. In Value Merchants, James C. Anderson, Nirmalya Kumar and James A. Narus put forth the argument that, rather than simply conceding price concessions, suppliers in business markets are better served by identifying value drains and value leaks when faced with customer price pressure. To learn more, read on:
Seeking Value Drains and Leaks, Not Price Cuts
Rather than trying to find ways to cut price, value merchants try to make the business with customers more profitable by finding value drains and value leaks. Value drains are services, programs and systems that cost the supplier more to provide than they are worth to customers receiving them and have no strategic significance. Value leaks are activities and practices a customer does that increase the cost of doing business for it and/or the supplier and yield no offsetting greater cost savings or value to either.
Identifying and eliminating value drains and value leaks represent a promising means for businesses acting as value merchants to improve their own as well as their customers' profitability. These changes in how the supplier and customer do business can provide cost savings to each, or one may incur incremental cost while the other gains greater offsetting cost savings.
In this latter case, most suppliers and customers are willing to share the net cost savings as an incentive to change, so that each firm is better off. Success at identifying and eliminating value drains and leaks promotes greater cooperation between a supplier and customer, with the intent of doing still better. Customer value assessment, along with activity-based costing analysis, provide the "Aha!" tools to detect value drains and leaks.
Case Study #1: Eastman Chemical
Eastman Chemical—a leading producer of chemicals, plastics and fibers—provides a notable example of identifying and eliminating a value drain. It was supplying an organic chemical intermediate to a leading pigment producer and was having difficulty getting to a price where the customer would be happy to do business. The Eastman salesperson, who had been trained in selling value and doing customer-process mapping, proposed studying the customer's production process to discover potential cost savings. This investigation indeed revealed a value drain. Eastman, in the final step of its production process, was eliminating moisture from the product, which was the traditional way of providing this product to customers. The salesperson discovered that the first step in the customer's process was to add moisture back to the product!
When apprised of this value drain, Eastman was able and willing to change its process to eliminate this step. The result was that Eastman was able to achieve efficiency increases in production as a result, as well as creating a model that later allowed for conversion of other customers with similar process steps. Eastman was able to improve its profitability through this cost saving while passing a portion of the savings on to the customer as a smaller price increase than would otherwise have been the case.
Case Study #2: Tata Steel
Tata Steel is a leading supplier in India. Through its customer value management (CVM) process, it strives to find and eliminate value drains and leaks in doing business with its strategic customers. The relationship between these customers and Tata Steel has undergone a notable change, from being adversarial to mutually reinforcing. Often, once the relationship is cemented through the CVM process, the customer also begins to contribute ideas on potential value drains and leaks. This is a magical moment in Tata's relationship with the customer.
In a value drain example from the tubes business, Tata Steel supplies steel tubes to a boiler manufacturer located 1,000 miles away. The tubes, after manufacturing, were specially oiled to avoid rusting en route to the customer's plant. Bizarre as it may seem, the customer first cleaned the oiled surface and then treated the surface of the tubes to allow them to pick up rust in its plant! As the CVM assessment revealed, a little bit of rust on the tubes was desirable to create enough friction between the tube and the bobbin drum while making coil-type boilers.
Eliminating the oiling process at Tata Steel and the subsequent cleaning process at the customers' end was a win-win solution for both firms. This resulted in a $30- to $40-per-metric-ton savings for the customer, while lowering Tata's costs by eliminating the oiling step in its process.
In a value leak example, Tata Steel shipped large tonnages of steel bars in straight and fixed lengths of 12 meters to construction firms purchasing steel reinforcing bars. The customer wanted differential lengths of 10 meters or 11 meters, and a fixed length offering from Tata Steel would imply 12% to 16% loss for the customer. The relationship was an "arms-length" transactional relationship. The CVM process revealed the value leaks to the Tata Steel sales manager and the customer representative. The two firms decided that it was more appropriate to roll and cut customized lengths at Tata Steel factory, and then ship the bars in ready-to-use lengths to the customer.
Tata and its customer conducted an assessment of the extra costs that Tata Steel would incur to make customized lengths at its mill, and the cost savings in conversion and wastage that the customer would receive from customized lengths. The two firms then were able to arrive at a price premium for customized lengths that more than covered Tata's incremental costs while providing the greater portion of the cost savings to the customer.
Tata finds that giving the customer the greater proportion of the identified cost savings leaves the customer delighted, while still giving Tata a "good enough" incremental margin over its additional costs.
In 2002, before the start of the CVM, the top 16 customers accounted for just 15% of Tata Steel's revenue in one of its business lines. In 2005, the revenue share from these 16 customers had increased to 35%. The marked improvement in share was due to higher share of business that these customers gave to Tata Steel by diverting business from other suppliers, by engaging Tata Steel in developing new products and due to increase in overall requirements of the customer as a result of its own growth in India.
The end result is that Tata is more often supplying these customers higher-end and more-customized products that differentiate it from competitors while also providing a higher level of profitability.
Editor's Note: In an exclusive feature article for Sales & Marketing Management's May/June issue, Anderson, Kumar and Narus will present insights, research findings and practical examples on how firms can transform their salespeople into value merchants.
Buy Value Merchants: Demonstrating and Documenting Superior Value in Business Markets.
Reprinted with permission from Harvard Business School Press. Excerpted from Value Merchants: Demonstrating and Documenting Superior Value in Business Markets by James C. Anderson, Nirmalya Kumar and James A. Narus. Copyright © 2007 James C. Anderson, Nirmalya Kumar and James A. Narus. All rights reserved.
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