Insights

Using Service Strategies To Avoid Price Pressures

At a recent workshop, we distributed a “quiz” with 10 quotes which we said were from recent press releases and annual reports from Fortune 500 companies, and we asked the workshop participants to identify the firm associated with each quote.  We told them to skip over the quote if they didn’t know the right firm or have a good guess.  There were exactly three quotes that everyone answered, identifying the firm associated with the quote.  For all of the other quotes, there were numerous blanks.  The quotes that everyone recognized were the following:

  • “[Our firm] has recently implemented new supply chain management procedures designed to drive costs out of the system.  We anticipate saving over $100 million per year through this initiative.”
  • “We have begun to tap low-cost supply sources, mainly from Asia, in our purchasing, with annual savings expected to exceed $50 million the first year.”
  • “Our goal is to consolidate our supplier base, reducing by half the number of suppliers from whom we buy in three years, resulting in a savings in excess of $100 million annually.”

It was quite revealing that every workshop participant recognized the companies associated with these three quotes.  Their answers were even more informative.  On the first question, across the fifteen workshop participants, twelve different companies were named.  On the second question, fourteen different companies were named.  On the third question, ten different companies were named.  The companies named spanned just about every sector of American industry.  Only one very large Detroit-based automobile manufacturer showed up on multiple answer sheets.

The learning from this exercise is very clear:  companies across the economy are focusing intensely on ways of reducing the prices that they pay for the goods and services they buy from their suppliers.  Everyone recognizes the intensity and pervasiveness of the pressures on suppliers to bring down their prices, and no one expects that these pressures will abate at any time in the near future.  Our guess is that every reader of this paper will “see some of their own customers” in the quotes above.

The question that emerges from this reality is how can suppliers gain some relief from ongoing price pressures and avoid the vicious spiral into a commodity pricing environment.  This is an important question from several perspectives.  Numerous suppliers point to these pressures as having adverse consequences not only on their own profitability, but also on their relationships with customers and on their ability to manage their internal plans and resources.  On recent projects, we heard the following during interviews with customers of the suppliers with whom we were working:  “In the past, we’ve always had an ongoing dialogue with [name of customer], but now there is an arms-length relationship dictated by their procurement managers.  As a result, we can’t bring our ideas effectively to them or hear anything about their priorities, so rather than being a source of innovation, they are looking at us as part of a group of commodity suppliers.  And the long-term implications are horrible, if we are forced to cut back on the kinds of people and programs that made us successful in the first place.”

For some suppliers and in some situations, there isn’t a good approach to avoiding commodity pricing pressures.  In those cases, their cost competitiveness will dictate their success or failure.  For other suppliers and situations, however, we have found a three-part approach to the challenge.  The three ingredients included in this approach are:

  1. Recognize the three ways in which a supplier can contribute value to their customer.
  2. Look down the entire customer chain for ideas.
  3. Become a “source of solutions”, not a “supplier of products and services”.

One common aspect of these three ingredients is that all three ask the supplier, at least to some degree, to put themselves into the shoes of their customers  We find, over and over, that customers have the best ideas as to how suppliers can be successful, so it is not surprising that these approaches draw heavily on learning that emerges from the customer environment.  We will discuss these three ingredients in the following sections of this paper.

Three Ways to Contribute Value to a Customer

We believe that suppliers have three ways in which they can create a “win” for their customers (beyond the option of offering lower prices to them):

  • Contribute to the customer’s ability to gain market share from its competitors – at prevailing market-based prices.
  • Contribute to the customer’s ability to charge a premium price for its products – without losing market share.
  • Contribute to the customer’s profit margin by lowering the costs of other purchased supplies, the costs of manufacturing, the costs of providing services, etc.

While not every supplier can identify options within one or more of these categories, many suppliers can contribute along these dimensions.  We believe that strong supplier action plans build from a careful assessment as to which of these options are possible and what it will take to contribute along each dimension.

The first option requires the supplier to present a value proposition to its customer saying that “inclusion of our products will help you to gain market share”.  If end customers recognize the performance superiority of the supplier’s products and reward the supplier’s customer with stronger market share, the customer can in fact be better off.  While many success stories in this category involve product ingredients, we have also seen companies successfully use services towards this end.  One company developed a very strong co-op marketing program, implemented in collaboration with its customers.  They developed a competent marketing services organization, with capabilities that ranged from trade show management through direct mail through web-site development.  In an interview, one customer commented that “the marketing services they brought to us were probably of greater value than anyone could have imagined, helping us to gain several points of market share”.

The second possible value contribution for the supplier would be to help their customer command a premium price for their product – without losing market share.  Simply put, if the customer is able to “pass along” the higher price from the supplier to end customers who feel that their product is better because of inclusion of the supplier’s product, the customer can increase profits by “marking up” the supplier’s product.  One organization with which we’ve worked redesigned their product so that it was possible for their customers to bring installation to the consumer’s site, rather than requiring the consumer to come to a service location.  While the product being installed was one that had literally moved into the category of “being given away by the pound”, the ability to offer on-site installation services allowed this supplier’s customers to charge a significant premium.  A customer observed that this “allowed us to move from being a struggling company selling a commodity product to becoming a highly valued service provider”.

The third option through which a supplier can present a value proposition to targeted customers requires saying that “inclusion of our products will save you money in other areas”.  To back this claim, it is likely that the supplier will have to showcase design, engineering, new materials, business systems, sales support services, or other initiatives that “take costs out of the total system”.  Even if such improved products or surrounding services cost more than offerings from the supplier’s competitors, the supplier’s customer can remain whole or see profit improvements if they see offsetting cost savings.  One company with whom we’ve worked provides logistics services to its customers on an outsourced basis.  It noticed that one of its customers was experiencing significant levels of damage to their products during shipment.  This logistics services supplier developed a new approach to packaging, which cost more in terms of packaging materials and packaging labor time, but which more than offset these increased costs by reducing product damage levels to nearly zero.

We cite these three approaches to creating value for a customer not only because they are the only options to avoid pricing pressures, but also because they can become the basis for creative thought about how to incorporate service strategies into a customer relationship.  The “litmus test” of services options that are under consideration is describing which of these three benefits will accrue to the customers who are expected to value the services being considered.  If the answer is “none of them”, it is unlikely that the services under consideration will improve the supplier’s position with its customers.

Looking Down the Customer Chain

Identifying options that achieve one of these three contributions to value can often be difficult.  One approach that we have often found valuable is to carefully study the entire customer chain that represents the pathway from the supplier to the final consumer.  In business-to-business markets, these customer chains can be complex, with many stages.  One supplier with whom we worked faced the following customer chain: Supplier->Distributor->Installer->Consumer.

This supplier sold its product to distributors, who sold to installers, who then sold and installed the product for the consumers at the end of this customer chain.  This supplier’s products were quite visible from a cost perspective, and there was a considerable level of competition at every stage of the customer chain.  As a result, distributors’ purchasing organizations had become aggressive in seeking price concessions, using a variety of pressures – “market tests”, competitive bids, switching from one supplier to another if the price was lower, and, in the case of one distributor, an Internet auction.  Recognizing the damage that these price reductions were doing to their own business, this supplier began an aggressive search for ways to contribute value and justify reasonable prices.

The solution turned out to be rooted several stages down the customer chain, at the Installer level.  The firm learned that installers were incurring significant costs in the installation process, and often had to make repeat calls because of incorrect installation.  Such situations furthermore damaged the installer’s relationship with the consumers, lowering their chances of referrals and repeat business.  The supplier was able to identify and implement a new approach to installer services that included training programs, technical support via either an 800 number line or the Internet, and even an extended warranty given to the consumer on the supplier’s part if installation was done by a certified technician  The supplier also implemented a marketing program that identified their certified installers and facilitated finding the nearest certified installer  Installers quickly learned the value of these services, and began to view this supplier’s products as the preferred ones.  While the products themselves were essentially the same as those offered by other suppliers, the services provided by this supplier to its installers created value in two of the three ways identified above.  They helped these installers gain market share (e.g., through referrals and through the extended warranty) and they helped the installer take costs out (e.g., by eliminating repeat calls due to installation problems).

This example is one that applies in many situations.  The contributions that a supplier can make are often to remote customers, two or three steps down the customer chain, instead of to the direct customer to whom they sell.  We find this to be far more true for services strategies than for changes in product design or product technology.  Looking down the customer chain can be a fertile source of ideas about services that can create value and help a firm differentiate its position.

Become a Source of Solutions

An executive in the company that developed the installer services program described above once commented to us that “if we had just come out with a new service offering for installers, including training plus technical support plus marketing support and so forth for $x per month, we wouldn’t have been successful”.  He continued with his observations on this experience:  “At first, I thought it was successful because we bundled the services with our product, but I’ve come to believe that the reason why this has been successful is that we solved a problem for the installers.  That’s why they are rewarding us – we are solving their problem.  They didn’t have a way to create a positive and profitable relationship with their own customers.  We gave them a solution.  That’s what they are buying from us.”

We have observed this result in numerous situations.  Customers that have rejected “buying more products” and “buying more services” over and over suddenly become enthusiastic and generous customers when a supplier brings them a “solution”.  Many of the other examples provided earlier in this paper were success stories because the supplier became a solutions supplier.  The company that developed the co-op marketing program offered a solution to its customer’s problem of locating new prospects.  The company that developed the mobile installation capability offered a solution to its customer’s problem of differentiating itself from its competitors.  The company that developed a new approach to packaging offered a solution to its customer’s problem of damaged merchandise.  Probably all three of these companies would have been told “No” if they had asked “Would you like to buy some more products and services from us?”  All three heard “Yes” when they asked “Are you interested in a solution to a problem that has been giving you fits?”

One interesting dimension of these case studies is that in each case, the company that brought the solution to its customers in fact became much more of a systems supplier, taking on a broader role in terms of integrating more products and services together.  These solutions providers were able to combine products and services in a very purposeful fashion, bringing creativity and insight so that the integration yielded a benefit for their customer in the form of a solution to an important problem.  We find that the companies that view “being a systems supplier” as a means towards the end of “becoming a source of solutions” are far more effective than those who view “being a systems supplier” as the end in and of itself.

When a supplier takes on the role of “being a source of solutions”, it once again is forced to put itself into its customer’s shoes, investing in knowledge about the problems that face that customer and in developing ideas about how they can contribute to their customer’s success in the marketplace or in improving its margins.  The three options for value creation and the ability to look down into the customer chain are the means by which the supplier can think from the perspective of its customer and get to the point at which the problems needing solutions, the contributions that their customers would value, and the solutions themselves all become visible.  At this point, the supplier is well along the road to the type of strategic supplier-customer relationship in which pricing pressures are less often the defining characteristic of the relationship.

Summary

In today’s business environment, pricing pressures are the norm for business-to-business suppliers, whose customers have sharp pencils and effective tactics with which to gain price concessions.  To combat these pressures, suppliers must identify the ways in which they can transform their relationships and move into a position of strategic importance to their customers.

Often, services strategies can be an important part of this transformation, as the supplier uses such services as a tool to create value for their customer.  We have identified the three ways in which a supplier can contribute to their customer’s business success:  helping the customer grow market share, helping the customer achieve a premium price, and helping the customer to take costs out of their system.  Numerous case studies can be cited in which services strategies were the critical tool to achieve one or more of these contributions.

Successful suppliers know that they can find rich opportunities for such value-creating services contributions at every stage of the customer chain.  They must therefore systematically study their options at each stage of the customer chain, and avoid restricting their search to options involving their direct customer.  Our experiences suggest that the “service rich” opportunities are often located two or more stages down the customer chain.

With many success stories involving the integration of products and services, it is important to recognize that the key ingredient in these success stories was the fact that the integration achieved a solution to a key problem facing the customer.  Suppliers must therefore think of themselves as “sources of solutions” rather than just as “systems integrators”.  The solutions perspective once again allows the supplier to evaluate options from the perspective of their customer.

While these tools and tactics will not make pricing pressure magically go away, they will help suppliers avoid situations in which a relationship unnecessarily turns sour, and create as much value as is possible in more difficult situations.  Doing so will, at minimum, allow the supplier to sustain a “last look” at business opportunities, avoiding the churn that can be so disruptive of plans and resource utilization.

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