CEOs of large companies often tell us that it is difficult to increase profits naturally. They think that it is only a matter of time before they are attacked and taken over, so they try to get stronger by expanding their business.
That kind of thinking is ludicrous—and strategically myopic. A company that is a market leader can increase its growth by using the data it already has about its customers. This data includes information about every type of customer.
Companies should focus more on customer segments rather than on products and territories in order to be successful
As a market leader, you should always be aware of potential threats and be prepared for them. The advantage that an incumbent has over its challengers is largely untapped and much bigger than any attacker.
The advantage to having your own business is that you should have a better understanding of the needs of your customers than anyone else. This is because you have a closer relationship with them and know them better.
In order to better serve your target demographic, it is important to understand how profitable it is to do so. By Investing resources into understanding and retaining them, you will be in a stronger position to do so.
Third, knowing the needs and profitability of your customer segments is more important than the features and functions of your product because it is harder to imitate.
In Order To Take Advantage Of the Situation, You Need To Change Your Way Of Thinking
You should base your strategy on customer segments that have specific needs, rather than on products or geographical areas. Your accounting system should show how profitable each segment is.
The system should not see sales, marketing, service, and R&D as costs that need to be the same for every customer, but as investments that will help increase profit for the most promising customer groups.
When an invader takes over a business, they target groups of customers that are easily taken advantage of. It may be beneficial to prospect for gold in uncharted areas as opposed to staying on your own territory.
This text tells how to build on what a company already has to maintain its leading position, using CEMEX as an example.
It demonstrates how successive refinements in customer-needs segmentation clarify sources of profitability, creating a virtuous circle in which the incumbent makes ever more targeted investments of scarce corporate resources that simultaneously increase profits and raise entry barriers for potential invaders.
Then we explain how to systematically create a customer-centric information base.
We also explore how to organize business units so that they focus not on products but on the customer segments and subsegments where opportunities for your company, as well as for current rivals and would-be disrupters, truly lie.
Extracting Gold From Concrete
An advantage that the current person in office has that few other people or companies use, is very powerful. Most businesses that do use it are ones that sell to consumers, for example Best Buy, Royal Bank of Canada, and Harrah’s.
CEMEX, a producer of commodity building materials, might be an unlikely candidate for our approach, but our research shows otherwise.
Zambrano, from a regional cement company to a global powerhouse A lot has been said about how well CEMEX has been doing since Lorenzo H. Zambrano became CEO and turned it from a regional cement company into a global powerhouse. A regional Mexican cement manufacturer has become a global behemoth.
Although it is not fully understood, CEMEX has found ways to make more profit by figuring out what their customers need and making decisions based on expected returns from different groups of customers.
The main reason CEMEX is now the world’s largest producer of ready-mix concrete is because it is efficient.
The company’s owners, therefore, have a clear economic incentive to bring the technology to market The company that developed the additive has a clear economic incentive to bring the technology to the market because it allows the company to produce a more durable and lower-cost product than its competitors.
More Additives Make Concrete Cheaper And Stronger
But there’s a trade-off: More additive makes the concrete less “workable” (that means it’s harder to prevent air pockets from forming in cavities where the concrete is poured, and the overall construction process takes longer).
Many offerings have trade-offs that the customer has to consider. The more cream and sugar a dairy puts in its ice cream, the more fat and calories it will have. However, it will also have a better flavor and texture.
Trade-offs like these are opportunities for differentiation. However, in our example, Mix C-Ment would not be able to find them because its way of thinking is based on traditional cost accounting.
The company tracks expenses associated with the production of different types of ready-mix concrete in a traditional product-oriented way.
The company does not keep track of data that would distinguish one customer from another, or information on sales, marketing, and other investments made with specific customers in mind.
Mix C-Ment, as the market leader, prices its products according to classic economic theory by taking into account the cost of production and the relationship between price and demand for the average customer.
A single good is priced to sell to the broad market. The table below shows that concrete containing 15% additive would generate a demand of 280 tons and yield the greatest profit: $60. (See the exhibit “Using Traditional Accounting to Sell Concrete.”)
An issue Mix C-Ment is having is that its executives are unsure of why customers would want a certain mix of products at a given price.
The company does not strive to give customers the most value for their money, or invest in ways to improve customer satisfaction.
1. Profiting From Marketing Investments
Mix C-Ment has not accounted for how it will serve its customer base beyond its current product offerings. The company is allocating its marketing, service, and other fixed costs to its two segments according to how many tons are sold.
What if the company spends an additional $40 on research to determine the specific marketing services that each customer segment requires? The strength seekers are content with paying the original price for the concrete that meets their requirements and only need minimal marketing assistance.
It is a waste of money to spend $200 on marketing for that particular group. New research shows that people who are looking for work need more support in marketing themselves so that they can get better construction bids. What’s more, they’d be willing to pay for it.
If Mix C-Ment relocated $100 worth of resources from those who are searching for a way to improve to those who are looking for a way to make the product workable, they would earn a $120 profit, even though they would have to spend $80 on customer research.
Since it hones in on specific clientele desires, Mix C-Ment’s outlook on marketing support goes from being an unproductive expense to a worth-while investment that benefits both the customer and the enterprise.
Would-be attackers who only see the price and features of Mix C-Ment’s products, and not its customer research, will have a hard time understanding why workability seekers are much less responsive to lower-priced offerings.
2. Voicing The Business-Building Imperative
Many executives at companies that have been around for a long time say that it feels unnatural and risky to try to build new businesses. Some people are skeptical that their workplaces can improve beyond long-standing methods and ways of thinking.
Many executives think it’s wiser to invest in more familiar places because the failure rate for startups is so high.
CEOs of established companies must advocate strongly for building new businesses, even when faced with arguments against it.
It’s their responsibility to make sure businesses are creating new ways to reach customers and are growing profitably.
Investors constitute the most important audience for such messages. CEOs must be able to show that the company’s investments in new businesses will be more successful than investments in other growth opportunities.
In order to make a strong argument for business growth, CEOs need to be honest about how much money new businesses will need (which can be up to $100 million) and how long it will take to become profitable (usually 3-5 years).
Although it takes longer to see results, organic growth typically generates more value than acquisitions.
A CEO should keep investors updated on how the company is doing and remind them that it takes time for improvements to be seen.
Internal stakeholders matter, too. The CEO needs to keep business-unit and functional heads informed and involved so that new businesses can benefit from the parent company’s assets.
One CEO decided that to grow, his company should enter the market for Internet of Things (IoT) products.
He realized that his company was not able to develop products for the Internet of Things, so he decided to create new businesses that could innovate quickly. The CEO wants business-unit and functional leaders to take the business-building effort seriously.
The company’s CEO allowed the leadership team to ask for help from executives in the main part of the company when they launched their first IoT venture. They also promised to get involved if any executives were slow to help the team. The CEO supported the team, allowing them to quickly release a minimum viable product.
3. Powering Up New Businesses
New businesses that are built by existing businesses can gain significant advantages from the parent company’s funding, customers, data, intellectual property, technology, and other assets.
This bank is helping new businesses by letting them market to the bank’s existing customers with the help of the bank’s employees.
To create the most advantages, big companies should let their new businesses choose which assets of the parent company will be most beneficial to them and allow them to use those assets with few conditions.
Making a relationship between a parent company and a new business can be difficult to do while still maintaining a balance. Once employees from the parent company start supporting a new business, they often try to make the new business conform to the larger organization’s standard processes and ways of working.
Although established conventions can provide guidance for new businesses, they can also limit their productivity.
In our experience, businesses owned by large companies often fail because of bureaucratic interference and the company’s refusal to invest its assets into the business.
Helper message: This is suggesting that executives should not try to force new businesses to operate like the existing business. It is more effective to keep them separate from the parent company’s processes and requirements.
One way that incumbents maintain their edge is by establishing new businesses as self-contained entities that are relatively autonomous, with their own leadership teams, governance mechanisms, management practices, and talent environments (including career paths and rewards).
This can be done by allowing new businesses to be independent from the parent company’s planning and budgeting cycles.
Instead of making new businesses compete with core divisions for funding, companies can set aside money to invest in new businesses and give them money when they reach certain development targets, as we will discuss below.
BP set up Launchpad to commercialize technological innovations created by BP’s R&D department.
The new businesses are based in a separate office from Launchpad, and they work with representatives from different BP functions. These representatives help the new businesses by using their relationships within the company to get them access to things like customers.
4. Sustaining Momentum
It is not as risky for an established company to sponsor something that will cause growth, like extending product lines or introducing products to new markets.
Starting a new business is riskier than continuing an existing one, but it can also be more rewarding. The best way to approach this is with different organizational structures in place to support the new venture.
A team that is dedicated to repeatedly building new businesses is required to evaluate different business ideas, choose which ones they want to support, find leaders for the new businesses, and oversee their development.
These responsibilities include making sure that the founders of new ventures test their assumptions and discontinuing ventures that are exposed to unmanageable risks.
The business-building teams that are the strongest include people from outside of the company who have experience leading and building startups, executives from the company who can help new businesses use the company’s assets to their advantage, and specialists in fields like design thinking and software development who can help until the new businesses are large enough to support themselves.
The people who are successful at keeping their jobs also give their teams the power to make the new business grow as they see fit, as long as they check to make sure their ideas are correct and fit in with what the main company is trying to do.
After realizing that the software platform was lacking direction and support from the dozens of engineers working on it, the executives at the industrial-products company decided to bring in a new leadership team.
The company’s senior management team put together a team of experienced entrepreneurs from both outside and inside the company. The team members were chosen for their ability to work together and their experience with the company’s related divisions, such as finance, operations, and IT.
The industrial company created a separate legal entity for the new business, which gave the new leadership team more flexibility to define the new business’s market, sharpen the product concept, and accelerate product development.
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