Kogan Page - Business Solutions on Demand - Transform the Business to Deliver Real Customer Value docx

A business design provides a blueprint for the acquisitionand development of capabilities, enablers and the customer interface needed to create and deliver customer value.New business de

Bu sin e ss Solu t ion s on D e m a n d: Tr a n sfor m t h e Bu sin e ss t o D e liv e r Re a l Cu st om e r V a lu e

Kogan Page © 2004

This motivational and fast-paced book emphasizes that for businesses to compete and survive, they have to exceed customer expectations The book shows how companies can increase sales and improve margins by introducing a range of solutions.

Ta ble of Con t e n t s

Business Solutions On Demand—Creating Customer Value at the Speed of Light

Foreword

Chapter 1 - Business Strategy and Transformation

Chapter 2 - Transformation in Food Retailing

Chapter 3 - The Low-Cost Business Model

Chapter 4 - The Solutions Business Model

Chapter 5 - Transformation in the Information Technology Industry

Chapter 6 - Industries transforming

Chapter 7 - Business Innovation

Chapter 8 - The Business Innovator

Chapter 9 - Solution Creation and Delivery

Chapter 10 - The Customer Relationship Manager

Chapter 11 - Solution Marketing

Chapter 12 - The Industry Marketing Manager

Chapter 13 - Knowledge Management

Chapter 14 - The Knowledge Manager

Chapter 15 - Business Design

Chapter 16 - Change Management

Index

List of Figures

List of Tables

Bu sin e ss Solu t ion s on D e m a n d: Tr a n sfor m t h e Bu sin e ss t o D e liv e r Re a l Cu st om e r V a lu e

Kogan Page © 2004

This motivational and fast-paced book emphasizes that for businesses to compete and survive, they have to exceed customer expectations The book shows how companies can increase sales and improve margins by introducing a range of solutions.

Ta ble of Con t e n t s

Business Solutions On Demand—Creating Customer Value at the Speed of Light

Foreword

Chapter 1 - Business Strategy and Transformation

Chapter 2 - Transformation in Food Retailing

Chapter 3 - The Low-Cost Business Model

Chapter 4 - The Solutions Business Model

Chapter 5 - Transformation in the Information Technology Industry

Chapter 6 - Industries transforming

Chapter 7 - Business Innovation

Chapter 8 - The Business Innovator

Chapter 9 - Solution Creation and Delivery

Chapter 10 - The Customer Relationship Manager

Chapter 11 - Solution Marketing

Chapter 12 - The Industry Marketing Manager

Chapter 13 - Knowledge Management

Chapter 14 - The Knowledge Manager

Chapter 15 - Business Design

Chapter 16 - Change Management

Index

List of Figures

List of Tables

Ba ck Cov e r

Based partly on IBM’s own transformation, and partly on the transformations that IBM has helped its clients to achieve, this ground-breaking book shows how companies can increase sales and improve margins by introducing a range of solutions.

It draws upon IBM’s highly readable and fast-paced, Business Solut ions on Dem and emphasizes that for today’s business

to compete and survive, it has to exceed the expectations of its customers.

With contributions from a host of

why corporations need to provide business solutions to stay competitive;

why business customers want to buy solutions;

what it takes to move from supplying products and services to creating and delivering solutions;

how you can learn from the experiences of leading suppliers of business solutions.

Business Solut ions on Dem and will be a stimulating read for all business leaders, sales and marketing professionals and all those committed to improving business performance If that sounds like your business agenda, make sure this important book is top on your reading list.

Abou t t h e Au t h or s

Mark Cerasale is a Senior Consultant in IBM’s Business Consulting Services division He specializes in customer

management, e-business and solution transformation, helping clients to improve business performance through

innovation, operational efficiency and customer loyalty.

Mark’s consulting experience covers many sectors, including automotive, chemical and telecommunications, electronics and IT For several years he was responsible for managing IBM client relationships and providing some of the world’s most successful companies with information technology-enabled solutions Mark, together with Merlin Stone, has co-authored several articles and management briefings, and has contributed to many white papers and books.

Merlin Stone is Business Research Leader with IBM’s Business Consulting Services division, where his role combines consulting and marketing with the development of business research partnerships with IBM’s clients and partners and various universities He runs he IBM Marketing Transformation Group and is a director of The Database Group Ltd, as well

as Qci Ltd, an OgilvyOne company that specializes in customer management consulting His consulting experience covers many sectors, including financial services, utilities, telecommunications, travel and transport, retailing, automotive, energy and IT.

Merlin is also the IBM Professor of Relationship Marketing at Bristol Business School and the author of many articles and over twenty books He is a Founder Fellow of the Institute of Direct Marketing, a Fellow of the editorial advisory boards of several key journals The CIM recently selected Merlin as one of the world’s 50 leading marketing thinkers He has a first- class honours degree and doctorate in economics.

Business Solutions On Demand—Creating Customer

Value at the Speed of Light

Mark Cerasale and Merlin Stone

London and Sterling, VA

Publisher’s note

Every possible effort has been made to ensure that the information contained in this book is accurate at the time ofgoing to press, and the publishers and authors cannot accept responsibility for any errors or omissions, howevercaused No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result

of the material in this publication can be accepted by the editor, the publisher or any of the authors

First published in Great Britain and the United States in 2004 by Kogan Page Limited

Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted underthe Copyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, inany form or by any means, with the prior permission in writing of the publishers, or in the case of reprographicreproduction in accordance with the terms and licences issued by the CLA Enquiries concerning reproductionoutside these terms should be sent to the publishers at the undermentioned addresses:

The right of the IBM Corporation to be identified as the author of this work has been asserted by them in

accordance with the Copyright, Designs and Patents Act 1988

ISBN 0 7494 4172 0

British Library Cataloguing-in-Publication Data

A CIP record for this book is available from the British Library

Library of Congress Cataloging-in-Publication Data

Cerasale, Mark Vincent, 1969-Business solutions on demand : creating customer value at the speed of light / MarkCerasale and Merlin Stone. 1st ed

To Stefania (my wife), Vincent and Jillian (my parents) and Lisa (my sister) Mark Cerasale

To my wife Ofra and daughters Maya and Talya Merlin Stone

Author profiles

Mark Cerasale is a Senior Consultant in IBM’s Business Consulting Services division He specializes in customer

relationship management and business transformation For several years Mark worked as a Client Manager,providing IT-enabled solutions to some of the world’s most successful companies As a consultant he has helpedmany clients to improve their business performance through solution transformation Please visit markcerasale.comfor more information

Merlin Stone is Business Research Leader with IBM and a director of QCi Ltd and The Database Group Ltd He is

a Founder Fellow of the Institute of Direct Marketing, a Fellow of the Chartered Institute of Marketing and is on theeditorial advisory boards of many journals He is IBM Professor of Relationship Marketing at Bristol BusinessSchool and a prolific author with 25 titles to his name

List of contributors

Julie Adams is a Managing Consultant in IBM’s Business Consulting Services division She specializes in

organizational change management and organizational development Over the last 10 years, she has developedparticular expertise in working with companies to get the best results from large scale business change

programmes, whilst minimizing impact on day-to-day business

Alan Clark is a Management Consultant in IBM’s Business Consulting Services division He focuses on delivering

business-tobusiness sales force improvement solutions In recent years he has worked with many internationalcompanies where a key factor in sales productivity improvement has been the shift away from traditional productselling

Howard Cox is Professor in International Business History at the London South Bank University Professor Cox

recently led a two year Leverhulme Trust funded project with Simon Mowatt and Martha Prevezer investigating

technology and industrial change He has published widely, including articles in Business History, The Business

Economist and the OUP book on the history of BAT, The Global Cigarette.

Lucia Cuttle is Automotive Marketing Manager with IBM’s Industrial Sector division She is responsible for

marketing IBM’s products, services and solutions to the automotive industry across Europe, the Middle East andAfrica

Bryan Foss is Customer Insight Solutions Executive within IBM Financial Services Bryan works with retail banks,

insurers, financial markets and other financial services companies globally Bryan is a joint author of four other

publications with Professor Merlin Stone, Fellow of the Chartered Institute of Marketing, IT editor of the Journal of

Financial Services Marketing and is a frequent presenter at business conferences around the world.

John Griffiths is a Client Executive in IBM’s Sales and Distribution division He has over twenty years experience

in selling and implementing complex IT solutions and services in the industrial sector As a management consultant

he has advised many major international companies on their Customer Relationship Management (CRM) strategy,knowledge management and IT strategy to support their transition from product to solution businesses

Simon Mowatt is Senior Research Lecturer at Auckland University of Technology and Visiting Fellow at the Centre

for International Business History at the University of Reading His interest is in technological change, business

networks and industrial transformation Simon has published in journals such as Industrial and Corporate Change and Industry and Innovation.

Martha Prevezer has worked at NEDO, London Business School, the Bank of England, South Bank University and

is currently at Birkbeck College She has published widely on biotechnology and has coauthored several books

examining the role of clusters in economic development.

Glenn Taylor is a Client Executive in IBM’s Sales and Distribution division He has 30 years experience in the IT

industry, of which he spent 14 in a sales role, and has applied his skills in large enterprises as well as start-ups

Abigail Tierney is the EMEA Marketing Manager for the Strategy and Change Practice within IBM Business

Consulting Services She works with consultants, customers, academics and influencers to drive business valueand deliver thought–leadership marketing

Kevin Wheatly is the Learning and Knowledge Industrial Sector Lead within IBM’s Business Consulting Services

division in Europe, the Middle East and Africa He is responsible for improving Knowledge Management andLearning across the Industrial Sector practice He has worked for IBM for over five years in various KnowledgeManagement roles both internally and assisting IBM clients

Overview

I wonder why you have chosen to look at this book Maybe you, like me, have begun to sense important changes inthe way that some buyer–seller relationships have developed The growing dominance of the customer is

provoking new and radical changes in business relationships: the growth of virtual businesses, networks of

alliances and new, complex, long-term partnerships between suppliers and customers If you see this in your ownbusiness or industry and want to understand more about what it takes to exploit this change effectively, I believethis book will help you

It shines a light on this new and changing world – where the boundary between one organization and anotherbecomes ever more complex and where what is deemed valuable migrates away from products and even servicestowards solutions and experiences The era of a mass-customized service – blending industrial economics andscale with bespoke outcomes – has begun It is a world where we in IBM have already staked out a leading

position and one we believe passionately will continue to develop in market after market

This book breaks new ground It is an exposition of how companies moving down this road work to transform bothwhat they and what their customers do Maybe you see this phenomenon as nothing new – a mere shift in thedivision of labour between supplier and customer

Maybe you see this as fundamentally no different from the ancient mercenary soldier or, in recent times, thechanging services of accounting, recruitment, marketing, communications, customer service businesses and manyothers I see the scale and economics of this trend as something different – not merely activity substitution but thetransformation of the commercial model

Making this kind of jump in a business is tough Many know this from their own bitter experience For as suppliers,the continually changing requirements for staff skills, technology, commercial approach, financial management andprogramme structure combine with the challenge of managing totally new economics during transition Business-as-usual management approaches do not succeed, and new approaches are needed to make the change quicklyand successfully

If you are considering making this change, then this book is for you It is not a recipe, nor even a menu It is more

of a guide – to the journey towards more effective and efficient, intensely partnered relationships

I hope that it stimulates your thinking and, encourages you to be bold, and, if you are already on the journey, that itgives you ideas that enhance your speed and direction Finally, I hope that it makes you think deeply about whatyou need to do to give your people and partners a more exciting and acceptable journey

I wish you success

Rod Street,

Partner, IBM Business Consulting Service

We would like to thank the following people for their support and contributions during the creation of this book: PaulClutterbuck, Iain Devine, Bryan Foss, Rod Street, Phil Walker, Jane Ashton, Maikel Vlugt, Alan Flack, Rob Smith,Anthony Marsella, Kevin Bishop and Julie Abbott

We also want to thank the many IBM clients whose experience of transformation we drew upon in writing this book

We are all learning together

Chapter 1: Business Strategy and Transformation

Mark Cerasale

INTRODUCTION

Managing a successful company is tough The pressures are greater than ever Satisfying the often conflictingneeds of customers, shareholders and employees has never been more challenging Increased competition andunpredictable change mean it is no longer enough for business leaders to maintain a steady hand on the tiller Tosucceed, they must plot a course, sail rough seas, explore uncharted waters and be prepared for the unexpectedalong the way

Business strategy is about deciding what to do It requires more than best-practice benchmarking, cost-reductioninitiatives and one-off process re-engineering These are often focused on operations Business strategy is

grounded in a vision of the future and is oriented towards innovation and growth Only when you know where youare trying to reach can you work out how to get there A business design provides a blueprint for the acquisitionand development of capabilities, enablers and the customer interface needed to create and deliver customer value.New business designs are emerging

Today’s business environment

Powerful forces such as globalization, deregulation and greater access to capital transformed business during the1980s and 1990s New management approaches, information technology, the Internet and increasing customerpower have altered the competitive landscape for ever Customers are more demanding: some want lower costs,others want solutions Markets have become saturated and competition in many industries is intense Today,industries are converging and change is unpredictable Many products and services are similar, perhaps

commoditized To succeed, companies must innovate, grow and reduce costs simultaneously

The economic growth of the late 1990s ended with a downturn in most economies The new economy of continualgrowth was short-lived After 2000, expansion plans were put on hold Cost-cutting started The events of 11September 2001 and the subsequent explosion of global terrorism changed the geopolitical landscape As if thingswere not complicated enough, a string of corporate scandals undermined the public’s trust in private enterprise andincreased demands for greater inspection and regulation

BUSINESS LEADERS FACE INCREASING PRESSURE

Nowhere is the pressure for better performance greater than at the very top According to a survey carried out byconsulting firm Booz Allen Hamilton, ‘Companies are setting higher standards of performance for chief executiveofficers than ever before, and CEOs are falling short in record numbers.’ Charles Lucier at Booz Allen Hamiltoncommented, ‘Business leaders are enduring scrutiny and pressure unseen since the Great Depression… There is

no longer any safe haven for chief executives who can’t deliver superior results.’ [ 1 ]

Today the symbiotic relationship between companies and their communities is better understood Many businessleaders would concur with the view expressed by Lou Gerstner, former chairman and CEO of IBM: ‘[C]orporationssucceed only if they operate in a healthy and vibrant society They need the communities where their customersand employees live to be strong, as much as they need successful research, planning and advertising Contributing

to their communities is, therefore, good business, too.’ [ 2 ]

The Internet enables charities, environmental groups and communities of consumer interest to come togetheracross the world and has increased their power Today, environmental issues influence political, economic andcorporate policy-making Some of the world’s largest oil companies are reinventing themselves to stay in tune withpublic opinion They are changing their brands, adapting their business designs, executing new strategies andinvesting in new markets such as renewable energy In the future, pressure from future generations may causemore change in industries deemed to be environmentally or socially ‘unfriendly’

Tough new legislation relating to the disposal and recycling of consumer goods, such as refrigerators and cars, hasforced manufacturers to redefine their product life cycles Sophisticated buyers are beginning to question the need

to own products at all There is more demand for services According to environmentalists Paul Hawken and Amoryand Hunter Lovins, ‘mere product-sellers will become suspect Why – a prospective buyer may ask – if your

product delivers its service with all of the operational advantages you claim, don’t you want to capture those

advantages for yourself by owning the product and just providing me with its service?’ [ 3 ]

markets, customers, capital and business talent

Today, competition has increased and change is unpredictable Success depends more on agility and focus.Customers are more demanding and companies must ‘sense and respond’ to their needs New technologies such

as the Internet allow companies to come together in value networks, where scale is less important In the past,assets and managerial structure were added to support growth In the future, networks of companies will cometogether to innovate and create growth A network economy is emerging in which success will be achieved byfocusing on the very few powerful forces operating in any arena and harnessing them to create exceptional

customer value

Partnering reduces costs, improves focus on core competencies, can help a company enter new markets andprovides opportunities to create exceptional customer value According to a recent report, ‘Of the 403 executivessurveyed on this subject by the Economist Intelligence Unit, 65% reported that their company’s dependence onexternal relationships to achieve business objectives had grown substantially over the past three years A similarproportion expected that dependence to increase significantly again over the coming three years.’ [ 4 ]

Partnering comes with its own challenges Most companies have little experience in finding and attracting strategicpartners and building relationships with them Successful partnerships are built on enduring relationships betweenindividuals and groups They require investment over time, exceptional mutual understanding, extraordinary trustand a clear sense of purpose

Employee value

For much of the 20th century, manual workers were common in most organizations Managers were concernedwith how to organize their work and how to improve their productivity Today, knowledge working has replacedphysical labour in many industries The knowledge worker, ‘the man who puts to work what he has between hisears rather than the brawn of his muscles or the skill of his hands’, [ 5 ]is now predominant Knowledge-intensiveindustries, such as software and biotechnology, have emerged Even industries such as manufacturing and

retailing rely on more information

In many services organizations, assets such as client relationships, goodwill, ideas and talent are intangible and

people-oriented Over a decade ago, Fred Moody wrote in the New York Times Magazine, ‘Microsoft’s only factory

asset is the human imagination.’ [ 6 ]Today, physical assets, such as industrial machinery, are rarely sources ofsustainable competitive advantage When motivated, employees create value through their ideas and their ability toinnovate The workforce, and how it is organized and managed, is an increasingly important source of competitiveadvantage

However, the job for life is a thing of the past Few workers have career horizons of more than five years and manyhave several careers Valuable information exists in employees’ heads in the form of knowledge – of how a

process works, a machine operates or a technology integrates Knowledgeable employees are in short supply andprone to move on if they are not treated well As they move between companies, they disseminate valuable

knowledge Companies are under pressure to attract and retain their human assets; a ‘war for talent’ is raging.The best and most successful employees want to work for the best and most successful companies Most

employees want a career, a decent rate of pay, respect from co-workers and a boss who supports them Someemployees are even more powerful and demanding A recent study concluded that factors such as corporate socialresponsibility (CSR) are beginning to figure heavily in an employee’s choice of employer: ‘there is an accumulation

of evidence which shows that an organization’s reputation in the field of business ethics and CSR can tangiblyaffect its attractiveness as an employer In a tight labour market, a positive employer “brand” can make a realdifference.’ [ 7 ]

The most educated, highly motivated and capable employees are in short supply A new generation of softwaretools is emerging to help employers manage their costs – for example, by improving utilization rates in servicesindustries Similarly, tools are emerging for workforce development These tools aim to improve productivity byenabling managers to match skills to positions and will help identify the best employees and support succession

planning Technology will enable internal forecasts and external trend analyses to be combined to provide betterforecasting of workforce needs.

Shareholder value

Many people lost their investments in the crash that followed the hi-tech and Internet stock boom of the late 1990s.Today, investors have little hunger for a return to the roller coaster of fortunes experienced then Investors aremore conservative and want to avoid great risks Today they want a reasonable rate of return balanced over theshort and the long term Investors want steady growth and more consistency If a company does not create

shareholder value through earnings, investors will withdraw their money, stock value will drop and access to futurecapital will be blocked

Investors are more knowledgeable and sophisticated They have learned that value from assets is more importantthan value of assets They know, too, that bigger is no longer necessarily better Shareholders value profits overrevenue and market value over market share Today’s sophisticated investors have moved their gaze from

technology, infrastructure and fanciful business concepts to real-world business strategy and design Investors arelooking for companies to innovate, grow and reduce costs at the same time The need for innovation has neverbeen greater

Shareholders are more demanding and will make their voices heard on all manner of issues, from the environment

to executive pay In an article in the London Sunday Times entitled ‘The rewards should be justified by the results’,

Peter Jauhal noted, ‘Executive pay is under the spotlight again, with public concern mounting over the justificationbeing offered for some remuneration packages… we may be seeing a new activism on the part of shareholders.’ [ 8 ]

Despite all this, most business leaders are optimistic about the future They continue to focus on achieving costreductions and improving productivity Fluctuating markets cause inefficiencies such as over-capacity in servicesand over-supply in industries, increasing costs Some suppliers have introduced adaptive or ‘on demand’ services

to bring their customers’ operating costs in line with market fluctuations

According to a study conducted by the Economist Intelligence Unit,

Despite executives’ expectations of better economic times, corporate strategies remain focused on efficiencydiscipline, cost control and lean operations Companies are hunkering down around their core businesses,and striving to strip away any activities that don’t constitute core competencies, whether through outsourcing

or divestment Mergers and acquisitions are generally viewed as too risky or too costly, though the slackglobal market offers some firms opportunities to acquire weak rivals or to ‘cherry pick’ top talent Insteadcompanies are increasingly turning to looser partnerships and alliances [ 9 ]

Best practice is operational, not strategic

Best-practice benchmarking is often used to cut costs It is one of the most widely used management tools Inmany ways, it makes much sense to use best-in-class strategy, organizational structure, processes and products

as models for re-engineering It can help achieve quick improvements and is appealing to investors, who often feelreassured when it is used According to Philipp Nattermann, ‘Best practice benchmarking – the measurement andimplementation of the most successful operational standard or strategy available in an industry – can be one of themost effective tools for increasing a corporation’s efficiency, productivity, and, ultimately, earnings.’ [ 10 ]

However, taking a best-practice approach can turn out to be the antithesis of innovation and growth A majordrawback of best-practice benchmarking is that it can ultimately kill margins When an innovation enables a

company to create a new market and capture high margins, new entrants are attracted and margins eventually godown Margins are cut for all players in the market: the first movers, ‘me toos’ and late arrivals In some companies,

imitating successful competitors too often determines what they do They do not understand that best-practicebenchmarking is an operational tool, not one for making strategy.

For years, companies have focused on occupying a position in the market already staked out by their quickest andmost successful competitor Soon companies begin herding, like lemmings, around the best-practice companies’business design Products and services become commoditized and margins are eroded as competition increasesfor smaller slices of customer and industry resources Conforming to the opinions and behaviour of others is naturalhuman behaviour The same behaviour applies to companies and strategy Warren Buffett once famously wrote,

‘Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemminghas ever received bad press.’ [ 11 ]

According to Philipp Nattermann,

Best practice doesn’t always equal best strategy Best practice benchmarking, rightly viewed as one of themost important tools for improving operational efficiency, can be a doubleedged sword Managers mustguard against transforming what is a purely process-related technique into the overriding goal of strategicdecision making When industry competitors begin to herd around a single strategy, declining margins arebound to follow [ 12 ]

Business process re-engineering is also an operational tool Approaches such as Six Sigma were widely adopted

in the 1990s Business process re-engineering aims to reduce costs and complexity in the way activities areperformed and at the same time improve customer satisfaction Some companies achieved significant benefitsfrom process reengineering; others were less successful While the primary goal of process re-engineering isusually improved customer satisfaction, the unstated aim is often cost reduction

[ 1 ]Booz Allen Hamilton, CEO succession 2002: deliver or depart [Online] www.bah.com [accessed 12 May 2003]

[ 2 ]Louis Gerstner, Who Says Elephants Can’t Dance?, HarperCollins, London, 2002 (p 273)

[ 3 ]Jeremy Rifkin, The Age of Access, Penguin Books, London, 2000 (p 90)

[ 4 ]The Economist Intelligence Unit, Extending the Enterprise, The Economist Intelligence Unit, London, 1999 (p 4)

[ 5 ]Peter Drucker, The Effective Executive, Butterworth-Heinemann, Oxford, 2001 (p 3)

[ 6 ]Fred Moody, Mr Software, New York Times Magazine, 25 August 1991 (p 56)

[ 7 ]The Work Foundation and The Future Foundation, The Ethical Employee, 2002 (p 1)

[ 8 ]Peter Jauhal, The rewards should be justified by the results, Sunday Times (London), 7 July 2002 (Business

Section)

[ 9 ]The Economist Intelligence Unit, CEO Agenda: Corporate priorities for 2003, The Economist Intelligence Unit,

London, 2003 (p 2)

[ 10 ]Philipp M Nattermann, Best practice does not equal best strategy, McKinsey Quarterly, no 2, 2000 (pp 22–31)

[ 11 ]Warren Buffett, Letter from the chairman, Berkshire Hathaway Annual Report, 1984 (quoted from Charles

Roxburgh, Hidden flaws in strategy, McKinsey Quarterly, no 2, 2003, p 35)

[ 12 ]Philipp M Nattermann, Best practice does not equal best strategy

BUSINESS STRATEGY

Business strategy is about deciding what to do It aims to create value for all stakeholders: customers,

shareholders, employees, business partners and the wider society in which they all reside While productivityimprovements and cost reduction are necessary, they may not constitute good strategy Downsizing and re-engineering provide opportunities to become as efficient as the next company They are necessary but they are notstrategic Though short-term tactics and long-term strategy are not mutually exclusive, strategy should be orientedtowards innovation and long-term growth

In today’s competitive markets, change is unpredictable Innovators, not imitators, will achieve exceptional growthover the long term The rewards for imitation are less attractive Competition has moved from individual productsand services to the level of corporations and their entire extended enterprises Companies now compete to createand lead industries and markets To become an industry leader and to retain that position, a company must takecharge of the process of industry transformation Business leaders must invent new industries and reinvent oldones Strategy must be oriented towards innovation and growth

Innovation and growth

Business leaders should look for ‘white-space’ areas of opportunity on the strategic landscape The number ofsuch white-space opportunities is almost unlimited There is obviously some risk in a strategy that looks to identify,develop and exploit white-space opportunities, but risks can be managed, and first-mover advantages make itworthwhile It is no longer enough to be number two or three in an industry; only industry leaders will create andcapture exceptional value

Competitors playing catch-up will inevitably cancel any advantage, so companies must innovate constantly to stayahead of the game They must keep inventing and reinventing their industries (and their strategies)

Some problems with strategy today

Today, business strategy may occur at the corporate level in the form of a major investment, such as an

acquisition, or a divestment, like selling off a manufacturing plant or business unit Sometimes such actions formthe basis of a shift in corporate direction All too often such strategy is thinly disguised imitation According to LouGerstner, ‘If a management team doesn’t believe that it has identified and is seriously funding new growth

opportunities, then it is likely to wander off and drink the heady brew of acquisitions and diversification – andultimately fail.’ [ 13 ]

Business strategy often appears in the form of strategic planning, which itself is often little more than incrementaltactical planning It is often just about making the numbers add up When strategic planning aims exclusively tosatisfy short-term shareholder expectations, it fails to be oriented towards innovation and inhibits opportunities forsignificant long-term growth Strategic planning often causes strategy to be set at a strategic business unit (SBU)level It is often then broken down further to business unit functions such as sales, marketing and manufacturing.This reduces opportunities to invent or reinvent whole industries Strategic planning can work well in stable

industries but is less suited to industries experiencing big changes

The strategic planning tools common in many companies often fail to help business leaders in identifying andexploiting white-space opportunities for innovation and growth Competitor analysis and scenario planning, forexample, are largely concerned with today’s competitors and optimizing positioning in today’s industries They donot help business leaders position their company against competitors that do not yet exist, in industries yet to becreated Companies that focus too much on the present will be constantly catching up with innovative competitors.Innovative competitors stay ahead by taking control of the process of industry transformation

A vision of industries invented or reinvented in the future requires more than contingency planning around anumber of likely scenarios Scenario planning and technology forecasting can provide input to the creation of aunique and compelling vision of the future but are not enough in themselves In a world of discontinuous changeand increased uncertainty, the number of potential permutations and future outcomes is limitless Scenarioplanning usually starts with the status quo and projects forward to what might be What is required is an approachthat creates a future vision of what could be and then works back to what must happen for that future vision tobecome a reality.

[ 13 ]Louis Gerstner, Who Says Elephants Can’t Dance? (p 228)

This means asking and answering questions like: What new regulations or political legislation will be in place? Howwill environment issues affect the way businesses operate? Which suppliers and business partners will be

important? What type of employees will be required and how many of them? Where will funding come from? Howmight the needs of shareholders be different? Who will be customers? What will their needs be? Are their needsexplicit or do they need developing? Is there opportunity to create a new need and be the first to satisfy it? Whichnew channels will be available? Would a direct relationship create value? Will margin exist in products or services?Who are tomorrow’s competitors?

Strategy starts with the customer

For much of the 20th century, under-supply made suppliers powerful Change (in the form of growth) was morecontinuous, predictable and consistent, and companies increased in size A central objective in large companieswas growth in market share Management was focused on today’s bottom line They attempted to make

productivity improvements in the form of lower manufacturing costs, better product quality and reduced time tomarket Companies defined themselves by what they produced rather than by the value they created for

Customers are familiar with many of today’s products and services They have access to more information throughnew channels such as the Internet They are more knowledgeable and discerning than ever before and manydemand exceptional value Customer relationships have come to the fore Suppliers must compete both on thequality and ingenuity of their products and through the quality of their customer relationships The need for

productivity improvements has not gone away: knowledgeable and powerful customers are sensitive to pricinganomalies

The customer has taken centre stage An understanding of customer needs and wants is the foundation of asuccessful business strategy Peter Drucker once wrote:

There is only one valid definition of a business purpose: to create a customer… What the business thinks itproduces is not of first importance – especially not to the future of the business and to its success What thecustomer thinks he is buying, what he considers ‘value’, is decisive – it determines what a business is, what itproduces and whether it will prosper [ 14 ]

According to The Economist,

Companies are redoubling their efforts to build better customer relationships Judging from the results of theEconomist Intelligence Unit online survey and in-depth interviews, this orientation will permeate everythingcompanies do in 2003 Senior management time will be devoted disproportionately to understanding

customer needs Technology investments will aim to leverage information about customers, to tailor products

to customer needs and to test satisfaction continuously [ 15 ]

Understanding customer needs

Some customer needs are explicit and can be quickly identified Others are less obvious and must be developed

In business-to-business settings, the most common way to understand customers’ needs is via face-to-facemeetings More structured methods, tools and approaches have been developed by strategists and businessconsultants Customer needs are captured using focus groups, market research and one-to-one interviews

However, trends can occur over many years New information technologies such as data analysis software enablesuppliers to ‘sense and respond’ to trends that are difficult to identify

Purchasing managers have become more sophisticated and knowledgeable Today, new approaches such as totalcost of ownership, supplier segmentation and reduction are widely used Some customers invest to improve mutualunderstanding with their suppliers, but only if those suppliers show ability to create exceptional value Trust mayneed to be established before a meaningful relationship can begin Establishing enduring customer relationshipsoften takes time and investment from both sides

Some suppliers are unable to get access to new customers, which may be a prerequisite to understanding theirneeds This can be a problem when a company enters a new market or introduces a new product that new

customers may be unfamiliar with Sometimes intermediaries, such as distributors, sit between suppliers and endcustomers and are reluctant to share information on customer needs They may resist introducing partners to thecustomer through fear of losing influence or to avoid opportunities for disintermediation

As markets evolve, buying responsibilities can shift and new customers may appear Customers needing solutions,for example, often have different roles and responsibilities from traditional product customers For solution

customers, the specifications of the product or service are less important than their economics For them, valueresides in the process, not the product Value is created by how the product is used, not by what it does (its

features and functions) As a result, responsibility for purchasing decisions moves from technical specialists tosenior administrators and business executives When this happens, a new customer interface must be put in place

[ 14 ]Peter Drucker, The Practice of Management, Butterworth-Heinemann, Oxford, 2001 (p 35)

[ 15 ]The Economist Intelligence Unit, CEO Agenda: Corporate priorities for 2003, The Economist Intelligence Unit,

London, 2003 (p 5)

BUSINESS DESIGN

A business design is an architecture that may be developed over a number of years It is an outcome of a businessvision and should provide a high-level blueprint for the creation and delivery of customer value It outlines the needfor future capabilities (such as skills) and enablers (such as technology) It also describes the customer interface –how products and services will be marketed, sold and distributed

According to Adrian Slywotzky, ‘a business design is the totality of how a company selects its customers, definesand differentiates its offerings, defines the tasks it will perform itself and those it will outsource, configures itsresources, goes to market, creates utility for customers, and captures profit.’ [ 16 ]Through business design

innovation a company configures the optimal business design for serving its chosen customers It is not enough towait for competitors to take the lead Only companies that are first to see future opportunities and then first to act toexploit them will achieve competitive advantage and rewards

Customer value

A business design is a high-level blueprint for the creation and delivery of customer value Some customersdemand greater value through lower costs Customers that want lower costs are familiar with the products andservices they require and are able to choose and buy without a great deal of expert advice and guidance fromintermediaries such as salespeople Customers that value lower costs will research their options, compare pricesand shop around for the best deal The products they buy are usually commoditized, and cost is the key factor indetermining which suppliers they choose Personal computer (PC) manufacturers, for example, satisfy the needs ofcustomers for cheaper PCs through low-cost business designs

Some customers demand exceptional value through solutions Solution customers need to solve complex

problems or exploit new opportunities for value creation They may not have the specialist knowledge or theresources required and often look to partners and suppliers for support Suppliers help them to understand theirissues and opportunities They can provide assistance in assessing the options and will often create and deliverunique solutions by customizing services and products Solutions are services-led IBM, for example, satisfies theneeds of its customers for information technology-enabled solutions

Customers value the benefits provided by products but are less likely to take ownership of them In a world of rapidchange, buying products makes less sense Some products need to be replaced or upgraded before they are evenpaid for Technology enables some products to be replaced by services Falling information and communicationtechnology costs mean that information technology, such as microchips, can be embedded into many new

products When technology-rich products are connected to the Internet they become devices for providing servicesand enable the creation of customer value at the speed of light Many manufacturers are introducing services inresponse to customer needs, and, as product margins erode, are introducing services-led business models

In creating a successful strategy to exploit white-space opportunities, it can be helpful to think of products andservices in terms of the value they create, rather than their features and functions Thinking in terms of featuresand functions limits opportunities to today’s products and services Technology enables customer value to becreated and delivered in new and exciting ways – the same value in a new delivery vehicle The value a telephoneanswering machine creates, for example, is more effective use of time In the past, answering machines werehardware devices, domestic appliances Today, enabled by computer software and communications technology,the same value is often provided remotely as a service

Creating and delivering customer value requires more than being ‘customer-led’ Many customer needs are

articulated; some are not The risk with being completely customer-led is that unarticulated needs may never beserved, and those needs often offer the greatest ‘white-space’ opportunities (since they are not being served by

competitors either) Akio Morita at Sony said, ‘Our plan is to lead the public with new products rather than ask themwhat kind of products they want The public does not know what is possible, but we do So instead of doing a lot ofmarket research, we refine our thinking on a product and its use and try to create a market for it by educating andcommunicating with the public.’ [ 17 ]

Capabilities

In 1990, C K Prahalad and Gary Hamel published an article entitled ‘The core competence of the corporation’ In itthey advocated a focus on learning rather than physical assets and suggested that companies should exit activitiesthat do not use core competencies [ 18 ]Core competencies are bundles of skills and technologies that enable acompany to provide a particular benefit to its customers Core competencies are, therefore, unlike strategic

business units, which are usually defined by specific product markets Focusing on core competencies encouragescompanies to identify and exploit what they do best and enables resources to be focused on areas of innovationand growth Core competencies create and deliver a class of customer benefits such as ‘low-cost’ or ‘solution’

A business design outlines the need for future capabilities (such as skills) and enablers (such as technology).Capabilities of a company selling low-cost PCs might include selling online, call centre management, build to orderand inventory management skills Capabilities in a solutions company like IBM include solution selling, businessconsulting, programme management, service delivery and industry marketing Some capabilities, such as

continuous innovation, knowledge management and the effective use of information technology, are common toboth business designs

The widespread adoption of the Internet and new technologies has made working with external partners cheaperand easier More companies are abandoning many non-core activities Core competency thinking has led somecompanies to define themselves in terms of what they do rather than what they make By redefining the nature of

‘served market’, core competency thinking offers opportunities for innovation, growth and the creation of newcustomer value Focusing on core competencies may take a company away from the markets it has traditionallyserved and into competition with new rivals

New competitors

The Prussian military expert Carl von Clausewitz wrote that one must judge an enemy by his capabilities, not by hisintentions [ 19 ]Most competitive analysis focuses on existing product or service markets As companies focus oncore competencies and industries converge, new and unfamiliar competitors emerge, often from unrelated

industries They may try to create a new industry for your customers based on their own vision of the future In theUnited Kingdom, for example, the financial services industry is being transformed by supermarkets offering bankingand insurance services They have access to capital and opportunities for partnering, allowing them to take on thelargest competitors

Enablers

Enablers are tangible and intangible assets that enable things to get done They include offices, factories, brands,products and employees Today, many companies are attempting to improve their balance sheets by selling offphysical assets that depreciate, often preferring to lease them instead Partnering and outsourcing provide

opportunities to enjoy the benefits of enablers without taking ownership Companies look to own assets only if there

is some advantage in doing so Customer data, for example, are an enabler that companies seek to own, becausethey enable better customer relationship management, although they may outsource the management of the data.Small start-up companies, particularly in knowledge industries, may rely on a just a few enablers for conductingbusiness, relying on partnerships and externally provided services instead Companies often have heritage

enablers – assets that they may have acquired and developed over many years – that can form the basis of futurebusiness designs IBM, for example, has a widely recognized brand that enables it to enter new product andservice markets and data centres that it uses to deliver new services

The customer interface

The customer interface – the way a company interacts with its customers – is an increasingly important element ofany business design For most of the 20th century, consumer demand was insatiable and products were in shortsupply During this era, management resources were focused on production Business designs were created tosustain product sales growth and achieve maximum operational efficiency Marketing focused on differentiationthrough product features and functions The role of the sales force was to communicate product value Distributionwas about getting as much product on to the market as quickly as possible

Greater competition, globalization and rapid imitation have caused many products and services to become

commoditized Over-supply, greater choice and access to information have made customers more discerning andpowerful Today, companies are fighting for a share of customer spend and attempt to build enduring relationshipswith customers by understanding and satisfying their needs In many companies, marketing, sales and distributionactivities, which constitute the customer interface, have remained unchanged for decades, and nowhere is theneed for transformation more evident

Customers demanding lower costs are familiar with the products and services they require and are able to chooseand buy without a great deal of expert advice and guidance from intermediaries such as salespeople They require

a new customer interface The costly field sales force can be made more efficient by adopting new technologies orcan be eliminated altogether The Internet and telephone-based call centres provide new opportunities to interactwith customers demanding lower costs Customers can access relevant information online, conduct research,compare buying options and make a purchase with the minimum of cost and inconvenience Outbound marketing

is enabled by technologies such as databases and telemarketing

Customers demanding solutions also require a new customer interface Customer relationship management, forexample, enables better customer management over time and improves marketing to business buyers The role ofthe sales force is shifting from communicating the value of products and services to creating value for customers.Today, in many industries, services form the basis of enduring relationships and are substituting traditional product-led distribution based on individual transactions IBM, for example, has introduced industry-oriented marketing,adopted solution selling methods, and developed business consulting and outsourcing service delivery capabilities

to support solution creation and delivery

Sony’s strategic vision

Sony has a vision of a future in which electronics, telecommunications and information technologies are

converging It anticipates that customers will demand new products and services through broadband networks –which will be cheaper to use and more widely adopted Sony is working towards a ‘personal broadband networksolutions’ business design:

Sony Corporation today [29 March 2001] announced its intention to transform itself into a Personal

Broadband Network Solutions Company for the coming broadband network society which is forecast to arrivearound the year 2005 Sony is making organizational changes aimed at deepening its interactive relationshipwith millions of customers worldwide, offering a variety of products and services optimized for the broadbandsociety As the broadband network era approaches, Sony will capitalize on its unique combination of

hardware and content assets [ 20 ]

Nobuyuki Idei, Sony chairman and CEO, commented:

Sony will continue to focus on and consolidate its unique resources in brand recognition, electronics

hardware expertise, entertainment business know-how and venture business development both within and

outside the company In enhancing group corporate value, we will pursue ‘soft alliances’ with outside

companies that will complement our existing internal resources, and accelerate the pace of change [ 21 ]

Strategies develop over the long term

It may take years before all the elements of a business design are in place Technologies and customer needsneed to be developed over many years before a new industry can be created During that time, companies begin atransformation journey They build the factories, warehouses and technology infrastructure, and hire the employeesthey will need They develop new capabilities such as solution selling, business consulting or new service deliveryconcepts They may need to transform the sales force or replace it entirely with new technology Companies mayneed to get agreement on standards, test product and service concepts with customers and build alliances withselected business partners, to prepare for and shape the emerging industry

When to create strategy and begin transformation

The right time to create a new strategy and to transform an industry is when a company is successful, or at leastnot in crisis During periods of crisis, business leaders are distracted by firefighting activities and the requiredresources are often in short supply It becomes difficult to attract key business partners and suppliers, the mostcapable employees abandon the sinking ship and access to investment capital is restricted When shareholderspress for short-term performance improvements, the natural tendency is to cut costs rather than invest for thelonger term The required capabilities and enablers do not get put in place and opportunities for innovation andgrowth are not exploited

White-space opportunities are often spotted first by industry outsiders who then create new business designs and

go about the business of industry transformation Incumbents often tend to rely far too long on their traditionalbusiness models, particularly if they have been successful They take the view that what worked well in the pastmust also work in the future It can take a fresh set of eyes to see the wood as distinct from the trees The

challenge for industry incumbents – leaders and laggards alike – is to continually reinvent their own industries andcreate new ones To do this they must develop a vision of the future, then configure a business design and

implement a strategy that aims at building it The need for business design innovation and transformation is realand immediate

[ 16 ]Adrian J Slywotzky, Value Migration, Harvard Business School Press, Boston, 1996 (p 4)

[ 17 ]Gary Hamel and C K Prahalad, Competing for the Future, Harvard Business School Press, Boston, 1996 (p

108)

[ 18 ]Gary Hamel and C K Prahalad, The core competence of the corporation, Harvard Business Review, May–June

1990 (pp 79–90)

[ 19 ]Michael Hammer, The Agenda: What every business must do to dominate the decade, Random House

Business Books, London, 2002 (p 253)

[ 20 ]Nobuyuki Idei, Sony press release, Transforming Sony into a ‘Personal Broadband Network Solutions

Company’ [Online] www.sony.net [accessed 29 March 2001]

[ 21 ]Nobuyuki Idei, Sony press release, Transforming Sony into a ‘Personal Broadband Network Solutions

Company’

I proposed that companies invest at least as much into looking for opportunities for innovation and growth as they

do in reducing costs, although both are important I argued that every company needs a vision (a view of howthings will be different) and a strategy (decisions on what must be done), and must be capable of executing it (itmust be able to make things happen) I suggested that that strategy should aim to create customer value, should

be oriented towards innovation and growth and should be based on an understanding of customer needs (bothtoday and in the future) I argued that strategy starts with the customer I suggested that the needs of somecustomers are changing: some customers want lower costs, others want solutions

I proposed that business leaders should attempt to transform both their companies and their industries Thecompany and the industry must be created, shaped and transformed over time I suggested that a business design

be created (based on the business vision) to guide the transformation The design should outline the need forfuture capabilities (things the company should be able to do) and enablers (things a company should have to getthings done), and describe the customer interface (how value will be created and delivered to the customer) Thetransformation journey can be long and difficult It should start sooner rather than later

In Chapter 2 we outline a transformation that took place in British food retailing, over several decades, during thelatter half of the 20th century This example aims to demonstrate how whole industries can be transformed throughnew business designs that create and deliver exceptional customer value In Chapter 3 we describe how productsare changing and how low-cost business models are emerging In Chapter 4 we describe how services are

changing and how solutions business models are emerging In the remaining chapters we explore aspects of thesolutions business model, many of which are still evolving

1 Booz Allen Hamilton, CEO succession 2002: deliver or depart [Online] www.bah.com [accessed 12 May 2003]

2 Louis Gerstner, Who Says Elephants Can’t Dance?, HarperCollins, London, 2002 (p 273)

3 Jeremy Rifkin, The Age of Access, Penguin Books, London, 2000 (p 90)

4 The Economist Intelligence Unit, Extending the Enterprise, The Economist Intelligence Unit, London, 1999 (p 4)

5 Peter Drucker, The Effective Executive, Butterworth-Heinemann, Oxford, 2001 (p 3)

6 Fred Moody, Mr Software, New York Times Magazine, 25 August 1991 (p 56)

7 The Work Foundation and The Future Foundation, The Ethical Employee, 2002 (p 1)

8 Peter Jauhal, The rewards should be justified by the results, Sunday Times (London), 7 July 2002 (Business

Section)

9 The Economist Intelligence Unit, CEO Agenda: Corporate priorities for 2003, The Economist Intelligence Unit,

London, 2003 (p 2)

10 Philipp M Nattermann, Best practice does not equal best strategy, McKinsey Quarterly, no 2, 2000 (pp 22–31)

11 Warren Buffett, Letter from the chairman, Berkshire Hathaway Annual Report, 1984 (quoted from Charles

Roxburgh, Hidden flaws in strategy, McKinsey Quarterly, no 2, 2003, p 35)

12 Philipp M Nattermann, Best practice does not equal best strategy

13 Louis Gerstner, Who Says Elephants Can’t Dance? (p 228)

14 Peter Drucker, The Practice of Management, Butterworth-Heinemann, Oxford, 2001 (p 35)

15 The Economist Intelligence Unit, CEO Agenda: Corporate priorities for 2003, The Economist Intelligence Unit,

London, 2003 (p 5)

16 Adrian J Slywotzky, Value Migration, Harvard Business School Press, Boston, 1996 (p 4)

17 Gary Hamel and C K Prahalad, Competing for the Future, Harvard Business School Press, Boston, 1996 (p

108)

18 Gary Hamel and C K Prahalad, The core competence of the corporation, Harvard Business Review, May–June

1990 (pp 79–90)

19 Michael Hammer, The Agenda: What every business must do to dominate the decade, Random House

Business Books, London, 2002 (p 253)

20 Nobuyuki Idei, Sony press release, Transforming Sony into a ‘Personal Broadband Network Solutions

Company’ [Online] www.sony.net [accessed 29 March 2001]

21 Nobuyuki Idei, Sony press release, Transforming Sony into a ‘Personal Broadband Network Solutions

Company’

Chapter 2: Transformation in Food Retailing

Howard Cox, Simon Mowatt, Martha Prevezer, Mark Cerasale and Merlin Stone

INTRODUCTION

Transformation can occur when companies combine industry-shaping strategies with effective execution Suchtransformations occurred in the United Kingdom in the frozen foods and chilled ready meals industries during thesecond half of the 20th century More women entered the workforce after the Second World War Pressure tobalance a full working day with household chores created opportunities for labour-saving innovations (which theirnew income meant they could afford) Frozen foods offered convenience to an increasingly busy and wealthypopulation During the 1980s and 1990s, consumers became more affluent, sophisticated and discerning Theydemanded food that was easier to prepare and tastier, for which they were prepared to pay a premium The ready-chilled foods sector emerged

The frozen foods sector emerged as a result of proprietary technology innovations that allowed continuous-processmanufacturing of standardized products Vertically integrated firms dominated the frozen foods industry In theearly days, a major challenge for frozen food manufacturers was to raise awareness of their new products Theyachieved this through mass-media advertising Another inhibitor was the need for special cold storage cabinets inthe retail environment

Manufacturers resolved this problem by providing them to retailers on favourable terms In this way, frozen foodmanufacturers created frozen foods markets that grew in size and diversity during the second half of the 20thcentury

By contrast, proprietary manufacturing techniques were not critical to the chilled ready meals industry proprietary information management systems were the key to success with chilled ready meals Chilled readymeals used established technologies of food preservation and established distribution channels However, theproducts’ short shelf life created new and complex logistical issues, which meant that manufacturing had to bebased on batch rather than continuous process production methods A major challenge was to match supply anddemand over relatively short time periods This was achieved through expert supply chain management and newinventory control systems Vertically integrated firms are less effective in such an environment Market-makingretailers, not manufacturers, emerged as industry leaders Retailers were able to bring their products to customers

Non-by leading and coordinating networks of suppliers and distributors

THE FROZEN FOOD INDUSTRY IN THE UNITED KINGDOM

Frozen food developed in two phases The first, beginning in the 1930s, involved introducing quick-freezing as away to preserve food Quick-freezing could be applied particularly to white fish and some green vegetables In thisphase of the development, quick-freezing had many parallels to high-speed canning, which had been applied toother foodstuffs since the 1880s In each case, the use of packaging facilitated the introduction of proprietarybranded goods that were supported by extensive advertising The second phase moved beyond the simple

preservation of foodstuffs into more innovative forms of product development In the United Kingdom from the 1950s, manufacturers of frozen foods, led by the Unilever subsidiary Birds Eye, began to introduce a range of newproducts such as fish fingers, beef-burgers and frozen ready meals

mid-The earliest applications of freezing technology to food preservation were designed to serve the catering trade.Towards the end of the Second World War, Unilever began to develop a market in frozen foodstuffs for final

consumers This innovation built directly on Unilever’s experience in the mass production of branded packagedconsumer goods At that time, the company was one of the few non-US firms to have developed an extensivemanagement structure, with its UK-based operation featuring four product divisions (soap, margarine, oil mills andfood) overarched by a range of advisory and service departments that served the entire range of the company’sinternational subsidiaries These service departments managed the entire value chain, including activities such asbuying, marketing, transport and advertising

The integrated value chain

For frozen food to be developed successfully into a mass consumer good, it was necessary to create new marketsupstream and downstream of production, and develop a supporting infrastructure Upstream markets were required

in which a sufficient volume of raw materials could be delivered in a way that enabled the process of quick-freezing.Downstream markets were required to store, handle and transport the frozen produce Retailers were needed tostore and distribute the products to final consumers Frozen food products were new and innovative; consumerswould have to be educated and informed about their use Only when all these things were in place was it possible

to reap the potential benefits of the new technology

Unilever had a long history of backward integration (of producing the food it required) A similar approach wastaken with frozen foods Several factories were opened in the 1940s More factories were acquired during the1950s as sales grew Birds Eye entered the broiler chicken industry in 1958, quickly building up its capacity toaround 20 farms, and in 1965 it acquired a controlling interest in North Eastern Fish Industries Ltd to provide adirect source of Newfoundland cod However, direct control over the provision of chicken and fish was eventuallyabandoned as overproduction and falling prices during the late 1960s and early 1970s made such investmentsuneconomic

The policy of backward integration was not adopted for vegetables Nevertheless, Birds Eye did develop backward integration through the use of annually negotiated forward contracts with local farmers, to whom theygave assurances of short-term renewal and, in many cases, provided seed Seed was supplied to allow

quasi-standardization and quality control This arrangement also ensured exclusivity for Birds Eye This meant that thisactivity was quasi-integrated into the Unilever structure The response of growers was to form committees such asthe Processed Vegetable Growers Association to negotiate with Unilever on their behalf

Creating the necessary markets downstream from the production process was more complicated Unilever wouldhave to apply the skills and resources it had developed to support its other food businesses Distribution andhandling of the products was placed into the hands of the refrigerated division of the company’s transportationsubsidiary, SPD SPD utilized its national network of depots and vehicles in a closely coordinated operation withBirds Eye’s own sales division Independent wholesalers were integrated into the company’s frozen food

distribution system in parts of the country too remote to operate economically These wholesalers were prevented(by contract) from distributing the rival brands of direct competitors.

Creating a profitable market downstream was challenging Unilever operated a small chain of retail stores but thesewould not provide the required sales volumes In the early 1950s few retailers had the equipment needed to displayand sell frozen food In 1953, Birds Eye persuaded two manufacturers of refrigerated equipment to design andmarket ‘open-top’ display cabinets for use by retailers In return, the company agreed to limit its sales to thoseretailers that installed them Later, Birds Eye developed a policy of leasing refrigerated cabinets to some of its moreimportant retail customers on condition that the equipment was used for stocking Birds Eye products or otherproducts that were not in direct competition Large retailers, such as J Sainsbury, developed their own refrigeratedcabinets in order to display a larger selection of stock and eventually began to offer their own-brand products.Meanwhile, advertising, sales promotions and temporary price reductions were used to encourage consumers tochange their buying behaviour (by adopting the new products)

In pioneering the mass market for frozen foodstuffs, Birds Eye had to take responsibility for putting the

infrastructure in place that would enable products to be sold in sufficient volume to turn a profit Birds Eye’s

approach was also adopted by its two main rivals, Ross Group Ltd and Findus Ltd (a subsidiary of Nestlé), whichbecame competitors in branded consumer markets during the 1960s Management of the supply chain in eachcase was extensive, and both companies developed integrated distribution operations, although in the case ofFindus this was a joint venture with J Lyons & Co Ltd Their links with independent wholesalers were made underconditions of exclusivity However, the dominant model (integrated supply chain supported by strong brand

advertising) became increasingly vulnerable during the 1960s as new forms of organization and market segmentsemerged

The causes of change

Three developments changed the structure of the UK frozen food industry in the 1960s and 1970s One of theseconcerned the rapid growth in demand for frozen food by the catering trade, which led to a pronounced bifurcation

of the frozen food industry The other two were brought about by increased competition in the market for frozenfood to households These involved the development of product differentiation and market segmentation on theone hand and the advancing power of multiple retailers on the other

Sales of frozen food increased to caterers New competitors, with relatively modest turnover, were able to enter themarket as a result of lower advertising and packaging costs These changes also facilitated a broadening of thedistribution arrangements within the frozen food industry In the past, retailers had been supplied through

manufacturers’ wholly owned distribution companies or through exclusive deals with independent wholesalers Thegrowth of small-scale manufacturers serving the catering trade encouraged companies to be set up specializing inthe provision of processing, storage and distribution services

Cold-store companies and specialist distributors entered the market, causing it to fragment The larger cold storagecompanies tended to be integrated concerns that also provided processing and distribution services Indeed, as therole of independent suppliers expanded, the freezing capacity of these large storage and distribution companiesbegan to rival those of the proprietary branded manufacturers The increasing number of independent distributorsenabled smaller, more specialized frozen food manufacturers to enter the market These included agriculturalcooperatives that were formed for the purpose of processing fruit and vegetables, and a number of small

manufacturing concerns that specialized in manufacturing products within a defined segment of the market

(vegetables, fish, meat products, fruit, confectionery) In some cases they specialized in a single product such asfrozen potato chips (fries) or pizzas

Frozen food retailing helped to speed up vertical industry disintegration The need for relatively small orders, in thesmall-scale segment of grocery retailing, led to the emergence of cash-and-carry wholesalers They acted asintermediaries between the distributing wholesalers and the retailers By the mid-1970s, for example, 60 per cent ofgreengrocers carried a small range of frozen food, increasing the availability of the main proprietary brands of

frozen food At the same time, the very rapid growth in sales of home freezers during the late 1960s and early1970s created a force in the opposite direction As more consumers were able to store frozen foods, sales volumesrose considerably New home freezer centres were opened, led by the Bejam Group in 1968, which combined thesale of home freezers with the retailing of bulk packs of frozen food Home freezer centres allowed smaller

manufacturers of frozen food to increase sales and reduce distribution costs

During the 1960s, supermarket shelf space was limited in the United Kingdom The growth of home freezer centresenabled the industry to overcome this growing constraint on retail sales During the same decade, the leadingmultiple retailers grew in size and power, taking an increasing share of the sales of Birds Eye’s products Birds Eyebegan offering the large multiples discounts relating to turnover and allocation of shelf space These discountsacted as entry barriers to rival suppliers that were attempting to gain sales through supermarkets The MonopoliesCommission report of 1976 ordered Birds Eye to end the discounts on condition that other manufacturing firms alsoceased such a strategy

In reality, the main threat to the proprietary brands in supermarkets arose less from rival manufacturers than fromthe multiple retailers themselves As in other product lines, supermarkets increasingly sought to introduce theirown-label brands of goods into their freezer cabinets during the 1960s Indeed, led by J Sainsbury and Marks &Spencer, the multiples’ own brands had made significant inroads into the frozen food market by the early 1970s.Although Birds Eye resisted the pressure to relabel its own products for retailers (although it did relabel products forthe generic or unbranded market), other manufacturers proved more willing to adopt an own-label strategy Thefirst own-label frozen food produced for retailers’ own brands was frozen fish, supplied by Ross (then a marginalmanufacturer in frozen foods) in 1957 Findus, which supplied products for Sainsbury, Marks & Spencer and otherleading multiples, saw the proportion of its gross sales (in value terms) accounted for by own-label products risefrom under 7 per cent in 1971 to 16.5 per cent just three years later The beginnings of the own-label industrystarted a revolution that was to be the turning point in the relationship between manufacturers and retailers

From the mid-1950s to the mid-1970s, the frozen food industry in the United Kingdom grew in both size and

complexity At the outset, only a firm such as Unilever, with vertical control over the value chain, could assemblethe various components required to create and profit from the market By the 1970s a whole raft of firms, small andlarge, were attracted to the market While manufacturing remained largely a classic oligopoly, the balance of powerwithin the value chain shifted towards the retailers However, two decades of continuous advertising had helpedestablish the proprietary brands and provided them with longevity The frozen food market is still dominated by the

‘big four’ companies, all subsidiaries of multinational firms: Birds Eye Walls Ltd, Nestlé Holdings (UK), Ross

Youngs and H J Heinz Company Ltd UK With the advent of chilled ready meals, however, an important segment ofthe processed food industry was about to be turned on its head

THE CHILLED READY MEALS INDUSTRY IN THE UNITED KINGDOM

Large manufacturers of frozen foods introduced ready meals to raise the value added component of their products.They were also responding to the opportunities presented by various demographic changes, notably increasedfemale employment British consumers took packaged foreign vacations and began acquiring a taste for non-British recipes An increasingly sophisticated range of products were found in the freezers of UK supermarkets andother retailers during the 1970s, starting with TV dinners by Birds Eye in 1969 In 1975, Birds Eye’s retail productrange included British staples such as cod and chips through to quasi-exotic Asian offerings such as sweet andsour chicken

The process of freezing and reconstituting meals in many cases caused the texture and flavour of the food todeteriorate If the dishes could be preserved by chilling rather than freezing, then a better product would end up onthe consumer’s dinner table The logistical difficulties involved were formidable, since the maximum period of timethat could elapse between production and final consumption of such products was a matter of days rather thanweeks While it might be possible to charge a premium price, the cost in wastage would be prohibitive unlesssupply and demand could be coordinated with unprecedented accuracy The retailers, not the manufacturers, werebest placed to manage the coordination of customer demand and product supply

In the United Kingdom the chilled ready meals market was pioneered by the multiple retailer Marks & Spencer,which specialized in high-quality fresh and convenience food products Its decision to provide premium-pricedchilled ready meals was to have important consequences for supply chain management and for the relationshipbetween retailers and suppliers in the industry Marks & Spencer’s long-term strategy was to differentiate onquality To achieve this, it had to forge close relationships with suppliers Marks & Spencer used its many years ofexperience in collaborative product development to exploit a latent demand for pre-prepared ‘fresh’ ready mealsduring the 1980s Unilever had supported the introduction of freezer technology in an attempt to enable consumers

to participate in the frozen food market By contrast, Marks & Spencer sought to exploit unsatisfied customerdemand Other retailers in the UK grocery market, such as J Sainsbury, sought to emulate this strategy

The network value chain

In the 1970s, large grocery retailers began to take control of product distribution Sainsbury, for example, pioneeredthe development of dedicated regional distribution centres (RDCs) as an intermediate stage in the distributionprocess These RDCs were owned by one of a growing number of specialist distributors but were operated onSainsbury’s behalf through a process of subcontracting Sainsbury contracted out the operation of its RDCs for twomain reasons First, there was organized labour unrest at the time, and, with inflationary pressures on wagesincreasing industrial action, contracting out removed Sainsbury from labour management problems in the area ofdistribution Second, the period was one during which Sainsbury and the other large retailers were using theirresources to expand the number and the geographical spread of their stores Transportation of products from theRDCs to the stores was largely undertaken directly by Sainsbury’s own fleet of vehicles By the 1990s the RDCpattern had become established with UK retailers, although they increasingly contracted out operations

Retailers also began to operate primary consolidation centres (PCCs) to which manufacturers were able to deliverincreasingly small batch-driven loads, prior to their transfer to the RDCs With PCCs, very small crate (rather thanpallet) based deliveries can be made Crates can accommodate partial boxes and are ideal for the delivery of low-demand, high value added products with a very short shelf life such as chilled ready meals In such cases theefficiency does not come from standardized delivery and economies of scale, but through the precise matching ofsupply and demand Larger manufacturers can coordinate the collection of stock from smaller suppliers for delivery

to the PCC Retailers use technologies such as Electronic Data Interchange (EDI) systems, and later the Internet,

to coordinate, control and manage the supply chain from beginning to end

Information technology as an enabler of transformation

The chilled ready meals industry evolved as a result of developments in information technology, not productiontechnology Information technology systems enabled the coordination of independent firms to create and deliverthe product (the chilled ready meal) to the customer Computer-controlled inventory management systems are alsocritical in the chilled ready meals industry Many such systems have been introduced since the 1980s Electronicpoint of sale (EPOS) systems also enabled the transformation of the industry EPOS systems improve stockmanagement by enabling retailers to record and replenish chilled stock in the limited space available on shelves.New scanning technology, which was introduced in the mid-1980s, has also improved supply chain management.Grocery retailers, constrained by the perishable nature of their produce, were the first to move from inventory-based systems to customer-driven systems

EDI and collaborative Internet technologies enabled the various players in the value chain to be coordinated in realtime This new ability to manage the supply chain allowed retailers to switch to customer demand-driven

replenishment systems These systems allowed the retailers to have better control of the supply chain and

increased the supplier’s dependency on retailers Information on customer buying behaviour was gathered fromstores and loyalty cards During the late 1990s, retailers invested in data warehousing systems Some retailersinvested in data mining technologies allowing them further insight into customer buying behaviour Control of thecustomer interface and ownership of customer data gave manufacturers a dominant position in the value chain.Sainsbury introduced computer-controlled stock management systems and was able to gather wholesaling

information more effectively The company extended its management control back down the value chain Thismove also enabled the company to obtain even more control by contracting directly for distribution services Themanufacturers had no choice but to relinquish some of their responsibilities Sainsbury was then able to unbundlemany of the services supplied by wholesaling subcontractors and gain more precise information over a variety ofcosts that had previously been invisible to them

Inventory management software has given Sainsbury more information and control over the value chain Theretailer retains direct ownership of the warehouse and the computer-controlled stock management system,

outsourcing other activities considered to be non-core Thus the integrated information system underpins andprovides control over a network of independent firms revolving around the hub played by the retailer’s head office

In Sainsbury’s terms, this arrangement represents the inverse of the concept of ‘hollowing out’, since it allows thecompany to maintain control over the critical system-wide information while enabling the company to relinquishdirect responsibility for its management

Retailers tend to own and maintain some logistics support services directly This enables them to benchmark theperformance of outsourced services and better understand other operating costs By keeping some services in-house, the retailer has better information and is able to maintain its position of power and control over suppliersand subcontractors This requires the management of many more transactions than are involved in conventionalsubcontracting, but information technologies such as the Internet have greatly reduced the cost of managing thesetransactions In the Information Age, an integrated information network has replaced a corporate hierarchy as themost efficient method of managing many discrete transactions

Collaborative product development

Marks & Spencer’s chilled ready meals featured attractive packaging and were marketed as high-quality priced products Their pricing and positioning offered them as a substitute for take-away meals and even restaurantfood Marks & Spencer’s customers were, in many ways, good prospects for chilled ready meals The companyhad already developed a range of chilled products such as meat pies and quiches under its own St Michael brandname Expanding this range into full meals, or meal centres, was a logical step that required marketing only at thepoint of sale Marks & Spencer was less concerned about advertising and awareness than with understandingcustomer preferences This marked a shift from one-way to two-way product information flows A proprietary

premium-charge card scheme enabled the company to obtain detailed information about customer buying habits holding customers were invited to special in-store events that also allowed the company to get to know them better.Marks & Spencer’s chilled ready meals were introduced as highvalue meal-replacement products As such, theirsuccess depended on continuous new product development (NPD) Successful NPD required the pooling ofknowledge from many sources When Sainsbury introduced chilled ready meals during the late 1980s, it

Card-assembled new product development teams that included employees from food manufacturing and packagingcompanies as well as its own staff These teams monitored purchasing patterns and studied eating trends inrestaurants before using the information gained to innovate with new products They learned about customer needsand developed products to satisfy them Despite having no manufacturing capability of their own, UK retailers havebeen able to compete head-to-head with branded manufacturers such as Unilever The retailers’ NPD groups alsohave expertise in areas such as food technology and hygiene They do not have direct access to manufacturingfacilities, so they tend to work closely with suppliers, who are obliged to absorb many of the costs incurred

The chilled food manufacturers with whom the retailers collaborate are a very different group from the early

pioneers of frozen food They are mainly smaller firms that can engage in systems of batch production; some are

no more than micro-kitchens employing fewer than five people Small manufacturers are capable of rapid andflexible development of new products, which is a critical success factor for the retailers The retailer supplies themanufacturer with ideas, technical help and access to its network of specialists This activity has produced

specialist food companies that provide products to several supermarkets For example, Noon Food Products is asupplier of chilled Indian-style ready meals to Sainsbury (and other retailers) but does not undertake the branding,marketing or distribution of its products Such suppliers are expected to come up with new recipes

The rise in ownership of microwave ovens fuelled the growth in demand for chilled ready meals Microwave

cooking created new challenges, not least with regard to packaging There have been many innovations in

packaging that were directly driven by the needs of consumers of chilled ready meals Microwaveable meals needcontainers with different degrees of ‘transparency’ in terms of their ability to transmit, reflect and absorb

microwaves ‘Active’ packaging has been developed that can control or influence the effects of microwave heating.Hygiene is also a key issue with regard to chilled ready meals Some products, for example, contain ingredientswith very different heating characteristics depending on whether they are heated in a conventional oven or bymicrowave Unless instructions are clear, food can be cooked incorrectly Therefore, packaging must be jointlydeveloped between the manufacturer and the retailer The retailer will often use the packaging as part of its genericown brand marketing strategy

New product development in the chilled ready meals industry involves the formation of collaborative teams drawing

on a wide range of information The retailers retain a dominant nodal position because they have control over thecustomer interface and can access customer data that provide them with information on customer needs andwants Retailers also control product development and the allocation of shelf space in stores This means that it iseasier to switch suppliers than the other way around This system gives them greater flexibility than would beallowed in a wholly owned value chain and enables them to sense and respond to changing customer needs.Retailers are able to exert considerable influence and control over suppliers and partners in the value chain, eventhose performing high-value activities

Retailers such as Marks & Spencer, Sainsbury and Tesco have exploited the market for chilled ready meals on thestrength of their own-label brands This is a clear sign of their dominance over manufacturers in this market Tocompete with retailers, manufacturers must resort to more costly direct methods such as advertising to increasesales The retailers can promote their products in-store at much lower cost Some retailers have benefited further.Tesco, for example, was able to improve its image dramatically during the 1990s partly through the association withquality and added value that came with the introduction of innovative chilled foods Marks & Spencer, Sainsburyand Tesco account for well over three-quarters of total sales of chilled ready meals in the United Kingdom Marks &Spencer alone accounts for nearly half of all sales

Efficient information management systems have raised the ability of retailers to exert control over the value chain in

the food industry However, unlike the earlier forms of control exercised by large manufacturers, based on verticallyintegrated organizational structures, the multiple retailers operate through management systems that take the form

of inter-firm networks This is perhaps most evident in the process of new product development Inter-firm

collaboration takes the form of long-term strategic alliances with companies whose core competencies are

complementary to those of the retailers Each firm must assess the benefits of collaboration Collaboration is oftenperformed in multidisciplinary teams whose common objective and continuous interaction help to facilitate mutualtrust The market-making role performed by the retailer is critical in making the collaboration a success In themarket for ready chilled meals, the retailers control the customer interface, they understand their customers’ needsand they manage the flow of information that gives them control of the collaborative network as a whole

In the case of frozen food, the impact of technical innovation occurred at the production stage and required

corresponding changes in the provision of raw materials, in the systems of distribution, wholesaling and retailing,and in the patterns of household consumption The creation of these various new markets was therefore a

prerequisite for the successful exploitation of the technology of quick-freezing Unilever and its subsidiary

companies were well placed to coordinate the flows of information needed to effect new processes of marketintermediation This was done partly through the company’s own corporate management system – as in the case ofthe inputs of chicken and fish, and the mode of distribution, wholesaling and, in some cases, retailing – and partlyvia a process of negotiation and persuasion – as in the case of long-term supply contracts with vegetable farmers,quantity discounts to large retailers and mass advertising campaigns to win over consumers

Once the new production technology had been successfully established, however, opportunities arose for thisprocess of intermediation to be undertaken by other actors operating at different stages of the supply chain Inparticular, in the 1960s and 1970s the multiple retailers were able to alter the mix of information that reached finalconsumers by adding their own-label products to proprietary brands from the large food processors and so gainincreasing influence over the information flows operating within the industry as a whole

The retailers’ position was further strengthened by the technical innovations that ushered in the Information Age.Enhanced systems of information management gave retailers that invested in the appropriate technology fargreater control over the process of inventory management and allowed them to introduce products featuring muchshorter shelf lives such as chilled ready meals With improved systems of stock management and easier access tocurrent consumer buying patterns and eating trends, retailers were also able to initiate a process of continuousproduct innovation by pooling knowledge with food manufacturers and packaging companies through the use ofstrategic alliances featuring multidisciplinary teams

Competitive advantage in the chilled ready meals industry has been gained less through technical advances in theprocess of production, and more by retailers’ ability to manage the coordination of their supply chain, even whencompetitors have access to the same suppliers and contractors The successful innovation of chilled ready mealsdepended on the information management facilities that arose as a result of the digital revolution, but it did notrequire large investments in the creation of new markets Rather, it had the effect of changing the nature of theexisting processes of intermediation that retailers previously engaged in

Increasing use of information technology enabled the outsourcing of the management services in warehousing andlogistics but without sacrificing control over the information flows that stemmed from them It also further

encouraged collaboration between complementary firms in the value adding chain, allowing pooling of

complementary sources of knowledge This, though it operated to the mutual benefit of all the parties involved, didnot oblige retailers to surrender the critical information regarding patterns of consumer demand Crucially,

information technology supported a shift from one-way to two-way processes of information exchange with

customers, allowing future purchasing trends to be anticipated and accommodated

A GLOBAL MOVEMENT

Parallels can be drawn with trends occurring in the US market in the same period Wal-Mart, for example, hasdeveloped one of the most mature retail ecosystems in the world Wal-Mart’s proposition is simple: good (oftenbranded) products at low prices K-Mart and Wal-Mart entered the discount market in the 1960s While K-Martopened stores near shopping malls and towns of more than 50,000 inhabitants, Wal-Mart targeted towns of around5,000 inhabitants, particularly in areas where they might serve more than one town Wal-Mart chose to competeagainst small stores, using its size to offer heavily discounted products This strategy proved successful While thearea was often big enough to support one store, it was not usually big enough to support more than one suchdiscounter This enabled Wal-Mart to beat its local competitors on price and protect itself from competition from itspeers such as K-Mart

Wal-Mart needed loyal and committed employees if it was to grow, which it needed to do to achieve economies ofscale Employees were provided with training and competitive pay and bonuses Many stores were located inremote parts of the country Wal-Mart’s strategy was to manage its network closely Control was maintainedthrough daily communication with the headquarters based in Arkansas Wal-Mart also needed an effective jointpurchasing and distribution system, so it set up a hub-and-spoke system of warehouses that provided goods tostores located no more than a day’s drive from the centre During the 1970s, Wal-Mart expanded through a

process by which it targeted an area, set up a hub distribution centre and then established as many stores in thearea as could be sustained by the local population This approach proved successful and deterred potentialcompetitors During the 1960s and 1970s, Wal-Mart focused on growth, and was quick to adopt new technologies

to support its rapid growth In the early 1980s, Wal-Mart launched its own satellite to stay in touch with its growingdistribution and store network

From the mid-1980s, Wal-Mart’s strategy was to consolidate By that time it had established itself in a nodalposition, leading and controlling a network of suppliers, many of which were major global product manufacturerswith considerable brand power The challenge for Wal-Mart business executives was to retain and increase

bargaining power against such influential suppliers Wal-Mart resisted pressure from suppliers to increase prices

By contrast, it put pressure on suppliers to continually lower their prices The low price strategy worked and Mart engendered strong brand loyalty among its customers Its policy of low prices without special sales or

Wal-promotions proved popular and became a de facto norm in discount retailing.

Growth and greater scale gave Wal-Mart better bargaining power, which it used to innovate with its value chain Itwas able to force suppliers to improve manufacturing efficiency by setting up crosscompany distribution systems Itcreated innovative relationships with key suppliers, often making use of new technologies to improve collaboration.James Moore reports, ‘[I]n 1987, Wal-Mart and Procter & Gamble reached an unprecedented accord to worktogether through extensive electronic ordering and information sharing between the companies In return, Wal-Martgives better payment terms than the rest of the retailing industry: on average, Wal-Mart pays its suppliers within 29days compared with 45 days at K-Mart.’ [ 1 ]Wal-Mart demonstrated its credentials as an innovator in other areastoo It successfully entered the membership discount market and was quick to use Internet technologies to improvecommunication and collaboration throughout the value chain

[ 1 ]James F Moore, Predators and prey: a new ecology of competition, Harvard Business Review, May–June 1993 (quoted from Don Tapscott, Creating Value in the Network Economy, Harvard Business School Publishing, Boston,

1999 (p 139)

The transformation of production processes that occurred across a range of manufacturing industries during theIndustrial Age generated new and more complex requirements for the processes of intermediation as well as forthe production systems themselves The development of hierarchical organizations provided firms with the ability tooversee directly many of these new tasks and to create the markets that supported them The advent of theInformation Age has tended not so much to require the creation of new markets as to alter the nature of existingrelationships of intermediation in ways that have facilitated a much wider collection of organizational forms

In this chapter we have outlined the transformation that took place in British food retailing and demonstrated howentire industries can be transformed through new business designs that create and deliver exceptional customervalue Chapter 3 describes how products are changing Many are becoming devices for delivering services It willalso describe how low-cost business models are emerging Chapter 4 analyses how business services evolve.Many manufacturers are introducing services because they are generally more profitable than products, andservices enable the creation and delivery of solutions Solutions are services-led Chapter 4 describes the

emergence of the solutions business model

1 James F Moore, Predators and prey: a new ecology of competition, Harvard Business Review, May–June 1993 (quoted from Don Tapscott, Creating Value in the Network Economy, Harvard Business School Publishing, Boston,

1999 (p 139)

Chapter 3: The Low-Cost Business Model

Mark Cerasale

INTRODUCTION

Every year it is becoming more difficult to satisfy customers and shareholders Homogeneity has become a

problem: companies offer increasingly similar products and services Further, many companies use similar workingpractices, and so produce similar results Powerful forces such as globalization, deregulation, easier access tocapital, new management approaches, cheaper and better information technology (IT), the Internet and increasingcustomer power have altered the competitive landscape for ever It is no longer enough to make and sell a product

or provide a service just like any other It’s time to do things differently

The very nature of products is changing Mass customization allows products to be tailored to the needs of

individual customers New products are brought to market more often and more quickly, causing over-supply.However, despite advances in technology, the rate of true product innovation is slowing At the same time, thespeed at which product and service innovation are imitated is increasing, leading to quicker product obsolescence

As a result, there is less opportunity to create and sustain healthy margins on new products The falling cost ofinformation technology has allowed manufacturers to embed technology, such as microchips, in many new

products When technology-rich products are connected to the Internet they become devices for providing services.Value is migrating from products to services

Over-supply of products and services has made customers more powerful Customers have become more

knowledgeable and sophisticated, and many demand exceptional value Some customers demand exceptionalvalue through solutions; others demand exceptional value through lower costs Some suppliers have sensed andresponded to these changes in customer demand and have developed and implemented models for solutioncreation and delivery or low-cost supply

THE CAUSES OF CHANGE

What forces shaped business in the 20th century? What will shape business in the 21st century? The 1980s and1990s were decades of increasing globalization and deregulation in many industries Unprecedented access tocapital meant that many new companies were formed and existing companies could grow New managementtechniques and best practices travelled the globe and became commonplace in many organizations The

widespread use of information technology and adoption of the Internet enabled further efficiencies Productivityimproved, competition increased and new markets emerged in the developed countries Many markets becamesaturated with products and services

Globalization

Globalization has increased competition Many products and services have become commoditized Over-supplyhas caused some markets to become saturated Manufacturing continues to migrate to developing economies,where labour costs are low China has successfully positioned itself to attract low-cost manufacturing and

assembly India has become a global centre of competence for software development Other developing countriesare looking to emulate these examples

Offshore companies have emerged for data entry, software development, customer support, financial services,equipment maintenance and many other services In the 1980s and 1990s, political stability, liberalization and theintroduction of free-market economics enabled Eastern Europe, Latin America and China to increase their

participation in world trade Developing countries can succeed by combining advanced communications,

transportation and technologies with a low-cost workforce

Globalization has raised the competitive bar and increased competition Many companies are moving their

operations to centres of excellence where they can access key resources and competencies such as processexpertise and technological know-how Many competencies are relocated to access the most advanced andsophisticated capabilities Thus, design might be based in Italy, technology development in the United States,engineering in Germany Geography no longer limits access to value added knowledge and capabilities

Deregulation

In the 1990s, deregulation accelerated in the United States and Europe Telecommunications, gas, electricity andwater industries transformed themselves to take up the opportunity Industrial giants expanded their portfolios totake on deregulated and non-regulated products and services Mergers and acquisitions were widespread.Companies grew in size, but in each market they met large competitors that had themselves crossed over theirown product frontiers Size allowed them to invest to overcome entry barriers, and economies of scale allowedthem to cut costs Ferocious competition led to price wars and lower margins New global giants emerged in newlyprivatized and deregulated industries Vodafone, a local UK player in the early 1990s, became the world’s largestmobile telecommunications provider

Access to capital

The state can no longer provide generous pensions Life expectancy and medical costs are rising fast The babyboom generation have invested heavily in the stock exchange, conscious of the need to prepare for a long andfruitful retirement They were accompanied by a new generation of investors eager to make a fortune, many laterdiscouraged by dot.com disasters Between 1995 and 2000 the NASDAQ Composite Index rocketed from 755 to4,696 and the Dow Jones Industrial Average climbed from less than 4,000 to nearly 11,500 This fuelled a hugeboom in capital spending Much of this fell apart in the early 21st century, leaving individuals and corporations with

assets depleted Corporations accelerated their search for low-cost solutions to their problems.

Economic growth fuelled by stock market investment and wide-scale share ownership energized the final decades

of the 20th century Start-ups and ventures flourished Established companies invested in new plant and

technology throughout the years of economic growth Despite the post-millennium economic downturn, when manyinvestors lost much of their life savings or their pensions, a culture of investment has been established Today,access to investment capital is neither the exclusive privilege of established companies, nor is it the inhibitor tobusiness it once was

New management approaches

Knowledge of best practice has spread throughout executive ranks through management training programmessuch as those leading to MBAs Professional services industries have evolved, and specialist advisory and

consulting firms have emerged to propagate new management ideas The effect has generally been positive.During the 1980s and 1990s new levels of efficiency and effectiveness were achieved through the widespreadadoption of new management approaches, techniques and tools

Occasionally when new approaches were adopted, unexpected consequences followed For example, during the1970s, global scale and experience effects were cited as key competitive advantages Companies made pre-emptive investments in large-scale plants in an attempt to secure the required minimum share of world capacity.While this strategy had the desired effect for many companies, in some industries it resulted in over-supply andsubsequently a need for price-cutting

Lean manufacturing, just-in-time (JIT) inventory management, total quality management (TQM), business processre-engineering (BPR) and focusing on core competencies are just a few of the concepts that transformed manycompanies in the final decades of the 20th century Without appropriate regulation against customer demand,productivity improvements have led to over-production and over-supply A further effect of homogeneity in

production techniques and business practices has been a reduction in product and service innovation and

differentiation

Information technology

During the 1980s and 1990s, information technology moved from the data centre into the hands of business users.Information technologies such as software applications offered opportunities to automate and integrate manualprocesses that were costly and prone to error At first, business software applications were often bespoke, but later

on, packages became available for applications such as computer-aided design (CAD), enterprise resourceplanning (ERP), supply chain management (SCM) and customer relationship management (CRM) Businessapplications and e-business (using Internet technologies to transform key business processes) combined to enablefurther productivity improvements According to Steve Hamm, Steve Rosenbush and Cliff Edwards, ‘Economistscredit tech spending with at least one-third of the productivity gains in the second half of the 1990s.’ [ 1 ]

In May 2003, Nicholas Carr published an article in the Harvard Business Review entitled ‘IT doesn’t matter’ [ 2 ]In it,

he argues that IT is affordable and accessible to most companies, and therefore no longer offers strategic value toanyone Certainly there are signs of commoditization in some parts of the IT industry; many IT products are

becoming commoditized As a result, the IT industry is entering a period of radical transformation In the future,products will increasingly be provided as services The widespread use of the Internet and availability of moreadvanced information technologies has led to a new phase of development for information technology

infrastructure and software application companies In the future, many IT services will be provided on a morevariable basis, much like a utility such as electricity Further analysis of the transformation taking place in the ITindustry will be provided in Chapter 5

The Internet

Information technology allows manual business processes to be automated The Internet has enabled many to betransformed; some processes can be eliminated all together E-business, the use of Internet technologies totransform key business processes, has had a profound effect on how many companies operate At first, internalbusiness processes such as human resource management (HRM) were transformed Later, as the Internet and e-business became more popular and pervasive, companies began connecting and integrating with their customers,business partners and suppliers.

The Internet has cut transaction costs, allowing companies to consolidate all manner of services such as IT supportthat before were provided locally at greater cost Lower transaction costs allow companies to source services such

as HRM support from third-party providers The Internet also facilitates closer collaboration between companies,allowing them to form strategic partnerships and virtual enterprises The lowering of transaction costs has alsoenabled companies to sell and distribute their products at lower cost

Mass customization of products

For most of the last century, manufacturing was the driving force of developed economies The product was king.From the beginning of that century, the pace of manufacturing innovation was breathtaking, and customer demandseemed insatiable Mass production transformed business and social life as new consumer markets were created.Mass production was the optimal model for the product economy, enabling uniform products to be manufactured inlarge volumes The 20th century was an age of product-led consumerism

Uniformity of the product was the key to mass production, yet mass production is based not on uniform products,but on uniform parts Those uniform parts can then be mass-assembled, or mass-customized, to create manydifferent products, tailored to the needs of each customer In mass production, products are produced and thenmarkets are created to distribute them In mass customization, products are assembled according to customers’individual needs and specifications Mass customization makes it necessary for business operations to begin withthe customer and work backwards This approach works better in the present era, now that the customer is moredemanding

Introduction of new products

The speed of introduction of new products has increased Customers have become more sophisticated and

discerning, and are demanding more of their suppliers than ever before This has increased pressure on suppliers

to bring new products to market more quickly and more frequently New information technology systems, design,manufacturing and product management techniques have greatly reduced the time it takes to introduce newproducts For example, in the automotive industry, the number of new vehicle models has increased significantly inrecent years

According to Ralph Szygenda, group vice president and chief information officer at General Motors, ‘We’re cuttingour product design cycle dramatically A few years ago, we had a 48-month design cycle

Today, we’re approaching 18 months,’ he said ‘We now have web-based design iteration flexibility lacking a fewyears ago Our common digital-based systems permit teams to design vehicles globally linked to production,procurement, and other GM functions.’ He also noted that GM has ‘integration centers’ around the world thatconnect designers, engineers, suppliers and manufacturing [ 3 ]

Product innovation

Greater customer sophistication and competition mean there is more need for continuous product innovation.However, the speed of product innovation appears to be decreasing The frequency of ground-breaking productand service innovations has slowed in most industries What was the last big product innovation in your industry? Isthere any sign yet of the next one? A study published in late 2002, as many economies were sliding into recession,

concluded that many consumers are not buying because they are disappointed by the level of innovation in virtuallyall product and service sectors [ 4 ]

As products become embedded with technology such as microchips and are connected to the Internet, theyprovide opportunities to access new services Perhaps product innovation in the future will appear less in the form

of traditional features and functions and more in the form of services delivered by the product? As everyday

devices at home and work become ‘intelligent’ with information technology and ‘connected’ to the Internet, there will

be more opportunities for innovation in service delivery

Product imitation

While the speed of product innovation may be slowing, the speed of innovation imitation is increasing Increasinglytransient employees, many of whom are so-called knowledge workers, take valuable knowledge with them whenthey leave Transient workers, flexible manufacturing and the proliferation of information have greatly reducedimitation cycle times When features and functions are embedded in software and services (and can be provided asupgrades over the Internet), imitation can occur almost instantaneously

In the automotive industry, features such as anti-lock braking and air-conditioning are standard on many vehicles Itwill not be long before more vehicles have telematics systems ‘as standard’, providing in-car entertainment andinformation services directly to the vehicle Innovation imitation is not confined to products It also extends toprocesses, organizations, policies and procedures, and, indeed, whole business models

Product obsolescence

The increasing frequency of new product introductions and the faster pace of innovation imitation have shortenedproduct life cycles Products and services are becoming obsolete more rapidly than ever before In the IT industry,Moore’s Law can be applied to many products Gordon Moore, founder of Intel, predicted that the processingpower of computer chips would continue to double every 18 months, while the cost of producing them would holdconstant or decrease While Moore’s Law applies primarily to information and communication technologies, similartrends appear in many industries Rapid product obsolescence and over-production have resulted in over-supply.Surplus stock and costly inventories have led to price discounting and margin erosion

Products as devices for providing services

The very nature of products is changing Taichi Sakaiya, director general of the Economic Planning Agency ofJapan, once predicted that ‘The significance of material goods [will be] as containers or vehicles of knowledge-value.’ [ 5 ]Many products are embedded with information technology such as microchips, enabling them to beconnected to the Internet and remotely accessed, managed and continually upgraded As information technologycontent and connectivity increase, the value a product creates migrates to the services it provides access to.Products are becoming devices through which services can be accessed

In the future, products may be introduced as ‘Trojan horses’ – a means of establishing a physical presence in anoffice, a factory or the home through which new services will be provided Many companies are designing productswith services in mind Microsoft may have introduced the X-Box to tap into the multi-billion-dollar games market but

it also clearly recognized an opportunity to connect a new generation of consumers to the Internet In the future, theX-Box may be positioned as an alternative to the PC for accessing all kinds of consumer services such as e-mail,television and movies

In the manufacturing industries of the future, the services and upgrades may count more than the product

Investment in technology has already transformed the nature of many industrial businesses As Jack Welch, chairman and CEO of General Electric (GE) put it, ‘Investing heavily in technology for services has changed thefundamentals of our service business Long-term service agreements wouldn’t be possible without these large

ex-investments in technology and… have greatly increased our intimacy with customers.’ [ 6 ]

The manufacturing industries of the future will be increasingly services-led Products may even be seen as a cost

of doing business According to Jeremy Rifkin, ‘With the containers or platform becoming so cheap to produce, andquality controls indistinguishable, the only area where opportunities exist to make money is in delivering expertise

to customers in the form of services While gross margins today are generally less than 30 percent, gross margins

in service-related activities often exceed 50 percent.’ [ 7 ]

Some companies are turning their backs on traditional ‘cost-plus’ charging models They make little or no profitfrom selling the product Instead, they charge customers for upgrades and support services In the mobile phoneindustry, network service providers often heavily subsidize products Some computer software firms give theirproducts away for free and charge only for upgrades and maintenance services The challenge in using thisapproach is to keep customers long enough to recoup product costs This depends on whether suppliers candevelop enduring relationships with customers by providing them with the value added services they require.Neil Gross, Peter Coy and Otis Port, in an article entitled ‘The technology paradox’, claim that

The new rules require more than ingenuity, agility and speed They call for redefining value in an economywhere the cost of raw technology is plummeting toward zero Sooner or later, this plunge will obliterate theworth of almost any specific piece of hardware or software Then, value will be in establishing a longtermrelationship with a customer – even if it means giving the first generation of a product away [ 8 ]

The customer has replaced the product on centre stage

[ 1 ]Steve Hamm, Steve Rosenbush and Cliff Edwards, Tech comes out swinging [Online],

http://www.businessweek.com [accessed 23 June 2003]

[ 2 ]Nicholas G Carr, ‘IT doesn’t matter’, Harvard Business Review, May 2003 (pp 3–10)

[ 3 ]Ralph Szygenda, Group Vice President and Chief Information Officer at General Motors, Auto Engineering

International, 2002

[ 4 ]According to a recent study published by Accenture (Stimulating Customer Demand through Meaningful

Innovation, November 2002), if consumers believe that a product will both be innovative and improve their quality of

life, 70 per cent of them are willing to pay more The report concluded that ‘Many consumers aren’t buying – oraren’t buying more – because they’re convinced that few companies have given them a compelling reason to do

so In short, they said, they’re disappointed by the level of innovation they value in virtually all product and servicesectors.’ According to the survey, there is an untapped resource among consumers: a desire for both high-qualityand innovative items See http://www.accenture.com/xdoc/en/ services/sba/sba_ideas_innovation.pdf

[ 5 ]Taichi Sakaiya, The Knowledge-Value Revolution, or, A History of the Future, trans George Fields and William

Marsh, Kodansha International, Tokyo, 1991 (p 60)

[ 6 ]Jack Welch, ‘Jack, What I’ve Learned Leading a Great Company and Great People’, Warner Books, New York,

2001 (p 322)

[ 7 ]Jeremy Rifkin, The Age of Access, Penguin Books, London, 2000 (p 92)

[ 8 ]Neil Gross, Peter Coy and Otis Port, The technology paradox: how companies can thrive as prices dive,

Business Week, 6 March 1995 (pp 76–77)