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THE TWO BEST CONSULTANTS IN THE WORLD

by Donald V. Potter

Many CEOs and top managers use consultants to help them make the tough decisions. But these people may be ignoring the two best, and cheapest, consultants a company has - its customers and its competitors.

It is common for a CEO to seek outside counsel when evaluating his company's situation. Most often he seeks the counsel of other CEOs during a board meeting or a round of golf. Fellow members of the CEO club are generally trustworthy, experienced, and willing to offer their advice gratis. Sometimes a CEO will ask the advice of outside professional consultants, whose services are most definitely not gratis but who are also trustworthy, experienced, and professional.

Often overlooked, though, are two of the most important consultants to top management. They are neither CEOs nor professional advisors. Yet, these two are the very best in the world at what they have to offer.

Why are they the best? They are convenient, cheap, and absolutely trustworthy. They are available to every company, regardless of size, industry, product line, or market. There is no time limit on the usefulness of what they say; in fact, their advice grows more valuable over time. And, most important, they are never wrong.

Who are these two? One of them is the customer; the other is the competitor. The customer informs a company about the value of a product, while the competitor is an authority on the company's costs. For a company to succeed, it must win on both value and cost. The information a company can obtain about its relative value (from the customer) and its relative costs (from the competition) is the most important evaluative information a CEO can have.

VALUE AND THE CUSTOMER

Value has two components - performance and price. Performance includes the features the company offers to solve a customer's problem, the reliability of the solution compared to other solutions, and the convenience with which the customer can acquire and use the solution. A company is a leader on value when its sales grow faster than the industry's average. This happens when its product offers either better performance or lower price.

The problem with value is that a disinterested party is needed to define it. Value is a relative term. It has meaning only in reference to some other company's product or service.

The counsel a customer offers a company is expressed through the medium of dollars. When a company offers its customers high value - defined as good performance for the price - the customers buy more of the company's products than those of its competitors. Over time, the company sees these decisions translate to high relative sales growth, increases that outpace the industry. Real leaders grow faster than their industries by maintaining a consistent value advantage in serving customers.

Federal Express is an example of a company that leads with value. It has enjoyed sales growth nearly six times that of the air freight industry as a whole. Similarly, customers have communicated their decision in Ford's Taurus and Sable models. Customers are buying more of these cars than they are buying competitor's products, thereby telling Ford that they approve of the value offered by the Taurus. General Motors is getting the opposite message again and again from its customers, as GM's market share declines.

The Howard Johnson's restaurant chain was once known for good value, and the HoJo's orange roof became a ubiquitous part of the U.S. landscape. Then, management started paying too little attention to performance and concentrating on containing costs to keep prices low. Competitors such as Denny's improved menus and tailored foods to local markets, while most HoJo restaurants offered inexpensive but dull food with poor service. By 1985, customers were giving Howard Johnson's management some very stern advice. The average HoJo's site had unit sales that were dead last in its industry - less than 70 percent of the sales of the average Denny's outlet. That same year the company was broken up.

A similar example of the edge performance holds over price comes from the recent experiences of the Yugo and Excel automobiles in the mini-car segments of the auto industry. Both cars appeared in 1986. The Yugo landed on our shores as the least expensive automobile sold in America, with a price of $3,995 per vehicle. At that price it made a big splash, selling 36,000 cars. Despite the Yugo's small engine, uncertain reliability, and somewhat dated styling, the car was a hit because of its low price. But if the Yugo caused a splash, the impact of the more expensive Hyundai Excel was the equivalent of a tsunami. Priced at $5,000, the Hyundai was at the low end of the mini-car market. But it came with features unavailable even at the high end of the market: a large engine, more comfort, and unusually good warranties. The Excel sold nearly 170,000 cars in 1986 and more than 260,000 in 1987.

" When it comes to making a determination on value, the customer's opinion is the only one that matters. No one else counts because no one else pays."

PRICE

Does the Excel example mean that customers don't care about price? Absolutely not. Price counts for much - after we have taken care of features, reliability, and convenience issues. We become price-sensitive only after we have satisfied ourselves that we do not see any significant performance differences among our alternatives. Once we reach that point, then price differences govern our decisions.

Family Dollar Stores' experience shows how price can become important. This successful Southeastern discount chain was opening more than 100 new stores a year. But as the company expanded rapidly, customers began discovering that prices on some products, such as health and beauty items, were 10 percent more than those of a major competitor, Wal-Mart. Wal-Mart offered at least equal performance to go with its lower prices. Value had slipped, and customers announced their opinion loud and clear. Sales growth fell from 9 percent in 1984 to 2 percent in 1985. Fortunately for the company's shareholders, Family Dollar's management listened to its consultants, the customers. The company cut prices and is now regaining some of its lost sales growth.

When it comes to making a determination on value, the customer's opinion is the only one that matters. No one else counts because no one else pays. A CEO can obtain a wide range of opinion from within his organization about the relative value of his company's products. He can also obtain opinions from outside advisors. But only the customer is objective, because the customer doesn't care about the company or the CEO. Customers are the best consulting diagnosticians of value because they buy what is best for themselves at a price that strikes them as fair relative to direct and indirect alternatives.

COSTS AND THE COMPETITION

The second half of the world's best consulting team is the competition. Competitors provide invaluable advice on how effectively a company manages its costs. The competition expresses this through relative profitability, measured by return on investment.

Returns begin with prices. Prices are set primarily by the competition. Since prices must be high enough to keep all needed producers in the market, they are established by the high-cost producers. Prices end up high enough to keep high-cost people producing, but low enough to discourage other potential producers from entering the market. The customers' view of value is then conditioned by the prices required to cover the marginal costs of high-cost competitors.

The world oil market today illustrates this principle. In the latter half of 1987, a high oil price would have been $22 a barrel. In 1980, a high price would have been $37 a barrel. Between 1980 and 1987, low-cost producers, most notable OPEC, expanded production. At the same time, high-cost producers, especially some U.S. domestic onshore stripper wells, were gradually squeezed out of the market by the steady fall in prices. Prices are set today by the costs of the remaining domestic stripper wells - the high-cost producers - while the low-cost producers realize the highest returns.

The price a customer pays for a product indicates the product's relative value and creates a flow of revenue. The revenue that price yields must cover all the costs of the product, including the carrying costs of capital employed (otherwise recognizable as interest on debt and net profits). Debt interest and net profits are what is left over after operating costs are subtracted from revenue. Thus, the company that has more left over as a percentage of its investment, compared with its competition, has managed its costs better. The lower the company's costs, relative to competitors, the higher will be the company's relative profitability and return.

The competition offers the CEO advice that is different from what the customers offer. Customers may say a company's value is high; competitors can attest to its low cost structure. IBM and Cray both dominate segments of the computer industry. IBM commands 90 percent of the mainframe business, while Cray sits on top of about two-thirds of the market for supercomputers. Customers have declared the value offered by these competitors to be very high. And the unusually high returns IBM and Cray earn in those markets are eloquent testimony to the low cost structures both companies have achieved.

But competitors can also reach conclusions opposite those of customers. Customers can affirm that value is high at the same time that competition declares the cost structure to be excessive. Pan Am's year-old experiment with a shuttle service in the Northeastern corridor has gained good market share but given the company low returns.

In another instance, the long-distance network at GTE Sprint has drawn rave reviews on value. The company's fiber-optic system and low pricing turned it into the fastest-growing national carrier and a real challenger for second place in the industry. Sprint's competitors have reached a more somber conclusion about the company's situation, though: costs are too high. The company has endured a sustained period of substantial losses.

The Tandon family of personal computers ran into a similar problem in 1986. The company offered an IBM-compatible family of computers at substantial discounts to the IBM standard. The products gained share but lost money. Growth better than the industry average accompanied by low returns have also characterized the personal-computer families of AT&T, ITT, and Zenith at one time or another. Customers said value was quite high, but competitors said costs were too high for the value offered.

Competitors in service businesses can send messages just as clearly as those in manufacturing businesses. The credit card market of 1987 produced returns on equity in the neighborhood of 40 percent - extraordinary high for any industry. The market is growing faster than low-cost entrants can expand, so prices are very high, creating the high returns that attract new entrants. The retailing giant, Sears, liked what it saw in the market and entered about two years ago with the Discover card. Customers liked the new card. Sears started out by offering it for free, and may keep it that way. Sears rebates up to 1 percent of purchases, in cash, to users, and offers a savings account feature attached to the card that has yielded $400 million in deposits in large accounts. The card is not carried by more than 13 million people.

So far, so good. But competition is sounding the alarm. The card has lost money in the first two years of its existence. At least part of these losses have been caused by substantial introductory costs. Still, with returns so high in the credit card market, the losses with the Discover card suggest that Sears' biggest challenge will be to establish itself as a low-cost provider before the growth of Visa, MasterCard, and (possibly) American Express catch up to the growth of the entire market and prices begin to be depressed.

Customers and competitors do not always say the same things. Their messages must be taken in tandem to be fully understood - and when their voices are heeded, there is no more valuable counsel available to a CEO.

"Reprinted from Business Horizons, September-October 1988 issue. Copyright 1988 by Indiana University Kelley School of Business. Used with permission".

(Note: This Perspective was written in the context of the economy in 1988. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)

 

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