categorystrategy

One of the most important concepts I will discuss here is that of solutions. I believe that consumers do not buy products and services as much as they buy an end result. They buy ingredients, but they want meals. They buy a video game, but they want entertainment. Knowing what’s needed and what’s important are the keys to designing a solution that a customer will buy. Whether my job has been in sales, analysis, or channel partner management, I have been a solution designer.

The way to turn a product into a solution is to incorporate value for the customer or end-user. Here are my ideas about a value chain and how products become solutions…

If we look back to the early years of American business the scene was dominated by the great vertically-integrated empires of the day - Standard Oil, Ford Motor Co., etc. It made sense in those days to own the entire value chain from raw materials, through processing and production, to consumer interaction and sale. At every step where there could be value added, profit was accumulated. And since competitors would be frozen out at each step from entering the production chain, margins could be protected.

As modern American business evolved it began to make sense to focus on a specific portion of the production process. The global economy was taking shape and bringing in competitive sources of materials and labor. Technology and distribution channels were improving to allow for the concept of just-in-time production. And understanding of consumer behavior, along with the technology to track it quickly and accurately, enabled the more efficient and adaptable to overtake the large and integrated.

So to visualize that change let’s view it as a series of vertical bars representing the old model of vertically integrated corporations and flip it on its side to represent the new horizontally competitive marketplace. In a horizontal playing field businesses focus on a portion of the product value chain and seek to maximize their profits there through efficient operations and/or superior products and services. Picture these discrete industries as horizontal bars stacked upon each other. A vertical slice out of these stacked horizontal markets creates an end product.

For example, let’s say that a consumer wants to do some online banking. There is not an online banking product, but rather a series of individual components that enable a task. Each of those components may be comprised of smaller components. In this case, to name a few individual market segments that contribute to the production of the end-user’s online banking “product”:

A computer, comprised of a CPU and other components
An operating system
An application to interact with online content (a web browser in this case)
A service providing access to the Internet
A bank and an online banking service

We could even go through these various layers and see more individual competitive markets. In some cases there are leaders or the classic model of two or three dominant players with others relegated to niche status. At the computer component level we have Intel dominating the market for CPUs and a couple of players splitting the lion’s share of the hard drive space. The computer is assembled by a company that buys those off-the-shelf components and applies a brand. In that space Dell dominates. Why does Dell not make the components that comprise its PCs? Because companies like Intel invest in those specific markets and do it better than anyone else could.

There are a host of economic reasons why it makes more sense to buy a computer CPU from a company like Intel including barrier to entry cost, but the most important reason is that the company that focuses on doing one thing well and depends on it for survival will be a formidable competitor. A challenger stepping out of their area of expertise will usually fail in the new market against the entrenched player that must defend market position or be eliminated, and will suffer in their market of core competency due to the distraction and waste of resources competing on another front line.

There is also a cost benefit as each level of component becomes better and cheaper. Look at each horizontal market in this layered example and you will see competitors putting pressure on the leader. The end game for this competition is commodity status. At that point the differentiating factors no longer matter and price approach the cost of manufacture. Or put another way, profit margins approach zero.

Traveling up the value chain we see the same commoditization pressure at each step and varying levels of success against it. We might have a Dell PC with an Intel microprocessor running a Windows operating system and Microsoft’s browser, connected to a DSL line or cable modem for Internet access, and finally interacting with an online banking site. Most people don’t see much competition in the operating system they use. Although there is healthy competition in that market it remains on the periphery. Web browsers are in almost exactly the same situation with Microsoft dominating. The Internet connection is a completely different story. Consumers buy their Internet access for a variety of reasons including availability, price, convenience of billing or installation, and simple inertia of incumbency. The pipe that moves the bits seems very close to a commodity and consumers can be enticed to switch providers with economic enticements or perception of improved service. The barrier to entry keeps additional providers out of the market and leaves the two incumbents of the phone company and the cable company to fight for residential broadband customers. Banks are in a different competitive situation where they have to compete on service, but also benefit from customers’ reluctance to switch to competitors. They are in a way entrenched commodities - there is little to entice customers to deal with the hassle of switching banks.

Step back from the model and you can visualize an epic struggle by the leader(s) in each horizontal market to add value and create differentiation. I have worked in three industries where this particular pressure was intense - packaged foods, networking equipment, and telecommunications. From a marketing perspective there are many methods to create differentiation among products under commoditization pressure. I won’t speak directly to that. What I will focus on is the integrated solution.

At some levels of our online banking example there are thriving market dominators. How do they do it? Let’s look at Dell first. Dell is a component assembler, and a PC market and distributor. It does compete on price, but it does so through operational excellence, as opposed to simply tolerating the greater pain of lower margins. Dell led the market to a new distribution method, first via the phone then online, and in turn served its customers better while taking significant cost out of the final product. The entrenched competitors when Dell began all utilized a two-tiered sales model where computers where assembled and then sold by others. This model had an extra step in the value chain, the reseller, which had to share in the profits. Dell eliminated this extra step, which gave that portion of the profit back to them. Dell thus integrated another vertical step in the horizontal value chain model to become more competitive.

At Kraft Foods we faced commoditization pressure in every category and every product. Marketing and brand power could overcome some of that pressure and allow for a premium price point but eventually it would become eroded by determined competitors. Ask yourself how much more you are willing to pay for Kraft branded cheese vs. a store brand. If you don’t pay much attention to cheese you might first think the brand alone would allow for very little price premium. But the category is very broad. Kraft has retained its dominant position in packaged foods through product innovation as much as through marketing. A brick of sharp cheddar comes from milk and has little room for differentiation. But processed cheese slices involve technology, process, and capital investment to produce. If you bit into a grilled cheese sandwich made with processed American cheese slices that were made cheaply with more oils instead of milk you would be unhappy. Manufacturing and more expensive ingredients make a difference. Kraft innovates by extending existing categories and creating new ones. It took small pieces of its Kraft cheese and Oscar Mayer lunch meets and created a packaged product called Lunchables. This quickly became a billion dollar business and invited a wide range of competitors. Kraft had integrated value from another part of the value chain into its product with Lunchables. In this case it was the convenience of assembling a little meal into the packaged product.

The pressure on the entire packaged foods industry, especially the so-called center of store, is food prepared away from home. This includes restaurant meals and prepared packaged foods found in the supermarket deli and other places around the perimeter of the store. The preparation is a separate component of the value chain. Kraft Lunchables took the core products of cheese and lunch meat, both under commoditization pressure, and reached up into the next layer of the value chain to integrate the value of preparation into their product. In the vertically integrated model of the American economy of the early 20th century Kraft would run its own company stores and restaurants to get the value from the food, the preparation, and the service. In the new horizontal economy Kraft focuses on its strengths of product differentiation and operational efficiency while integrating value from other layers of the value chain model where possible.

Doing this successfully is the way to create a solution from a product. In the telecommunications industry there is tremendous competition for the basic circuits that enable voice and data traffic. Customer service and branding cannot overcome the commoditization pressure. The way to create success is to integrate business value to product offerings and turn them into solutions. This the role I am in right now and I will explore how I work to create that customer value within my portfolio of products in later posts.