Buyer value and differentiation of the firm

Uniqueness does   not  lead   to   differentiation   unless   it   is valuable to the buyer.   A successful differentiator  finds ways of creating value for buyers that  yield a price   premium  in   excess of the extra  cost. The  starting point  for   understanding  what  is valuable   to   the   buyer is the   buyer’s   value   chain.   Buyers   have   value   chains   consisting   of the activities they perform just as a firm does, as discussed in Chapter 2. A firm’s product  or service is a purchased  input  to its buyer’s value chain. Steel is a raw material  that is typically cut, bent, machined, or otherwise converted  in its buyer’s production  process to become part of components and ultimately end products,  for example. The buyer’s value chain determines the way in which a firm’s product is actually used as well as the firm’s other effects on the buyer’s activities. These determine the buyer’s needs and are the underpinnings of buyer value and differentiation.

Although buyer value chains are easiest to visualize for industrial, commercial, or institutional buyers, individual  consumers  also have value chains. A consumer’s value chain represents  the sequence of activities performed by a household and its various members in which the product or service fits. To understand how a product fits into a household value chain it is usually necessary to identify those activities in which   a   product  is   directly   or   indirectly   involved,   typically   not all the activities a household performs. A television serves as entertain­ ment for various   members  of a   household  during  some   periods of the day, and serves as a background noise during  others. The set is typically switched on and off a number  of times each day and the channel may be changed  frequently. Traveler’s checks are typically bought in quantity  at a bank  and then used occasionally in the course of a vacation or business trip.   Redeeming  any extra  checks after the trip involves a visit to the bank, which  means  that many  checks are saved for future trips instead. A commercial, institutional, or industrial buyer’s value chain reflects its strategy and approach  to implementa­ tion, while a household’s value chain reflects its members’ habits and needs. W hat is valuable for either  type of buyer,   however,   grows out of how a product  and the firm supplying  it affect the buyer’s chain.

1. Buyer Value

A firm creates value for a buyer  that  justifies a premium  price (or preference at an equal price) through two mechanisms:

  • by lowering buyer cost
  • by raising buyer performance

For industrial, commercial, and  institutional  buyers, differentia­ tion requires that a firm be uniquely able to create competitive advantage for its buyer in ways besides selling   to   them   at a lower price.   If a firm is able to lower its buyer’s cost or enhance its buyer’s performance, the buyer will be willing to pay a premium price. If the components supplied by a well respected bicycle parts  supplier  allow a bicycle assembler to improve differentiation and thereby  charge a higher price, for example, the assembler will be willing to pay a premium for the components. Similarly, the fact that  K odak’s  Ektaprint  copier lowers the cost of a finished set of collated documents  with a recirculating document feeder and an in-line autom atic stapler  that  reduces the buyer’s personnel cost means that the buyer is willing to pay a premium for the copier. In both instances, the firm was able to enhance the competitive advantage  of its buyer  even though  not  selling its product at a cheaper price.

The principle is the same for households  and  individual consum­ ers, though the measurement of buyer cost and particularly buyer performance  may be more  subtle.   For  household  buyers,   the cost of a product includes not only financial costs but also time or convenience costs. The cost of time for a consumer  reflects   the   opportunity  cost of using it elsewhere, as well as the implicit cost of frustration, annoy­ ance, or exertion. Buyer  value results from lowering any of these costs for the buyer. A refrigerator that uses less electricity than other refrig­ erators can command a premium. A vacuum cleaner that saves vacu­ uming  time and reduces exertion is also valuable to   the   household buyer. Offering direct  marketing  that saves the buyer shopping  time may not be valuable if the buyer enjoys shopping, however.

Raising buyer performance for consumers  involves raising their level of satisfaction or meeting their needs. If a TV set’s better picture quality and faster warmup time lead to more  satisfaction in watching it relative to competitors’ sets, for example,   the buyer  will be willing to pay a premium.  Status or prestige are im portant needs just as are the features of a product  or its quality.   Although  it may   be difficult to value buyer performance for consumers,  their value chains will suggest the im portant dimensions of satisfaction.

Industrial, commercial, and institutional buyers sometimes re­ semble consumers in instances where  their  objectives are not  solely profits or revenue growth. Buyers may value a supplier that provides satisfaction or prestige for executives or   other  employees   even   if it does not contribute to the profit of the company. This reflects the differences that often exist between employee and company goals. Simi­ larly, a hospital values a diagnostic device that yields better treatment even if the hospital does not earn higher profit as a result. This reflects both the goal of  providing  quality patient  care and  the fact that a large number  of hospitals are nonprofit  institutions. Many  organiza­ tions have other  goals in addition  to profitability even   if they   are profit making, which may enter into buyer value.

2. The Value Chain  and Buyer Value

A firm lowers buyer  cost or   raises buyer  performance  through the impact of its value chain on the buyer’s value chain. A firm may affect the buyer’s chain by simply providing an input to one buyer activity. Frequently,  however, a firm’s product  will have both  direct and indirect impacts  on the buyer’s chain  that  go beyond  the activity in which the product is actually used. For example, weight is important in a typewriter that  is moved from place to place though  it is not relevant if one   views   the   buyer   activity   simply   as   typing.   Moreover, a firm typically impacts the buyer  not  only through  its product but also through such activities as the logistical system, order entry system, sales force, and applications engineering group. Even firm activities representing a small fraction of total cost can have a substantial impact on   differentiation.    Sometimes    the    buyer    has    individual    contact with value activities of the firm (e.g., the sales force) while in other cases the buyer  only observes the outcome  of a group  of activities (e.g., the ultimate  on-time or late delivery). Thus,  the value a firm creates for its buyer is determined by the whole array of links between the firm’s value chain and its buyer’s value chain, represented schemati­ cally in Figure 4 -2 .

Heavy trucks offer a useful example  of multiple  links. A heavy truck directly influences its buyer’s logistical costs— a function  of the truck’s carrying  capacity, ease of loading and   unloading,  fuel costs, and maintenance  costs.   The  truck  will   also have   indirect effects on its buyer’s other costs. Its capacity will influence the frequency with which the buyer makes deliveries. The truck may contribute  product quality through  the amount  of shaking  it subjects the cargo   to, as well as the temperature and humidity conditions in transit. The truck may also affect the buyer’s packaging costs, a function of the protection required to avoid damage. Finally, the truck may incrementally affect brand identity through its appearance and the visibility of the logo painted on the side.

Not only will the truck  itself affect the buyer’s value chain, but several other value activities of the truck  manufacturer will probably affect the buyer as well. Spare parts availability will affect the downtime experienced by the buyer.   Credit  policies will affect the financing cost of the truck. The quality of the truck  m anufacturer’s sales force may well determine their helpfulness in suggesting new maintenance proce­ dures and truck utilization practices. All these links between a truck manufacturer’s  value activities and  the   buyer  may potentially   add to or subtract from buyer cost or performance.  The principle also holds true for household buyers.

The links between a firm and  its buyer’s value chain that  are relevant to buyer value depend on how the firm’s product is actually used by the buyer,  not  necessarily how it was intended  to be used. Even the most carefully designed product can yield unsatisfactory performance  if a buyer  does not  understand  how to install, operate, or maintain it or if it is used for a purpose for which it was not intended. For example, a housewife may get terrible results from a frozen food product if it is cooked at the wrong  temperature.  Similarly, a machine can malfunction quickly if it is not oiled in the right place.

Every impact of a firm on its buyer’s value chain, including every link between firm and buyer value activities, represents a possible op­ portunity for differentiation. The more direct and indirect impacts a product  has   on   its buyer’s value   chain,  the   richer  the   possibilities for differentiation tend to be and the greater the overall level of achiev­ able differentiation. A truck m anufacturer with a sophisticated under­ standing of how   it impacts  its buyer’s value chain,   for example, can not  only design the truck  to   provide  greater  benefits to   the buyer, but  can perform other  value activities such as service, spare parts supply, and financing to be more valuable to the buyer.

Differentiation,   then,   grows out  of all the   links between a firm and its buyer in which  the firm is unique.   The value of  being unique in a value activity is its direct   and   indirect  impact  on   the buyer’s cost or performance. A firm’s overall level of differentiation is the cumulative value to the buyer of the uniqueness throughout its value chain. This cumulative value can be calculated and provides the upper limit of the price premium the firm can command relative to its com­ petitors. Since the firm must necessarily share some o f the value it creates with its buyer in order to give the buyer an incentive to pur­ chase, the actual price premium will be somewhat less in practice.

3. Lowering Buyer Cost

Anything  a firm can do that  lowers the   buyer’s total  cost of using a product or other buyer costs represents a potential basis for differentiation. Actions that lower the cost of buyer value activities representing a significant fraction   of the   buyer’s cost   constitute  the most significant opportunities.  There  are frequently many  ways to lower buyer cost if a firm has a sophisticated  understanding  of how buyers use its product  and how its various marketing,  delivery, and other activities affect buyer costs.

A firm can lower its buyer’s cost in a number of ways:

  • Lower delivery,  installation,   or   financing   cost
  • Lower the required rate of usage of the product
  • Lower the direct cost of using the product, such as labor, fuel, maintenance, required space
  • Lower the indirect   cost of using   the   product,  or   the     impact of the product on other value For example, a light component may reduce the transport costs of the end product
  • Lower the buyer cost in other value activities unconnected with the physical product
  • Lower the risk of product failure and thus the buyer’s expected cost of failure.

Table 4 -1 lists some of the ways in which a firm’s product itself can lower the buyer’s direct cost of use. In addition  to lowering buyer cost through its product characteristics  as illustrated  by the examples in Table 4 -1 , a firm can lower its buyer’s cost of use through  many other value activities. Reliability of deliveries reduces buyer  inventory, and short lead times in supplying spare parts reduce downtime. Order­ ing and billing procedures can reduce the buyer’s accounting and pro­ curement costs. American Hospital Supply’s on-line ordering system for hospitals,   for example,   allows   purchase  orders  to   be placed by less skilled, lower paid   clerks   instead   of purchasing  agents.   A firm can also provide buyers with advice or technical assistance that reduces their costs. Intel, for example, has a development system to help buyers design   its   microprocessors  cheaply   and   rapidly   into   their  products. A firm can also take over buyer functions,  in effect forward  integrat­ ing into the buyer’s value chain. In wholesaling, for example, Napco stocks shelves, prices goods, and  replaces slow-moving items for its buyers.

A number of more  extended  examples will illustrate how firms have lowered their buyers’ costs and achieved differentiation. Kodak’s copiers, described earlier, lower the buyer’s   cost   of making   collated and stapled copies. The  industry  leader  Xerox  was more  concerned with copying speed itself, which failed to recognize the buyer’s full cost of using copiers. In the moving industry, Bekins has offered guar­ anteed pickup and delivery dates, a fixed price for a move   that  is quoted in advance, a $100 late payment  to   the   buyer  if the   move does not occur on time, and reimbursement  for damaged  goods based on their replacement  costs instead of  purchase  price. All these lower the buyer’s direct and indirect cost of a move (and increase peace of mind as well). In fasteners, Velcro uses a system involving many small plastic hooks that  connect  to a fibrous pad. Velcro fasteners are easier to install than  other  forms of fastening devices and eliminate the need for skilled labor in the fastening steps on the buyer’s assembly line.

In seeking opportunities  to lower buyer  costs, a firm must chart in detail how its product moves through  or affects the buyer’s value chain, including the buyer’s inventory, handling,  technology  develop­ ment, and administrative  activities. It must  also be familiar with all other products  or inputs   its product  is used with,   and  understand how its product  interfaces with them.  The  firm must  also identify every other value activity in its value chain  that  affects the buyer’s chain.

4. Raising Buyer Performance

Raising buyer  performance  will depend  on   understanding  what is desirable performance from the buyer’s viewpoint. Raising the per­ formance of industrial,  commercial,  and institutional  buyer   depends on what creates differentiation   with   their  buyers.   Thus  the   needs of the buyer’s buyer must be understood, requiring the same analysis as the analysis of buyer value. A truck sold to a buyer who is a consumer goods company  that  uses it to   carry  goods to   retail stores   provides an example. If the retail stores desire frequent deliveries, the consumer goods company will be very interested in a truck  with carrying capacity to make frequent   deliveries   at   reasonable   cost.   Similarly,   in   selling to automobile   manufacturers   Velcro   achieves   differentiation   because its fasteners are more  flexible and   allow   interior  design options for cars that are appreciated by consumers.

Raising performance of industrial, commercial,  or institutional buyers can also be based on helping them   meet their noneconomic goals such as status, image, or prestige. In heavy trucks, for example, PACCAR has achieved a high level of differentiation for its Kenworth “K-W hopper”  trucks  by careful handcrafting  and  by tailoring them to individual owner specifications. These have little to do with the economic performance of the truck. However, many Kenworth buyers are owner-operators who derive value from the appearance and brand image of their trucks.

For products  sold to consumers,  raising buyer performance will be a function of better satisfying needs. American  Express traveler’s checks are used in a stream   of consumer  activities   in   which cash needs are irregular, travel plans change, banks are not always available, and a risk of theft or loss exists. American Express differentiates itself because its buyers  value the security of redemption  anywhere as well as rapid replacement of lost checks. American Express provides easy redemption anywhere via many offices throughout the world that oper­ ate long hours.

5. Buyer Perception  of Value

Whatever the value a firm provides  its buyers, buyers  often have a difficult time assessing   it in   advance.   Even   careful   inspection and test driving of a truck, for example, does not allow the buyer to assess completely   its   comfort,  durability,   fuel   usage,   and  repair  frequency. A detailed understanding of how the physical product affects a buyer’s cost or performance often requires extensive experience in its use. A buyer faces an even more  difficult challenge in knowing  how all the other activities a firm performs  will affect buyer  value. Moreover, a buyer  cannot  always completely   or accurately  gauge the performance of a firm and its product  even after the product  has been purchased and used.

Buyers, then, frequently do not fully understand  all the ways in which a supplier actually or potentially  might  lower their  costs or improve performance— that is, buyers often do not  know what they should be looking for in a supplier. While buyers are more likely to understand the direct  impacts  of a firm on their value chains, they often fail to recognize the indirect impacts or the ways in which other supplier activities besides the product  affect them.  Buyers can some­ times perceive too much value just as they can fail to perceive enough. For example, buyers sometimes see only the price of a product when measuring its value and do   not  add   up   other,   more  hidden,  costs such as freight or installation. The buyer’s perception of a firm and its product, therefore, can be as im portant  as the reality of what the firm offers in determining the effective level of differentiation achieved. Moreover, buyers’ incomplete knowledge of what is valuable to them can become an opportunity  for differentiation   strategy,   since a firm may be able to adopt a new form of differentiation preemptively and educate buyers to value it.

A buyer’s incomplete knowledge implies that the differentiation actually achieved   may   well be based   in part  on   the factors used by the buyer to infer or judge  whether  a firm will lower its cost or improve its performance relative to competitors (or is doing so cur­ rently). Buyers use such indications as advertising, reputation,  packag­ ing, the professionalism, appearance,  and personality of supplier employees,   the   attractiveness  of facilities,   and   information  provided in sales presentations  to infer the value a firm will or does create. I term such factors that  buyers use to infer the value a firm creates signals of value.

Some signals of value require ongoing expenditure by a firm (e.g., packaging, advertising) while others reflect the stock of goodwill or reputation a firm has built up over time.   Similarly,   some signals of value are not directly controlled by the firm at all (e.g., word of mouth). Signaling may be as necessary, in some  industries, to expose hidden costs of a product on which the firm has an advantage over competitors as it is to expose unrecognized benefits. In some, if not many, industries, signals of value are as important as the actual value created in determin­ ing realized differentiation. This  is particularly  true where a firm’s impact on buyer  cost or   performance  is subjective,   indirect,   or hard to quantify, when many buyers are first-time buyers, buyers are unso­ phisticated, or repurchase is infrequent. Good examples would be legal services, cosmetics,   and consulting.   However,  the need to signal value is present in virtually every industry.

Buyers will not pay for value that they do not perceive, no matter how real it may be. Thus, the price premium  a firm commands will reflect both the value   actually   delivered   to   its buyer  and   the   extent to which the buyer perceives this value. This is illustrated  schematically in Figure 4 -3 . A firm that  delivers only modest  value but  signals it more effectively may actually command  a higher  price than  a firm that delivers higher value but signals it  poorly.

In the long   run,   the upper  limit of the   price   premium  a firm can command reflects its actual impact  on buyer  value— impact on buyer cost and performance relative to competitors. Through effective signaling of value, a firm may be able to command a price in excess of true   value   for a time.   Eventually,  however,   the failure   of a firm to deliver perceived value to match  its price tends to become known, partly through the efforts of competitors.8 The converse is less true, however. By failing to signal its value effectively, a firm may never realize the price premium its actual value deserves.

Figure 4 – 3 .    Actual Versus Perceived Buyer Value

6. Buyer Value and  the Real Buyer

A firm or household does not purchase  a product;  individual decision makers do. Both actual value and signals of value are assessed and interpreted by these decision makers.  The identity of the specific person or persons who make the   purchase  decision   will influence, if not determine, the value attached to a product. The decision maker may not necessarily be the   person   who   pays   for   the   product  (e.g., the doctor, not  the patient, chooses drugs)  and  may be different from the user (e.g., the purchasing  agent  chooses a product  used in the plant). The  channel  may also make  its own decision about  whether to stock a firm’s product and whether the firm is a desirable supplier. Different   decision   makers  will value different   things   about  a sup­ plier and use different signals to assess   them.   A   purchasing  agent may not value reliability as highly as a plant manager, for example, because the purchasing  agent is more  detached  from the consequences of product failure. The purchasing agent  may be motivated  more  to keep the cost of purchase to a minimum.  There  may also be more than one decision maker for a product. Both husband and wife typically decide on buying a house, for example, and travel agents and tour brokers all can play a role in choosing an airline or resort  hotel. Similarly, the purchasing department and plant engineer often jointly choose pieces of production equipment. A number of individuals fre­ quently influence the decision maker  though  they may   not  participate in the decision  directly. Such individuals may be able to veto a supplier, despite the fact that they do not have the power to choose.

Identifying the value a firm creates for the buyer and the signals of value used by   the   buyer,   then,   rests   on   determining  the   identity of the real buyer. The  process of identifying the real buyer often sug­ gests new dimensions of performance that are not immediately appar­ ent if the buyer is viewed as the firm or household. These can include such factors as prestige, personal relationships  with supplier personnel that are valued in   their own   right,   and   the desire to avoid   personal risk in the purchase  decision by choosing a well-known supplier. IBM has exploited its position as a “safe” choice as a supplier, for example, as has Kodak in amateur photography. The expertise and sources of information   available   to   the   real buyer  will also   shape what  signals of value will be convincing— an engineer might  use technical publica­ tions and advertising in technical journals as signals while an account­ ing clerk might be more swayed by polished salespeople and  glossy brochures.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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