Better, Simpler Strategy by Felix Oberholzer-Gee

1 Simpler, Better

In the past few decades, strategy has become increasingly sophisticated. If you work for a sizable organization, chances are your company has a marketing strategy (to track and shape consumer tastes), a corporate strategy (to benefit from synergies), a global strategy (to capture worldwide business opportunities), an innovation strategy (to pull ahead of the competition), an intellectual property strategy (to defend the spoils of innovation), a digital strategy (to exploit the internet), a social strategy (to interact with communities online), and a talent strategy (to attract individuals with extraordinary skills). And in each of these domains, talented people work on long lists of urgent initiatives.

Companies are right, of course, to consider all these challenges. Rapid technological change, global competition, supply chain disruptions due to climate change and worldwide health emergencies, as well as ever-evolving consumer tastes, do conspire to upend traditional ways of doing business

I see evidence of such increased expectations everywhere. They manifest themselves in outstanding products, unbelievable experiences, and deals of a lifetime—but also in long working hours, seemingly impossible stretch goals, and harried lives

Think about it. How can it be that so many companies, their ranks filled with talented and highly engaged employees, have so little to show for so much effort? Why do hard work and sophisticated strategy lead to enduring financial success for some companies but not for others? We have the most educated workforce in human history and incredibly talented corporate leaders. Why does enduring success so often seem elusive?

When our companies fall short of expectations, we often suspect that we are missing some key ingredient. If only we had a better talent strategy. If only we had a more robust supply chain. If only we had a richer innovation pipeline. If only … And so we develop a talent strategy, invest in business resilience, accelerate innovation cycles. As our strategic initiatives multiply, something unforeseen happens. In concentrating on all the trees, we lose sight of the forest. In a profusion of activities, an overall direction, a guiding principle, is hard to see Any promising idea is an idea that seems worth pursuing. In the end, common sense rules, and strategy loses much of its ability to steer our businesses. In this world, strategic planning becomes an annual ritual that feels bureaucratic and less than helpful in resolving critical issues. In fact, it is not difficult to find firms that have no strategy at all. In many others, it consists of an 80-page deck that is rich in data but short on insights, fabulous at listing considerations but of little help in actual decision-making.1 When I review companies’ strategic plans, I often see a plethora of frameworks—many of them inconsistent with each other—but few guideposts for effective management

In this book, I argue that strategic management faces an attractive back-to-basics opportunity. By simplifying strategy, we can make it more powerful. By using an overarching, easy-to-grasp framework that is tied to financial success, we gain a common language that allows us to evaluate and pull together the many activities that take place in our organizations today.

I have seen the effect of simpler thinking in hundreds of executives I have taught at Harvard Business School. These managers were familiar with popular strategy frameworks, and their firms had often implemented laborious planning processes to guide investment decisions and managerial attention. Yet in many instances, it was difficult, even for these accomplished professionals, to recognize how specific projects were linked to their firm’s strategy. At best, strategy provided smart arguments for and against business propositions, but it offered little guidance on how to choose and where to focus. As a result, initiatives and activities proliferated. When no one knows when to say no, most ideas (brought forward by talented and ambitious employees) seem like good ideas. And when most ideas seem like good ideas, we end up in the hyperactivity that pervades the business world today

I honed my approach to strategy in response to the challenges that I observed in the classroom and in my capacity as an adviser to companies. In my experience, value-based strategy, the approach I describe in this book, is well suited to cutting through complexities and evaluating strategic initiatives. The framework provides a powerful tool that will allow you to see how your digital strategy is (or is not) related to your global ambitions, and how your marketing strategy is (or is not) consistent with the way you compete in the market for talent. Value-based strategy helps inform your decisions about where to focus and how to deepen your firm’s competitive advantage

The basic intuition underlying value-based strategy could not be simpler: companies that achieve enduring financial success create substantial value for their customers, their employees, or their suppliers

Willingness-to-pay (WTP) sits at the top end of the value stick. It represents the customer’s point of view. More specifically, it is the most a customer would ever pay for a product or service. If companies find ways to improve their product, WTP will increase

Willingness-to-sell (WTS), at the bottom end of the value stick, refers to employees and suppliers. For employees, WTS is the minimum compensation they require to accept a job offer. If companies make work more attractive, WTS declines. If a job is particularly dangerous, WTS increases and workers require more compensation.4 In the case of suppliers, WTS is the lowest price at which they are willing to sell products and services. If companies make it easier for their suppliers to produce and ship products, supplier WTS will fall

The difference between WTP and WTS, the length of the stick, is the value that a firm creates. Research shows that extraordinary financial performance (returns in excess of a firm’s cost of capital) is rooted in greater value creation.5 And there are only two ways to create additional value: increase WTP, or lower WTS.6 Strategy is conceptually simple, and simpler strategic thinking, I am convinced, will lead to better outcomes

Renew Blue

An example of the power of this approach is Best Buy, America’s biggest consumer electronics and appliances retailer. In late 2012, the company was looking for a new CEO. Imagine yourself taking on this role. It seemed impossible to succeed. Best Buy, most of us thought, was doomed. Amazon had successfully grown its electronics business at the expense of Best Buy, offering consumers a broad selection of products and aggressive pricing

Hubert Joly, a former strategy consultant and most recently CEO of Carlson, a hotel and travel conglomerate, took on the challenge. Recognizing the dire circumstances, Joly and his team devised a plan they dubbed Renew Blue. The core idea was to create more customer value by increasing WTP and improving price perception. Rather than thinking of Best Buy’s more than 1,000 stores as a liability that made it difficult to compete, the company reimagined their role and turned them into assets. Going forward, the stores would serve four functions: points of sale (the traditional role), showrooms for brands that built stores-within-a-store, pickup locations, and mini-warehouses

Best Buy had allowed Apple to operate its own showrooms in Best Buy stores starting in 2007. Joly expanded the program, adding Samsung Experience Shops and Windows Stores in 2013 and the Sony Experience a year later. Even Amazon eventually opened kiosks in Best Buy stores

Renew Blue provided Best Buy a new lease on life. Look at all the ways in which Joly and his team managed to increase customer WTP and decrease vendor and staff WTS

The Best Buy turnaround illustrates some of the key principles of value-based strategy:

• Companies that excel at creating value focus squarely on WTP and WTS. Every significant initiative is designed to either enhance the customer experience—that is, increase consumers’ WTP—or make it more attractive for vendors and employees to work with the company, in other words, decrease their WTS
• Companies that outperform their peers increase WTP or decrease WTS in ways that are difficult to imitate. Best Buy’s most distinctive asset is its large network of stores. Skillful, impartial service provided in a brick-and-mortar environment is difficult for Best Buy’s competitors to match
• Simplicity opens up room for creativity and broad engagement. Joly describes the Renew Blue strategy in the simplest of terms: Our mission is to be the destination and authority for technology products and services. We are here to help our customers discover, choose, purchase, finance, activate, enjoy, and eventually replace their technology products
• Many of the most successful companies focus on their competitive position inside an industry, as opposed to the average performance of their segment of the economy. There are three reasons why this type of thinking is prevalent in companies that create exceptional value A first is that in most industries, variation in profitability inside the industry exceeds the profitability differences across industries. A second reason to focus on competitive positions inside an industry is that positive industry fundamentals will simply be reflected in the multiples that companies need to pay to enter an attractive industry. Finally, for companies that happen to be in struggling industries, a focus on headwinds is demoralizing, and it likely contributes to decreases in productivity
• Was Best Buy lucky? No doubt The best firms build on their circumstances, whatever those may be. Value-based strategy is not about the hand that you are dealt. It is about better ways to play
• Will Best Buy be a long-term success? Time is generally not kind to high-performing organizations

A Preview

In the pages that follow, I will take the principal idea that animated Best Buy’s strategy—long-term financial success reflects superior value creation—and explore how firms in different industries and business contexts have applied this approach in practice. Think of this book as a journey along the value stick

Part one (Exceptional Performance)—We ask why some companies are so much more successful than others

Part two (Value for Customers)—Do you tend to root for the underdog? If so, you will love the story about the ways Amazon gained a toehold in the market for consumer electronics in fierce competition with then-dominant Sony

Part three (Value for Talent and Suppliers)—Our attention will swing to the bottom of the value stick. We will meet companies that gain a competitive advantage by decreasing the WTS of their employees and their suppliers

Part four (Productivity)—If you had to guess, how wide do you think the productivity gap is between an industry’s bottom 10 percent of companies and the top 10 percent? It is substantial

Part five (Implementation)—As the first parts of this book show, strategies that lead to exceptional performance are built on three ideas: value for customers (raising WTP), value for employees and suppliers (reducing WTS), and increases in productivity (lowering cost and WTS).

Part six (Value)—Strategy is conceptually simple, because it serves a single purpose: creating value. Companies that do this well end up leading their industries

Value-based strategy is uniquely suited to help us see a way forward. To make progress, value must sit at the very core of every business. Even the most vexing problems can bend when we apply enough creativity and imagination to create more value for customers, employees, and suppliers As far as value creation is concerned, there is no difference between shareholder and stakeholder capitalism. Creating more value—increasing WTP and lowering WTS—is simply good business. But value-based thinking also shows that we have considerable degrees of freedom to decide how to share the value that we create. Companies can balance multiple interests; there is no reason to believe that firms need to be beholden to shareholders alone. As we debate how value is best distributed, value-based thinking can serve as a helpful guide

2 A Sea of Opportunities

I know it is probably poor storytelling, but I am tempted to share the good news right up front. I am incredibly optimistic about the potential of most companies to create more value and substantially improve their financial performance

There is no one metric that captures all facets of financial performance. But if I had to pick a single one, I would choose return on invested capital (ROIC). ROIC compares the profit realized from business operations (operating income) with the capital (equity and debt) that is employed to generate that profit. In other words, ROIC tells us how good a business is at turning investors’ funds into income from operations

When I first studied this type of data, I was surprised by the large differences in performance. These are all large, well-known companies—think Microsoft, Boeing, CBS, FedEx, and Twitter. Yet it is remarkable how much an average firm (ROIC of 13.1 percent) could improve if it moved closer to the very best performers, companies like AutoZone (average ROIC of 41.9 percent), Colgate-Palmolive (37.6 percent), and Apple (32 percent).

When I meet with executives whose companies achieve less-than-stellar performance, the typical conversation quickly turns to industry dynamics

But even in an industry as challenging as insurance, we observe stark differences in financial performance. Somehow it is possible to do well, and the best companies achieve remarkable returns in excess of 20 percent.

Insurance is not an exception. In industry after industry, the leading companies outperform their weaker siblings by substantial margins

Looking at star performers over time yields a glass half-full/glass half-empty story. The good news is that the most successful companies continue to outperform their rivals. Microsoft is a prime example

The perception that competition is more heated than before is real, no doubt. But is it true? We can test this view by examining the speed of decline in financial performance in different periods of time.

The performance of leading companies suffers over time, but the trend is no more pronounced today than it was at earlier points in time

Seeing these broad patterns of financial performance, I hope you walk away as optimistic as I am. For nearly every company, substantial improvements in performance are within reach. Here is what I have learned from exploring the data

• In every corner of the world economy, it is easy to find firms that are far more financially successful than others
• Even after accounting for the influence of business cycles and country environments, we are left with significant differences in profitability across companies that operate in the same industry
• Even modest advances have dramatic financial implications
• The potential for performance gains inside your industry is usually greater than the gains you should expect from entering a different industry
• There is little evidence in the data that attaining stellar financial results over long periods has become more difficult

3 Think Value, Not Profit

There are few better places to observe value creation than outside the entrance of an Apple store. Watch customers as they exit with their elegant, beautifully packaged devices in hand. Sure, they paid a hefty price for the superb design, but just look at their faces, beaming with pride and anticipation! Or online, head over to Facebook and Instagram, where you will see other instances of value creation. Look at the pictures and videos your friends post when they receive a coveted job offer or earn a promotion. Happy faces again

Think of WTP and WTS as walk-away points. WTP is the maximum a customer would ever pay for a product. Charge one cent more, and the customer is better off walking away from the transaction

Value Capture

Companies create value by increasing WTP and decreasing WTS. They capture value by setting prices and compensation. The overall value that a business creates gets divided three ways

The difference between WTP and price is value for the customer. Apple’s products may be expensive, but customer appreciation for the devices is even higher. The happy faces at the Apple store mirror the degree to which WTP exceeds the price. In value-based thinking, price is not a determining factor of WTP. We often use WTP and price interchangeably. But it is useful to keep them separate

At the lower end of the value stick, the difference between an employee’s compensation and her WTS is the satisfaction that she derives from work. The idea is simple. If compensation were set exactly at WTS, she would be indifferent between work and her next best opportunity—perhaps another job, perhaps leisure. If the firm pays more than WTS, employee satisfaction increases. A similar logic applies to suppliers. Their share of value is the difference between how much they get paid by the firm (the firm’s cost) and their WTS. Think of it as a surplus that the suppliers earn from the transaction

The final portion of value—the difference between price and cost—accrues to the firm. Think back to chapter 2 and the dramatic differences in profitability that we observed. If we want to understand why some companies are much more profitable than others, a useful starting point is to identify the reasons why the middle section of the value stick—the firm’s margins—is slim for some companies and fat for others

Value sticks illustrate that there are only two avenues for companies to create value: increase WTP or decrease WTS. Every strategic initiative needs to be evaluated against these two metrics. Unless an activity increases WTP or decreases WTS, it will not contribute to the firm’s competitive standing. When I visit companies, I am always impressed by the myriad of activities I observe. At the same time, I often find myself at a loss to see how certain initiatives will help increase WTP or decrease WTS. If your organization feels overburdened, if you feel unreasonably stretched, here is your chance to cut back. Unless an initiative promises to increase WTP or decrease WTS, it is not worth pursuing

Competition

To see how much value companies manage to capture, it is helpful to take into account competitive forces

Imagine you are going to book a round-trip flight from Boston to Los Angeles. Expedia offers a variety of options. The three lowest-priced flights are on American Airlines, Alaska Airlines, and Delta Air Lines. They are all priced similarly

How would you choose between the three options?

The price of the flight, I am sure, will loom large in your decision. Why? Simply because there is nothing else to consider. The more similar the three value sticks, the greater is the tendency for passengers to focus on price

In fact, it is no coincidence that the prices for these flights are so close. Lacking meaningful differentiation, the three airlines are forced to compete on price.

At times, I meet businesspeople who complain about their customers’ price sensitivity. But heightened sensitivity simply reflects a firm’s competitive position. If the value stick of a business closely resembles the value stick of other businesses, how do you suppose customers choose? They will focus on price, putting pressure on margins and reducing the firm’s ability to capture the value it creates

By contrast, firms that create superior value enjoy an increased ability to charge premium prices. Expedia rates JetBlue’s least expensive Boston to Los Angeles flight an 8.7. Not surprisingly, it is priced higher ($411); passengers expect a better experience

What matters is the difference between WTP and price—in other words, customer delight.

Differences

As this discussion illustrates, all ability to capture value depends on differences in value creation. In their quest for exceptional performance, many executives ask themselves what they might do to increase their firm’s returns This is the wrong question to set out from. To begin your journey toward increased financial performance, create differentiated value and profits will follow. Fail to do so, and no amount of business acumen will generate exceptional results. The greater the similarity between two value sticks, the greater the pressure to compete on price

When I ask executives who apply value-based strategy in their business what they perceive as particularly useful about this type of thinking, they often make the following points

• We live in a complicated world. Value-based strategy helps us see how we can create value
• In competition, more generous margins (and greater profitability) reflect an ability to create superior customer delight, greater employee satisfaction, and more generous supplier surplus
• Strategists think in differences

A profound question to ask is the following: If your company were to disappear tomorrow, who would miss it? Perhaps your customers, who found supreme delight in your products and services? Perhaps your staff, who cherished working in your company? Perhaps the suppliers, who enjoyed a special relationship with your firm? Someone needs to miss you. If no one misses you, if your value stick resembles everybody else’s, you are not making a difference. And without a meaningful difference, your company has little chance of earning returns in excess of your cost of capital

Part Two Value for Customers

4 Claps and Cheers Creating Customer Delight

What do the Rubik’s Cube, the cholesterol drug Lipitor, the Switch game console, Super Mario Bros., the Toyota Corolla, and Lady Gaga’s Fame perfume have in common? They are all products that flew off the shelves as soon as they were launched. The Rubik’s Cube sold 2 million units in the first two years. Nintendo’s Switch racked up 1.3 million unit sales in a single week. In each of their respective categories, these are among the most successful product launches of all time

As these examples illustrate, there are innumerable ways to raise the WTP for products and services. Think of WTP as a wide-open construct. It is influenced by the utility of products, the pleasures they evoke, the status they confer, the joy they bring, and even by social considerations that have little to do with the characteristics of the products themselves

Companies that focus on WTP enjoy a long-term competitive advantage for several reasons. One is that we trust companies that have our best interests at heart. In addition, these organizations are often better at identifying opportunities for value creation. They also tend to be more skillful at recognizing the needs of multiple groups of customers and intermediaries, paying attention to instances where raising the WTP for one group lowers the WTP for others. Finally, companies that raise WTP substantially benefit from customer selection effects. Let me illustrate each of these factors with an example

Customers’ Best Interests

Clients’ WTP and customer delight always came first

Identifying Novel Opportunities

Focused on WTP. With that broader notion, it offered convenience throughout the customer journey

Once you start thinking in terms of WTP, new opportunities to create customer delight arise all the time, and all kinds of obvious decisions become a little less evident.

Recognizing the Needs of Customers and Intermediaries

Business models describe how companies capture value. Without value creation, however, the question of how you capture value is moot. Even worse, an obsession with business models can easily undermine value creation

Benefiting from Customer Selection Effects

Companies that focus on WTP also perform better because they get to serve the right customers. Depending on how your company raises WTP, specific groups will find your product extra appealing

WTP as Your North Star

The difference between a product-centric mindset that is motivated mostly by sales and a mindset that focuses on WTP may seem like a fine distinction at first

Taking value creation seriously can have dramatic strategic consequences

Making It Stick

Even in organizations whose culture is firmly centered on customer WTP, it is helpful to develop practices that periodically remind everyone of their firm’s focus

Amazon is well known for a set of practices that encourage the organization to think in terms of WTP. In Amazon meetings, there is always an empty chair. It is reserved for the customer, whom the meeting ostensibly serves.23 When Amazon managers build a new service, they begin by writing an internal press release that announces the launch of the (not-yet-existing) service.24

This practice—working backwards in Amazon-speak—encourages employees to determine a target audience first and then describe the appeal of the new service

The concept is so simple: increase the maximum amount that a customer would ever be willing to pay for your product. The resulting opportunities, however, are extraordinary. As you begin to use the value stick and WTP to formulate your company’s strategy, keep these considerations in mind

• A sales-focused mindset risks ignoring opportunities to raise customer WTP
• An obsession with business models—how you capture value—is particularly risky, because value capture is a zero-sum game
• Interdependence is the rule, not the exception
• Leading need not mean winning
• What do executives love best about customer delight? The fact that it is highly contagious

5 Hiding in Plain Sight Near-Customers

How much do you know about individuals (or businesses) who are not currently active in your market? Is it really true that they would never, ever purchase your product? Are you perhaps just a small twist away from turning them into customers

Most managers pay scant attention to consumers who are not in the market. Once the addressable market is defined, the conventional thinking goes, why waste time chasing unlikely prospects? But as Taobao’s success illustrates, attractive business opportunities may hide in plain sight, in the very near-customer segments that we tend to write off. Drastic misperceptions are one reason why these segments may seem impenetrable. Recall that willingness-to-pay (WTP) and customer delight reflect opinions and impressions, not facts and figures. If near-customers hold misguided views, it is challenging to see their true demand for a product or a service

Of course, not every customer who is not in the market represents an attractive target. Think of a continuum of individuals ranging from those who would never buy your product to the most loyal group

Near-customers are the ones whose WTP is fairly close to the level that is required to make a purchase. Understanding the determinants of this group’s WTP can reveal substantial business opportunities. It is useful to ask, Why are your near-customers not in the market for your product? Do they misperceive its value? How might you tweak your offering to boost their WTP and turn them into buyers?

Studies of customer journeys often reveal why near-customers do not buy. For instance, the reasons why people abandon online shopping carts suggest multiple ways to boost WTP

When seeking business success with near-customers in mind, ask the following questions.

• Do you have a deep understanding of the reasons why some individuals do not consider your products or services?
• Do stereotypes prevent your organization from learning more about near-customers?
• Do you assume that serving near-customers will require significant investments in product or service?
• Do your incentive systems discourage interactions with near-customers?

6 Looking for Helpers Winning with Complements

Products and services that raise the willingness-to-pay (WTP) for another product are called complements. These (easily overlooked) helpers contribute substantially to the WTP of just about every product ever created. Just think of all the complements without which cars would be far less valuable: roads, parking garages, gas stations, repair shops, GPS, and driving schools

It is difficult to overestimate the importance of complements. Without them, the WTP for many products and services would be far lower, sometimes even zero. Smartphones and applications, printers and cartridges, coffee machines and capsules, ebooks and tablets

Think about your own business. What complements raise the WTP for your products and services?

Complements are particularly powerful if they raise the WTP for your product specifically

Ask yourself how your company benefits most. If you want to grow the category—a rising tide lifts all boats—non-proprietary, industry-level complements suit your needs best. If your goal is to gain market share, proprietary complements are more powerful

Did your company choose this latter option? If so, watch out for entrepreneurs who create value by breaking exclusivity and creating industrywide complements

Discovering Complements

Companies are often counseled to focus on a limited set of products and services. As a rule, this is good advice. Mastering new activities is challenging, and collaborating with companies that possess specialized knowledge often beats in-house production. But focus must not be taken to mean that you overlook factors that help lift the WTP for your products

When I introduce the concept of complements in my courses, I often ask participants how they would increase the WTP for a moviegoing experience. The most common suggestions I receive are installing more comfortable seats, improving sound, and enabling online seat reservations. Note that all of these ideas improve the WTP for the experience itself. This is how we usually think about creating value; we focus on making the products themselves more attractive. When I push for complements, I often hear popcorn, sometimes alcoholic beverages. Seldom does anyone mention parking

What I learn from such responses is that it is not easy to discover complements. We know they are important, but seeing them is not straightforward

Shifting Value

You are already familiar with many instances where this mechanism is at play. Consumers purchase bigger cars when gasoline is less expensive. We don’t mind spending hundreds of dollars on smartphones so long as there are lots of free (or cheap) applications available. Concert prices rose quickly once recorded music was freely available on the internet.16 In each of these instances, falling prices for one product raised the WTP for a complement. In business, we typically treat falling prices as bad news because it is more difficult to be profitable when pricing pressures mount. This view is incomplete, however. What really happens is more subtle. When prices fall, value shifts; it moves from the less-expensive product to its complements

Frenemies

A complementor is not your friend. Complementors appreciate each other because they jointly create value. And they quarrel over how to share that value

As you explore the importance of complements for your organization, remember that working with complementors can be difficult emotionally. Feeling bitter and disappointed when they seek to capture value will make it more challenging for you to see the next set of opportunities for collaboration. At the same time, a naive attitude that sees complementors as friends can leave your business with little protection from value-grabbing complementors. The most successful executives maintain a delicate emotional balance in their relationship with complementors: optimistic with regard to the promise of collaboration and, at the same time, realistic about the need to share (and occasionally fight for) their slice of the pie.

Profit Pools

Some companies don’t have to worry about frenemy-complementors; they offer their own complements. Michelin has tires and guides. Gillette manufactures blades and razors. Apple created portables and iTunes. Some companies use their own complements to differentiate a core service in which they enjoy little advantage

A common recommendation is to give away the core product and increase the price of the complement.

Technology companies face similar questions. Some underprice their hardware and make money on software

But then there is Apple. It follows exactly the opposite strategy. It sells hardware at a premium and gives away software. When the company introduced iTunes, not only was the software free, but Apple also gave away the entire value of music. After paying music labels about 70 cents for each song downloaded from iTunes, the 99-cent price tag barely covered the cost of credit card processing and Apple’s own operations

The ability to move pools of profit from intensely competitive domains to calmer waters is one of the great benefits of producing complements in-house and controlling their supply, as Apple does

As you think about how to price complements, it is helpful to consider the two extreme options. What if you made the bulk of profits with your main product and gave away the complements? What if you were to do the reverse?

Competition is the most important but not the only factor that guides the monetization of complements. Product variety and the timing of consumer purchases also help you decide how to shift profits

As I think about complements, the following observations strike me as particularly important

• Complements help raise WTP
• Complements often seem unrelated to the core of your business
• We want complements to be inexpensive (unless we sell them)
• Complementors are frenemies
• Companies that produce their own complements get to shift profit pools from one complement to another

# 7 Friend or Foe?

Business history provides numerous examples that illustrate how difficult it is to recognize complements. When radio became popular in the 1920s, the American Society of Composers, Authors and Publishers (ASCAP) battled the new medium, convinced that radio would reduce record sales

In other instances, it is difficult to predict how the relationship between two products will evolve over time. Computers and paper are a good example

Computers arrived, as predicted, and the consumption of paper exploded. Computers and printers proved to be complements, not substitutes.

History teaches two lessons: When you are asked to predict the influence of a new technology or a novel business model, don’t trust your intuition too much. This is a difficult task. Carefully thinking through the timing of the likely consequences and considering second-order effects can help you get it right. Second, never forget that you are more inclined to see substitution than complementarity. For all their importance, complements are difficult to spot.

Measuring Complementarity

Studying history is useful because it helps us see broad patterns of technological progress and executive judgment. Unfortunately, in our day jobs we cannot afford to watch history unfold to reveal complementarities and substitution effects. We need to press ahead.

Turning to data is a natural response. Couldn’t careful analysis tell us whether a new technology is a substitute or a complement?

To gain further insight, you can study time trends. Did the readership of printed products collapse right after you launched the online version? How did the beginning of e-commerce operations influence same-store sales? As you study time trends, keep the computer-and-paper example in mind. The relationship between products is not set in stone; it evolves with customer preferences and habits. As a result, time trend analyses need to be updated frequently.

The most powerful way to study complementarities is by experimenting and A/B testing. This approach provides deep insights, because it directly simulates the world that we cannot see

Distinguishing complements from substitutes is often surprisingly difficult. When I study companies that have developed a sophisticated approach to telling them apart, I see the following.

• These organizations are aware of a built-in bias to mistake complements for substitutes. They always ask, What is the best case you can make to argue that a new technology or a new product might be a complement?
• Pattern recognition and trend analyses are quick, inexpensive ways to identify complements. They are useful but not foolproof.
• The most advanced firms run experiments to guide their intuition about complementarities

8 Tipping Points

Network effects are a positive feedback loop: as more retailers attract a larger number of customers, additional retailers are drawn in. Network effects can cause markets to reach a tipping point: to spring from very low adoption to universal acceptance in no time at all. And the reverse is true as well.

Three Flavors

It is useful to distinguish three types of network effects. They all raise WTP as adoption of a product increases, but the mechanism by which this occurs differs

Direct network effects increase WTP whenever additional customers purchase a product (figure 8-2a). Any communication device is a good example. Think of the very first person who bought a fax machine. The device had no value; there was no one with whom to exchange fax messages. As the machines proliferated, the WTP for fax machines increased with the number of businesses and individuals who owned one

Indirect network effects raise customer WTP with the help of a complement (figure 8-2b). Game consoles and games, cars and repair shops, and smartphones and applications are all examples of markets with indirect network effects. As more customers purchase smartphones, developers will create more apps

The third type of network effect is characteristic of platform businesses (see figure 8-2c). These companies attract more than one type of customer (or supplier), and WTP increases for one group as the other grows larger. Think of online travel agencies. Hotels find it more advantageous to list their properties on Expedia as more people book on the platform

Sometimes, Winners Take All

Fifteen years after its founding, Facebook dominates social media. With 2.4 billion monthly active users, the company is the leading social network in more than 90 percent of all countries. Its share of social media page views is 50 percent in the United States, 70 percent in Africa, and 80 percent in Asia*, Europe, and South America.3 While successful historically, the company is now under enormous competitive and political pressure

Facebook’s performance is testament to the remarkable power of network effects. The company benefits from all three types

At their most powerful, network effects provide formidable advantages, and markets tip in favor of a few companies

The Geography of Network Effects

The strength of network effects depends on the number of users, but the relevant number is rarely the global one. Think of a company like Uber. Platform network effects play in its favor. Passengers benefit if the number of drivers increases, and drivers are more likely to join Uber if there are more passengers. But for Uber, the relevant number of users is entirely local

Local Competition

How many different ride-sharing apps do you use? If I had to guess, I would say more than one. If you live in San Francisco, you probably have apps for Uber and Lyft. If Jakarta is home, I would guess you use Gojek and Grab. In Seoul, I would expect to see Kakao, TMap, and perhaps even TADA. Not only do network effects rarely lead to Facebook-style global dominance, even at the local level, winner-take-all outcomes are the exception. Different platforms often compete side by side

As wait times fall, the incremental benefit to passengers gets progressively smaller. Few people care whether their car arrives in a minute or in 30 seconds

Ride sharing teaches a critical lesson. It is wonderful to know that your business benefits from network effects. It is even more important, however, to have a thorough understanding of how the number of customers will influence WTP. Knowing the mechanism by which adoption raises WTP helps you assess how competitive a market will be.

In all these examples, it is key to think about the incremental customer delight and supplier surplus that is created as you broaden the scope of platform services. Do you really strengthen your network effects—even at your current scale?

The Price of Exclusivity

It is interesting to apply the lessons of 1997 to Apple’s current situation. Figure 8-6 shows the company’s market share in mobile operating systems.18 Is Apple in trouble once again?

It is easy to see that same scenario. The company sells expensive phones, and it generates a precious sense of exclusivity. Meanwhile, the competing platform, Google’s Android, is the default operating system on less-expensive devices that dominate the global market. Isn’t this a replay of the 1980s and 1990s? Is Android the new Windows?

For Apple, the key question is whether complementors will continue to develop products and services for an operating system with a 20 percent market share. If complements are not too expensive to produce, the answer is yes, and Apple will thrive. If complements require significant and perhaps country-specific investments, however, Apple will come under pressure in countries like Indonesia, where its market share has fallen to less than 6 percent

While no one knows the trajectory of technology, understanding how the cost of developing complements can elevate or diminish the importance of network effects is a critical skill that every strategist needs in their toolbox.

The Savvy Strategist—Imaginative and Vigilant

Managing in environments that have strong network effects is challenging because the feedback loops accelerate change: seemingly in the blink of an eye, cash disappears; platforms like TikTok, an entertainment app, and Pinduoduo, an e-commerce business, gain hundreds of millions of users almost overnight. In other instances, network effects impede change: they give rise to a stable set of platforms that dominate their industries decade after decade. Network effects create turbulence and intransigence; they generate vast opportunities for change and nearly immutable competitive outcomes. What mindset should you adopt in this type of environment? I argue that imagination and vigilance are two of the most important traits.

Imagination

A common view is that industries either have network effects or they don’t. This mindset is too narrow. Many companies gain advantage by creating network effects where none existed. Others succeed by making existing effects much more powerful. Apple’s FaceTime service created new network effects for customers who owned iPhones and iPads. UberPool added network effects between passengers who want to travel to similar destinations.

Vigilance

Even if your firm lacks opportunities to create network effects, other companies might succeed at building them. Because network effects create a significant first-mover advantage, it is critical that you spot budding networks and up-and-coming platforms early. Pay close attention not only to rival companies but also to suppliers. The latter, recent business history shows, can become particularly powerful. Online platforms are a fairly recent phenomenon in many supply chains. But once they are established, they are difficult to displace, and they are likely to help themselves to a significant share of your profits

I find it interesting to see how many network effects we now take for granted. Remember when searching for information required a trip to the library? Finding high school classmates involved thumbing through yearbooks and telephone directories? Estimating traffic was an art, not a science? How we trekked from store to store to find the products we wanted to purchase? Network effects underpin many of the businesses that have had such an impact on the way we live and work today. Technology made these advances feasible, but network effects are the reason these businesses were actually built and why they attracted the talent and the capital that allowed them to offer their services at scale

As I think about network effects, a few insights stand out for me

• Network effects increase WTP by connecting users directly, through complements or via platforms. Companies that build network effects raise WTP and they limit competition at the same time.
• Market share is an inadequate predictor of profitability. It should never be used as a strategic goal. Markets with network effects, however, are an exception. They reward companies with more users and greater share.
• Facebook-style winner-take-all outcomes are rare. Interestingly, geography both limits and enhances the strategic value of network effects. If these are local in nature, different companies win in different markets. But if the markets are small enough, they are more likely to tip and create a single winner. The net result is a patchwork of local champions.

The dark side of network effects is the extent to which they limit competition. The question of whether companies like Facebook, Google, and Alibaba have become too big is hotly contested.24 To resolve the issue, we need to weigh the customer delight that results from network effects against the cost of limited competition

9 Strategies for Underdogs

Network effects benefit larger companies and their customers. Whoever gets to scale first will have a substantial advantage. Building a network-effects business is a mad rush. But what about the companies that are left behind? What about small firms? Are there effective strategies for companies that have a limited number of customers? Yes! There are many examples of smaller companies that compete successfully with (and sometimes even displace) larger organizations that benefit from network effects

Creating Customer Delight That Does Not Reflect Scale

As powerful as network effects can be, it is important to remember that WTP and customer delight are the currency that ultimately counts. In this sense, there is nothing magical about network effects.1 An increase in WTP that results from network effects is no more valuable than increases in WTP that reflect great ideas, a more pleasant customer experience, or less-expensive complements

Favoring One Group on the Platform

Platforms serve multiple groups of customers, and while many create value for all groups, some choices betray the organization’s primary orientation. A travel site that sorts hotels by profit margin primarily serves the lodging industry. A site that sorts by customer reviews has the opposite orientation. The distinction between buyer-focused and seller-dominated platforms is particularly stark in B2B. At one extreme, procurement platforms serve buyers by creating efficiencies in purchasing.

If yours is a small company staring at a large platform, it is always worth asking whether you might be able to create meaningful differentiation by focusing on the WTP of the group that is less favored by your competitor.

Serving a Small Set of Customers

In all likelihood, this is the most counterintuitive move that platforms make when they compete against larger rivals that benefit from network effects. How can you succeed against big by being small?

To understand eharmony, let’s think about what happens when a dating site begins attracting more customers. As its membership grows, WTP is pulled in opposite directions.11 For a man who would like to date a woman, WTP increases as more women join the site. This is the classic network effect. It is sometimes called a cross-side network effect because it describes the connections between different groups on the platform

Focus on a limited set of customers is not the most intuitive advice if you are trying to build a business that will benefit from network effects. It is nevertheless good advice. By serving a select group of users who benefit most from being connected to one another, you might be able to compete with much bigger platforms

In the early days of studying companies that benefit from network effects, many investors assumed these companies were poised to dominate their markets. Scaling quickly without any regard for profitability became the mantra.16 This approach is deeply flawed for two reasons. In chapter 8, we observed how geography often limits the power of network effects. In this chapter, we have seen that markets with network effects often remain competitive because small players find ways to persist

• Underdogs lift WTP in ways that do not depend on scale. Network effects are one way to raise WTP, but there are many others. As long as these alternatives require no substantial investments, the smaller organization is not at a disadvantage in exploiting them.
• Underdogs cater to neglected parties. Most platforms favor specific groups—customers or vendors. Serving the unloved group allows for meaningful differentiation
• Underdogs focus on a small group of customers who place a high value on connections with one another. The number of users, a common proxy for the strength of network effects, has always been a flawed metric. In practice, customers attach a different value to connections with different groups. The dominant platform boasts the largest number of users. But smaller companies can build businesses that emphasize high-value connections.

Part Three Value for Talent and Suppliers

10 Feeling Heard Value for Employees

Having explored the principal ways in which companies raise willingness-to-pay (WTP)—more attractive products, complements, and network effects—we now turn to the lower end of the value stick to see how companies improve their financial performance by creating value for their employees and suppliers

Let us look at employees first. Services dominate advanced economies—they contribute almost 80 percent of US GDP—and both their cost and their value to customers are greatly influenced by the engagement of employees. How do you attract a talented and motivated workforce? The joy and satisfaction that workers derive from their job are the difference between their compensation and their willingness-to-sell (WTS). If a company pays the bare minimum that is required to keep people in their jobs, compensation matches WTS. Firms can do better by increasing compensation or by making work more attractive.

At first, it might seem that more generous pay and improved working conditions would both produce the same effect: greater employee satisfaction. While the end result may be the same, there are important differences between the two strategies

Increased compensation lowers the firm’s margins. There is no value creation, only redistribution. By contrast, more attractive working conditions create more value by reducing WTS, the lowest compensation that a person is willing to accept for the work.

Companies that find ways to lower WTS not only have more satisfied employees, they also attract workers who particularly value the ways in which the company reduces WTS. For example, BayCare, an organization that runs hospitals and outpatient centers in Florida, is nationally recognized for the quality of its training.1 Its innovative programs include individual learning maps and regular interactions with senior leaders. Not surprisingly, BayCare is particularly attractive to healthcare professionals who value continued training and education

Such selection effects are particularly valuable if they help retain and attract highly talented employees. As you know, these individuals can make a critical difference

Although compensation-focused talent strategies yield less-powerful selection effects, the universal appeal of money can also be a strength, of

course. It is easy, however, to overestimate the draw of increased compensation, especially among better-paid employees

Every initiative that results in better working conditions creates value. If the programs are expensive, however, it is more challenging for companies to capture that value, because cost will increase as WTS falls

Job Quality at Quest Diagnostics

When MaryAnn Camacho first walked into one of Quest Diagnostics’ call centers, she immediately noticed a large group of people just waiting around.6 Later that day, she would be told that those nervous-looking individuals were new customer service representatives, about 50 of them

Working in a Quest call center has never been easy (and the global pandemic of 2020 made it even harder). Each day, the 850 reps and 50 supervisors answer about 55,000 calls, most of which are related to patient test results

Imagine yourself in Camacho’s role. How do you turn around this call center?

The cornerstone of the transformation is not difficult to see: more attractive working conditions. In building a better work environment, Camacho and her team followed elements of a process that has proven successful in many organizations

Transforming the Call Centers

• Breaking the cycle—Quest had been stuck in a vicious cycle. Poor center performance led to high turnover, which made it difficult to invest in workers. Camacho needed to find a way to break the cycle. She accomplished this by raising everyone’s base compensation and introducing incentives that reward tenure and on-the-job performance. Quest also created clear career paths for its call center employees, providing them with a longer-term perspective. In monthly performance reviews, supervisors began to discuss performance, personal goals, and career trajectories with each of their reps
• High expectations—Camacho made it abundantly clear that she had high expectations. She broadened the center’s performance metrics and instituted a stricter attendance policy. “You cannot let nonperformer[s] continue … because it becomes cancerous for the team,” she explains
• Making the job easier—To make the job easier, the company created an expanded set of self-serve options, reducing call volume by 10 percent. Quest also added a subject matter expert to each of the teams, thus providing deeper technical expertise.
• Building capabilities—With reduced attrition, training became more meaningful, and Quest refocused it on customers. “Training used to be function-focused,” says Quest’s head of training. “We are now able to train for the ‘why’ behind the way we do things.”9 Employees can apply to become members of a newly established Quest management system (QMS) team, a central resource with expertise in continuous improvement techniques. In their application for QMS, reps need to suggest seven process improvements. If accepted into the team, they are taught Excel, data collection, root-cause problem solving, Gantt charts, and techniques for managing meetings and change. Call center teams also compete to become model pods: teams that are charged with suggesting and implementing process improvements. “Each one of the supervisors was so hungry to have investment and training and believed that they could actually do the job [of a model pod], they blew us away,” recalls Camacho. “Members of my staff were in tears, and said things like, ‘I didn’t know they had it in them. I can’t believe what I just saw.’ And I said, ‘You know, you invite people to the table and they’ll rise to the occasion.
• Making change real—The QMS team and the model pods soon discovered ways to make work easier and more efficient. Bilingual reps now receive advance notice of a caller’s preferred language, saving about 20 seconds on each call; reps send faxes from their desktops instead of getting up to use the centrally located fax machines; when a physician is paged, the notice includes patient IDs, making it easier to pull up the relevant lab results when the doctor calls back. The best ideas conceived by the model pods are quickly implemented systemwide, creating highly visible change and momentum. Valuable suggestions also come from frontline idea cards (FICs). When Professor Zeynep Ton studied Quest’s transformation, she interviewed call center reps, many of whom were particularly enthusiastic about the cards. One explained the general reaction: “FICs were the most important change.… It allows us to say, ‘Hey, we need someone or something to help us. We need tools or processes put in place.’ And we can be involved in helping make those changes.” Another rep stated, “Before the FICs, you never felt like your ideas were being heard. You could say something to someone, but it just didn’t go anywhere. Now, it feels like management cares about our ideas and how we feel.”
• Shifting ownership—Quest’s bottom-up approach purposely shifts responsibility for continued change to individual reps and teams. Model pods meet for daily huddles: short meetings led by a rep chosen by the team’s supervisor. Ton observes, “Initially, the reps didn’t know what to do, but over time, the huddles became more structured. Members discussed performance metrics, ideas for improvement, and current projects.
• Recognizing progress—Quest rewards exceptional performance financially—the company created a 6 percent bonus pool, for example—and in more symbolic ways. Wow calls acknowledge employees who have been praised by clients. Members of the 100 Club—reps who achieve perfect performance in monitored calls—receive a free snack. Impactful FICs are rewarded with small gifts.

WTS and Productivity

Two observations about the transformation at Quest strike me as particularly interesting. The first is that none of the changes are groundbreaking, unheard-of innovations. Scholars of service quality will easily recognize many of the steps in Quest’s journey. What was required to transform the organization was a deliberate and thoughtful attempt to create a more attractive work environment, an approach that promised to substantially lower WTS

Second, Quest’s transformation nicely illustrates how changes in WTS often lead to changes in cost. Quest was able to pay its reps more and contain spending, because it increased the productivity of its call center reps

As in many service settings, better working conditions also had an impact on service quality and customer WTP

Tell Me, Muse, of the Many Ways

There are innumerable ways to decrease WTS. The ability to identify these opportunities requires that you understand, in some detail, the work that is being performed in your organization, the joys and challenges associated with each activity, and the ways employees are likely to react to changes in their routines. Just like finding ways to raise WTP requires a deep understanding of customers, identifying avenues to lower WTS presupposes intimacy with your staff and their (work) lives. A narrow focus on products and sales, as we saw in our discussion of WTP in chapter 4, is often less helpful than a wider lens that is trained on the entire customer experience. The same is true for WTS. Making work more attractive is a far broader undertaking than optimizing processes, because work is so much more than a narrow set of activities that we perform every day. Work includes the tone of feedback, the laughs we share with coworkers, the anxiety we feel when we face challenging tasks, our commutes, the food choices in the cafeteria, the joy (or dread) when we are getting dressed in the morning. And any one of these facets of work can be improved.

Paying Market

I find the rules that companies use to set prices endlessly fascinating. In my conversations with marketing executives, I always ask about their company’s pricing policy. The answers often include references to premium prices, price leadership, value-based pricing, and similar concepts. When I ask human resource professionals that same question about their compensation policy, the response is almost invariably, We pay market.

The contrast is interesting. When we price products and services, we think in terms of differences. It is intuitive that customers would pay premium prices for premium products and receive a discount for middling quality. We understand that no two products are exactly identical and that prices will reflect the differences

The data show that they are. Compensation patterns in the United States clearly indicate that companies pay vastly different salaries for similar work. Figure 10-3 shows the fraction of workers in an occupation who get paid more and less than the average of that occupation in the local market

To be competitive in the market for talent, companies do need to match competing offers. But matching does not imply paying the same compensation (paying market). Matching means creating as much value for your employees—the difference between compensation and WTS—as your company’s competitors

At the top of the value stick, companies offer premium products to increase WTP. They then share that extra value by charging premium prices. As long as the price increase is smaller than the rise in WTP, both customers and the company are better off. At the bottom of the value stick, companies create more attractive working conditions to lower WTS. They then share this value by reducing compensation. As long as the drop in WTS is greater than the reduction in salaries, both employees and the company are better off

An interesting question remains: if the logic of value creation and value capture is identical at both ends of the value stick, why does encouraging premium pricing feel so different from advocating for reduced compensation? Why do marketing and human resource managers describe their pricing policies (which are, in fact, quite similar) in such different terms? I have two conjectures.

• Power—Employees and customers fare better if significant value creation (higher WTP, lower WTS) precedes more-limited value capture (through premium pricing and reduced compensation). But there is no guarantee that it will
• Experience—How satisfied are you with your job? Has your satisfaction changed over time? For nearly everyone, the answer is yes. Many components of WTS depend on experience, and it takes time to learn the facets of a new job and a company’s culture

Power and experience are two of the reasons why competing for talent by reducing WTS is a demanding (if promising) strategy. As you consider this opportunity for your company, I have four recommendations

• Be specific—If you compete for talent by offering better working conditions, be specific about the ways in which you decrease WTS
• Be predictable—Focus on initiatives that lower WTS in a predictable manner. Flexible hours and opportunities to work from home, for instance, are easy to grasp, and it’s straightforward to commit to these benefits
• Share creatively—Consider various ways to share value with your workforce. Reducing compensation is only one of many ways to capture value from improved working conditions
• Magnify existing benefits—It might seem that lowering WTS by increasing job amenities (for instance, better mentoring) or reducing disamenities (for example, less noise) would have the same effect

In my experience, WTS is the least intuitive of the four elements that make up the value stick. But, as the examples in this chapter illustrate, lowering WTS by making work more attractive is a powerful method of creating value for your employees and your company. The following ideas are particularly important

• Making work more attractive need not be rocket science
• Identifying attractive opportunities to reduce WTS requires you to be familiar with the many ways in which work touches the lives of your employees
• Initiatives that decrease WTS not only increase employee satisfaction, they also create powerful selection effects
• As you choose ways to decrease WTS, think about whether the expected selection effect supports your business objectives
• Companies that successfully lower WTS are able to participate in the value they create in many ways

11 Gigs and Passions

Digital technology allows companies to compete for talent in novel ways. Increased flexibility, in particular, opens new avenues for value creation

How much value is created when individuals are allowed to choose their hours?2 Uber is a good example. As is typical for gig work, drivers can drop in and out of the app with few limitations

Flextime on Demand

While companies have made significant progress, the demand for flexibility still outstrips current policies in many firms

An even bigger challenge is the acceptance of flextime programs. Introducing them is a first step; getting employees to actually use them is another. Professional services firms are a case in point: nearly all of them have flextime policies, but most employees do not take advantage of them

As you think about ways to create value for the employees in your organization by way of flexible work arrangements, keep the following in mind

• Employees are more likely to make use of flextime when KPIs emphasize productivity, not long hours
• Role models matter
• Make flextime a point of open conversation
• Refrain from celebrating a long-hours culture

Enter Passions

Flexibility is of substantial value in many contexts. But it can be truly transformational when coupled with personal passions. Think about your own interests. What is your favorite pastime? Are you a gardener? Writer? Movie buff—excuse me—cinephile? Our passions move WTS in a powerful way. We all have activities that we pursue for pure enjoyment, no compensation needed

Is the promise of gig-economy platforms to deliver high quality at low prices an illusion? Is the truth that the benefits of gig work come at the expense of (mostly desperate) freelancers? As a businessperson who wants to do the right thing, should you ever say no when someone is willing to provide high-quality work for little money? These questions are at the very heart of the debate about gig-economy platforms and the need to regulate these businesses

Let’s explore these issues using the principle of value creation as our moral compass. Business practices are defensible as long as they make employees and independent contractors better off. Freelancers working for little money is not per se an indication that they are being exploited; their WTS for the task might be really low. But it is a warning sign that warrants further investigation. My hope is that you will ask questions such as these

• Is it even plausible that WTS is low? For work that is not intrinsically attractive, the answer is probably no. Remember, it is passions that drive down WTS. Also, contractors for whom the work constitutes their principal income are unlikely to have low WTS
• Does the work arrangement create value other than financial compensation? One reason that some of Crowdspring’s designers work for small prizes is that they expect benefits other than money. Some hope to learn from company feedback. Others seek to build a reputation
• Are expectations of longer-term benefits reasonable? It is not easy for gig workers to estimate the value of longer-term benefits. What is the likelihood that a poorly paid freelancer will be awarded additional work? How likely is it that an unpaid engagement will open the door to a permanent position? Often, the business is better informed about the longer-term prospects than the freelancer
• Is it in the best interest of your business to respond to low WTS with low compensation?

Compensation policies induce powerful selection effects. Even in cases with genuinely low WTS, sharing more value with employees and freelancers can have a profound impact on the quality of work.

Looking at flexible work arrangements and gig-economy business models, I take away a number of insights

• Digital platforms that connect companies with passionate workers can help shift corporate boundaries.
• Even in 2020, workplace flexibility is still in short supply and is an effective tool to lower WTS
• Developing rules for flexwork is only a first step. Encouraging employees to make use of the flexibility often requires a broader change in culture
• Linking people’s passions to your business purpose is an exciting avenue for value creation
• Engaging passionate individuals requires careful consideration of their expectations. Gig work can create substantial value for workers but it also risks exploiting them

12 Supply Chains Are People, Too

Companies hope to increase their margins by paying their suppliers less. Predictably, the suppliers push back. They seek to enlarge their own surplus: the difference between willingness-to-sell (WTS) and cost. These efforts create no value; whatever one party gains, it must come out of the pocket of the other

There is, of course, a second avenue to increased profitability. If you manage to decrease the WTS of your suppliers, more value is created. Your company and your suppliers can be better off at the same time. Your supplier’s WTS, you will recall, is the lowest price that they would ever accept from you. If you pay more than WTS—cost is greater than WTS, as shown in figure 12-1—the supplier will earn a surplus, a margin that is greater than the profitability that is built into WTS.

WTS varies from one buyer-supplier pair to another. It is determined by the relationship between the two. For instance, if a supplier earns bragging rights by providing products to a famous company, her WTS will be lowered. If a buyer is a headache to work with, he will face suppliers with a higher WTS.

Such buyer-specific considerations aside, how do you actually lower the WTS of your suppliers? By making it more cost effective to sell to your organization. Any initiative that makes life easier for your suppliers, any investment on your part that makes them more productive, will lower their WTS and create more value

A good example of two mechanisms that ensure your suppliers benefit from low WTS: careful supplier selection and the transfer of management expertise. In this chapter, we will see how leading firms employ both techniques.

Teaching Your Suppliers

Most companies detail the obligations of their suppliers in comprehensive contracts and service-level agreements. Many also develop codes of conduct that describe their expectations of supplier behavior. Nike, in early 2000, sought an even closer collaboration with its vendors when it decided to teach them lean manufacturing

Teaching your suppliers to become more productive is an effective way to lower their WTS and create more value

The Shadow of Value Capture

Even in buyer-supplier relationships that focus on value creation, the shadow of value capture is ever present. Suppliers are anxious that investments in production capacity will not pay off if buyers, seeing the newly installed capacity, demand prices that make the investment unattractive. Buyers fear that suppliers will exploit a close relationship if they become too dependent on a firm Both sides make costly moves to protect themselves. Buyers resort to sourcing from multiple suppliers when it would in fact be advantageous to work with only one.17 Suppliers refuse to work with buyers they do not trust

So how do leading companies do it? When I speak with supply chain executives who have successfully lowered their suppliers’ WTS and created long-term value for themselves and for their suppliers, I often hear pieces of advice like this

• Be selective. Developing and maintaining supplier intimacy is challenging and time-consuming. Limit the number of vendor relationships in which you invest
• Get to know your supplier. It is tempting to view your supplier relationships exclusively through the prism of cost, but this lens is too narrow. As a highly successful manager once reminded me, Supply chains are people, too!
• Focus on outcomes, not billing codes. Significant opportunities to lower WTS often result from changes in your behavior
• Align external and internal incentives. With broad goals in place, you can define metrics that align with these goals and link them to financial incentives
• Keep an open mind. The dark side of deep relationships is, well, the depth of these relationships. Once you build trust with a supplier, you have limited incentives to search elsewhere

Collaboration in supply chains is not a new idea, of course. But the shift in perspective that comes with value-based thinking is useful nevertheless. These are some of the key insights

• By helping your suppliers lower their cost, by making it easier for them to sell to your organization, you end up helping yourself. Ask not what your supplier can do for you
• The logic of value capture dominates many buyer-supplier relationships
• Making value creation the center of a buyer-supplier relationship is hard work, and you want to be careful in the selection of the suppliers with whom you build this type of relationship

Part Four Productivity

13 When Big Is Beautiful

Whenever I examine productivity data, I can scarcely believe the dramatic differences between companies in the same industry.* On average, a US company at the 90th percentile of productivity creates twice as much output as a company at the 10th percentile—with identical inputs!1 The dispersion is even more pronounced in China and in India, where we often see 90–10 ratios of 5:1.2 Nor are these fleeting differences. Gaps in productivity tend to persist over long periods

In this and upcoming chapters, we will examine three forces that help determine productivity: scale (this chapter), learning (chapter 14), and operational effectiveness

Scale

To see how fixed costs create economies of scale, imagine a trading floor with a trader who executes a single trade per day. This trade is incredibly expensive, because the entire cost of the trading infrastructure is allocated to this one transaction. As the number of trades increases, the fixed cost is spread over more and more trades, leading to a decline in average cost (figure 13-3). The incremental effect of spreading that same fixed cost, however, gets smaller as trading activity increases.

Minimum Efficient Scale

Do you know your firm’s minimum efficient scale (MES), the business volume that you need to be cost competitive? This is a number that every businessperson ought to be aware of.* If your company is smaller than MES, you will not be able to compete with larger rivals on the basis of cost. On the other hand, once your organization achieves MES, continued growth no longer results in a greater cost advantage. In fact, for some companies, average cost might increase because of the complexity of running a very large organization

Scale as a Barrier to Entry

At their most powerful, economies of scale can create completely uncontested markets

In the pre-digital economy, I would first look to fixed cost to get a sense of how competitive a new market will be. In the internet era, network effects are often as influential as fixed cost in determining the number of companies that can compete. But economies of scale remain important in many sectors of the economy. A few considerations stand out for me

• Every strategist needs to know the minimum efficient scale of their firm
• Minimum efficient scale changes over time. Some of these changes mirror trends in technology and consumer tastes
• If your company competes on quality, make sure to compare the benefits of raising WTP with the help of fixed or variable costs

14 Learning

When Henry Ford first started making the famous Model T in 1909, producing each vehicle cost the company $1,300.1 By 1926, wages at Ford had increased threefold, while the cost of producing a vehicle had dropped to $840.2 Ford’s secret? The learning curve.3 As companies increase the cumulative volume of production, costs often decline because employees gain familiarity with the product and processes, and they find ever new ways to improve productivity (figure 14-1). By the time Ford had produced 10 million cars in 1926, learning alone had reduced costs by more than one-third

For companies that compete on learning effects, an important question is whether learning can be transferred from one worker to another, from existing plants to new ones. Can you lock in these advances? Or do you have to relearn processes every time you expand production capacity?

Learning not only improves productivity, it also raises willingness-to-pay (WTP) in many contexts. In health care, for example, it takes surgical teams less time to perform operations if they frequently perform the same procedures

Recent advances in artificial intelligence and machine learning, in particular, have renewed companies’ interest in learning as a source of competitive advantage. In only one of many examples, anomaly detection algorithms now help reduce cost across a wide variety of applications in many different industries. In manufacturing, AI prevents faulty parts from entering production; in financial services, the algorithms help spot fraud; and in health care, machine learning identifies anomalous physiological readings.

Many forms of learning are related to the volume of available data and to cumulative output. But it is good to keep an open mind

As you consider opportunities for your company to compete on the strength of learning effects, keep the following in mind

• If you have a long head start, learning effects will discourage rival companies from entering your market. But if your head start is short, learning effects make your competitors more aggressive; everyone will scramble to ramp up production as quickly as they can
• Learning effects are most powerful if they reduce cost at an intermediate pace. If costs decline very fast (as in the automobile example in figure 14-2) or very slowly, there is little advantage in having produced more than your competitors
• As you observe firms in your industry learning, it is tempting to cut prices to catch up. Keep in mind, though, that companies learn from their own experience and from observing other firms in their industry (just as you did). The easier it is to learn from others, the more modest your planned price cut should be
• Be aware of a dark side of learning. Because you benefit from running the same process many times, learning can lock in your organization and stifle innovation.

15 No Reason to Sneer

Professor Michael Porter popularized the distinction between operational effectiveness and strategy. Strategic moves, he explains, confer a lasting competitive advantage. Operational effectiveness is important but not sufficient to achieve corporate success.1 After all, everybody strives to be operationally efficient; there is no lasting advantage in adopting modern management practices, because every company will use these techniques if they prove effective. Smart strategic moves create differences between companies. Investments in operational effectiveness reinforce similarities

Warren Buffett is credited with a story about a parade that nicely illustrates Professor Porter’s powerful idea: One spectator, determined to get a better view, stands on his tiptoes. It works well initially until everyone else does the same. Then, the taxing effort of standing on your toes becomes necessary to be able to see anything at all. Now, not only is any advantage squandered, but we’re all worse off than we were when we first started

Buffett’s story builds on two assumptions. The first is that standing on tiptoes will spread quickly; any initial advantage is fleeting. The second is that the effect of tiptoeing is similar for everyone. The spectators are all a few inches taller, but the differences in height remain roughly the same. Is investing in operational effectiveness really like standing on your tiptoes? Let’s find out. We first discuss the speed with which management practices spread

The Speed of Diffusion

My colleague Professor Raffaella Sadun, a prominent member of the group, explains the key finding: If you look at our data, it’s obvious that core management practices can’t be taken for granted. There are enormous differences in how well managers execute even basic tasks like setting targets and tracking performance. And these differences matter: better-managed firms are at a long-term advantage; they are more productive, more profitable, and they grow at a faster pace.

This pattern—excellence and mediocrity living side by side—is repeated across dozens of management practices

You might wonder why so many firms fail to adopt core management practices if they have such significant payoffs. Three barriers seem to be particularly important.

• Knowing your company—Many managers find it difficult to assess the quality of management at their firms
• Managerial involvement—Some executives prefer a hands-on management style; they frequently visit plants and work one-on-one with employees and suppliers on operational tasks. Others focus on collaboration in the C-suite. There is no general performance advantage in adopting either style, but hands-on managers run the risk of seeing process-oriented management techniques as a substitute for their own personal involvement
• Understanding the promise—Not seeing the likely performance consequences of better management is a final hurdle for companies to make the necessary investments

Springboard for Strategy

Standing on tiptoes at a parade is self-defeating, not only because everyone will quickly imitate the move but also because the results do not vary much from one spectator to the next. Do companies that invest in operational effectiveness share this fate? Will they end up looking like everyone else?

As organizations invest in operational effectiveness, it is of course possible that they end up performing the exact same set of activities as their competitors. But it is unlikely. Even if two companies embrace the same management approach—say, continuous improvement or high-powered incentives—their implementations will vary, and they will discover different avenues to raise willingness-to-pay (WTP) or lower willingness-to-sell (WTS). As a result, operational effectiveness can serve as a powerful springboard to strategic renewal.

Thinking about the role of operational effectiveness in explaining differences in productivity across companies, I take away a few insights

• Good management practices and operational effectiveness help create meaningful differentiation between companies
• Operational effectiveness and strategy are intertwined. My advice is to pay little attention to the distinction. Do not dismiss an initiative simply because it seems to be an investment in operational effectiveness. It might well turn out to be the catalyst for a strategic renewal
• Rather than asking whether projects fall in the strategy or in the operational effectiveness bucket, consider their potential to raise WTP or lower WTS
• There is no doubt that improving the quality of management can create substantial value

Part Five Implementation

16 Asking How

Once you have decided how to create value—raise willingness-to-pay (WTP) or lower willingness-to-sell (WTS)—it is time to bring your strategy to life. What could be more exciting? At this step, questions will abound. How will activities have to change? How do you adjust investment patterns? What projects will you prioritize? In this final part of the book, we will see how companies move from strategy formulation to strategy implementation

Prior to making any commitment to initiatives and projects, it is critical that you understand, in some detail, how they would move WTP or WTS. Companies often build on broad strategic ideas, many of which come in the form of simple recipes—be number one or number two in your market, create a powerful brand, invest in adjacent businesses, build global scale. When I study such recipes, I invariably find that they work for some companies but not for others. To be specific, consider the idea that a prominent brand will confer a lasting competitive advantage

Before you commit to a strategic course and begin implementation it is useful to ask, What are the circumstances under which [insert your favorite recipe for strategic success] will increase WTP or lower WTS? This question is powerful, because it prompts you to be specific about the mechanisms by which a proposed initiative will change WTP or WTS. Often it is only when we observe the underlying mechanisms that we begin to understand why generally sound strategic advice might not apply to a specific firm’s circumstances Examining how an initiative raises WTP or lowers WTS also allows you to recognize the resources and capabilities your company needs if you are to bring the strategy to life. Figure 16-3 illustrates this link between mechanisms and resources.

Asking how a strategic initiative creates value often yields surprising insights. What appeared to be one strategy, one recipe for success, is often a set of different strategies that require distinct capabilities and resources.3 A stronger brand, for instance, can raise WTP by conferring status, by reducing uncertainty, and by establishing tastes and norms. Depending on the mechanism that they employ, brands delight customers in radically different ways. Let me illustrate each of these mechanisms to highlight how different they are

Conferring Identity

The idea that branding a product helps customers communicate who they are is intuitive. The techniques that brands use to do this are nuanced and fascinating. Mercedes-Benz, for instance, affixes its famous star to the hood or the grill of most of its models. The star varies in size, ranging from less than 8 centimeters to almost 20 centimeters. The largest stars are reserved for the least expensive models. On average, customers pay an additional $5,000 for every 1-centimeter decrease in the size of the star.4 Brand managers at Mercedes understand that their less-affluent customers have a greater WTP for social differentiation via prominent brand markers. By contrast, the brand’s richer clientele prefers more subtle signals, hence the smaller star

Reducing Uncertainty

How do you increase WTP to such an extent that you can charge a 200 percent price premium for a product with many substitutes? Ask Bayer how it does it. The pharmaceutical company created aspirin in 1897, and the success of the drug continues more than a century later. What is remarkable is that aspirin is not protected by any patent. How does Bayer defend its position?

Brands like Bayer are valuable because they reduce a trace of uncertainty about the performance of products. Is the generic version really just as good as the real drug? Is Bayer perhaps a more reliable manufacturer compared with others that make the same drug? As uncertainty vanishes, these brands lose in value

Setting Standards of Performance

In some cases, brands raise WTP by teaching us what experiences and products should look, feel, and even taste like. With a 25 percent market share, Folgers is America’s number one coffee brand.13 (In case you wondered, Starbucks has a 12 percent market share.) But Folgers has limited success in New York City, where Maxwell House dominates. The latter’s advantage is no secret: Maxwell House was the brand that taught New Yorkers what coffee tastes like

Summarizes the three main ways in which strong brands raise WTP.

While the discussion here has focused on brand strategy, the key points hold more generally.

• Recipes for strategic success often mask different mechanisms that connect WTP or WTS with financial performance
• Depending on which of these mechanisms you employ, different resources and capabilities become critical
• By being specific about the mechanisms that connect strategic advice and WTP or WTS—by asking how—you gain a deeper understanding of the likely financial implications of strategic ideas

17 Being Bad in the Service of Good

Few entrepreneurial careers illustrate the role of fortunate accidents (and accidental fortunes) as clearly as that of Stewart Butterfield, cofounder of Flickr and Slack. Butterfield’s first startup built a multiplayer online game whose main purpose was to kick ass. It largely failed to do so, but the tools created for developing the game provided the building blocks for Flickr, a photo-sharing site that Butterfield eventually sold to Yahoo! He later returned to gaming to produce Glitch, another failure—and another instance where software written for a project that failed proved generally useful: thus was born Slack. The workplace communication platform went public in 2019. A year later, it was valued at $15 billion.

In many ways, Slack exemplifies the mindset we have explored throughout this book. The company obsesses about customer willingness-to-pay (WTP) and talent willingness-to-sell (WTS). Slack works hard to escape a narrow product mindset

Because the company espouses a broad notion of value creation, Slack seems novel and unique to many of its customers, which is interesting because it is not. Similar products existed before Slack, but Yammer, HipChat, and Campfire failed to catch on because clients found it difficult to see how group messaging would create value. Butterfield describes the process of developing a deep understanding of customer WTP

• Just as much as our job is to build something genuinely useful, something which really does make people’s working lives simpler, more pleasant and more productive, our job is also to understand what people think they want and then translate the value of Slack into their terms.… Putting yourself in the mind of someone who is coming to Slack for the first time—especially a real someone, who is being made to try this thing by their boss, who is already a bit hangry because they didn’t have time for breakfast, and who is anxious about finishing off a project before they take off for the long weekend—putting yourself in their mind means looking at Slack the way you look at some random piece of software in which you have no investment and no special interest

For a company that is as obsessed with WTP as Slack is, Butterfield and his team made a counterintuitive decision when they first developed the communication platform

Making Trade-Offs Visible

In many executive education courses at Harvard Business School, we conduct what we call a value map exercise. Of all the hands-on tasks with which we engage our course participants, this is one of our most impactful activities. We must have run this exercise with hundreds of companies. It leaves a deep impression every time

You begin to build a value map by selecting a group of customers—or a group of employees if you create a map for talent. Next, you compile a list of criteria that are important to these customers when they make a purchase. These criteria are called value drivers Think of them as the product and service attributes that determine WTP (or WTS).

You then rank the value drivers from most important to least important. For example, your customers might value speed of service above all else. In this case, speed is value driver number one. If your customers do not care much about the price of your service, price goes toward the bottom of the list. Keep in mind that this is the customer’s perspective, not yours. In a final step, indicate for each value driver how good your company is at meeting this customer demand. For instance, speed could be important for your customers, but your company might be mediocre at providing fast service

Value maps allow you to see, at a glance, your competitive standing and strategic opportunities

Value map for a global consulting firm…

As you can see in figure 17-2, the firm’s clients care most about how well their account is managed and the firm’s innovation capabilities. These are the top two value drivers. Global reach and stakeholder management are less critical. The figure also shows that the firm’s value proposition is not particularly well aligned with the clients’ WTP. The firm underperforms on some important service attributes

Executive Ambition Meets Trade-Offs

When I conduct this exercise at Harvard Business School, we discuss the importance of trade-offs before the executives create value maps for their own firms. It is usually a short conversation. Everyone agrees that companies cannot be good at everything; true excellence requires firms to shift resources from value drivers of lesser importance to critical customer concerns that drive WTP.

All the arrows point to the right! A good hour after we have all agreed on the importance of trade-offs for business success, there are often few trade-offs in sight. Smart, ambitious executives want to become better at everything. Does this remind you of your firm? Do you sit in meetings where you make long lists of products and processes to improve? The sad news is, of course, that any attempt to get better at everything virtually guarantees mediocrity—exhausted mediocrity at that. By spreading scarce resources across many value drivers, you make it impossible for your organization to achieve true excellence

I have been thinking about why it is so difficult to make trade-offs. Why is it challenging to decide what not to do? Where not to invest? Where to underperform? Here is one conjecture: the idea of trade-offs applies least to incredibly talented, supersmart people, the type I encounter in C-suites and in HBS executive education programs. These folks can be good at almost everything. And if they sacrifice a little sleep, they get huge amounts of work done, just in time and in fabulous quality. The danger is to take this model of personal success and apply it to organizations. (Some) people can be good at almost everything, but companies cannot

The lessons here are straightforward

• Value maps are a simple tool that provide a wealth of information. They reveal the product and service attributes that determine customer WTP; they show where you have an advantage in creating customer delight and where you lag; and, perhaps most importantly, they indicate if your firm is making appropriate trade-offs. Do you excel where it counts?
• It is exciting to decide where to excel and figure out how to make progress. It is far harder, however, to determine where not to invest, where to underperform. True excellence is built on trade-offs. No company can be good at everything. to ask, What will we stop doing?
• The next time you and your team sit in a strategy meeting and you start making a long list of issues to resolve, projects to complete, and services to improve, remember

18 Guiding Investment

Value maps are not only a powerful way to visualize trade-offs but they also help guide investments and connect strategy with operations. In this chapter, we will see how companies use value maps to link strategic choices with activities and budgets.

Choosing a Value Proposition

You will recall (from chapter 3) that a company’s ability to capture some of the value that it creates depends entirely on differences—differences in willingness-to-pay (WTP) or willingness-to-sell (WTS). By comparing your company’s value curve to the value propositions of your competitors, you can identify relevant differences and devise ways to heighten them.

When Expedia, the online travel agency, set out to build its value map, the company began by asking customers how they choose travel sites. It started with personal, open-ended conversations and focus groups; both techniques are well suited to identifying critical value drivers

You see that Airbnb leads the industry in providing value for money. Expedia scores top points for saving time and money. Google has made the clearest trade-offs; it dominates the planning stage of travel but lacks many other services that travelers need. Booking.com and Hotels.com are essentially undifferentiated

Grouping value drivers is helpful because it provides a sense of brand personality

A careful analysis like Expedia’s allows your company to select a favorable competitive position, one that will include significant points of differentiation—a set of value drivers that will ensure you stand out from the competition. To best your rivals on these dimensions, you will have to divert resources from other value drivers, areas where you do not excel. These are the trade-offs associated with your competitive position

Let’s look at a hypothetical example. Suppose Expedia were to consider the three changes to its value proposition shown in figure 18-3.4 What criteria would you apply to select a proposal? Here are the key considerations

• What is the return on investment? For each proposal, you can calculate an expected return on investment. Proposal 1—improving the way you help travelers work around their budgets—might be very effective in raising WTP, but developing and implementing it could be expensive and might therefore reduce financial returns. For each change in a value driver, you will want to determine both the impact on WTP and the resources and capabilities required to create more value
• How important is the value driver? Because you seek exceptional returns for changes in your value proposition, the most attractive initiatives improve value drivers that sit near the top of the chart. You should be skeptical about the merits of investments in lower-ranked value drivers
• Is the value driver part of a theme? Groups of value drivers that serve a similar purpose often make attractive investment opportunities. As Anand pointed out, themes help your company stand out in the minds of consumers.
• Are you catching up or pulling ahead? Choosing between projects that make up for shortcomings (proposal 1) and initiatives that deepen a current competitive advantage (proposal 2) can be difficult, especially when they yield similar financial returns. In these situations, it is important to remember what you hope to achieve. You want to raise WTP—both projects do so—while maintaining or increasing differentiation
• Where do you underinvest? Spotting opportunities to do less is as important as thinking about ways to raise WTP. Proposal 3 might be an attractive target for underinvestment, because it removes (costly) options that are of lesser importance to travelers

Taking all these considerations into account, you are likely to come up with a value curve that slants from the top right to the bottom left, as we discussed in chapter 17: you excel at the dimensions that are important for the WTP of your customers, and you deprioritize value drivers that have less impact on value creation

Customer Segments

Expedia used its value map to sharpen the company’s overall competitive profile. You can also employ value maps to make more granular investment decisions. Customer segmentation is an example. Most companies serve more than one segment, and initiatives that benefit one of them may or may not create an advantage with others

Differences in value drivers across segments have important implications for strategy. The analysis will show that it is impossible to serve all segments successfully, so you might decide to focus on a particular subset of customer groups

My recommendation is to begin your value curve analyses by employing a fine-grained customer segmentation. Create separate value curves for many different groups of customers. If the data show that two segments have nearly identical value drivers, you can treat the two groups as one segment. If you begin with a broad grouping, however, subtle differences that might influence your strategy will remain hidden

Customer Journeys

Value curve data can also be employed to guide customers more effectively through the buying process

How can the firm encourage broader adoption? Value curves will show you which drivers are particularly effective at moving customers from one location in the funnel to the next lists the relevant value drivers in order of importance.

From Value Maps to Strategy Implementation

Once you decide which value drivers to strengthen and which ones to deemphasize, strategy implementation follows naturally. The key steps are to generate ideas that have the potential to move the value drivers in the desired direction; this is a chance to let your creativity shine—and then to assign responsibility for implementation.8 Figure 18-6 illustrates

the process, using KitchenAid appliances as an example. Whirlpool, the company that owns the brand, focused its investments on four value drivers: versatility, performance, styling, and craftsmanship. For each of these, the company developed a tagline that describes the benefit from the customer’s point of view. Versatility aspires to provide cooking/warming ‘how I need it … where I need it,’ and craftsmanship means fit, feel & finish that is durable and never fails. Engineers used the taglines to identify strings of innovation projects. Whirlpool calls these strings migration paths. Each path promises to raise WTP along one of the four dimensions. The rectangles in figure 18-6 represent the planned innovation projects.9

What I find particularly interesting about Whirlpool’s migration paths is that they include projects for which the operating units currently lack resources. Placing these projects on the paths is valuable, because it shows opportunities for reallocating talent and capital in the interest of raising customer WTP even more effectively

Seeing the four migration paths (represented by the large arrows), you might conclude that Whirlpool decided to compete on innovation. But this impression is false. Innovation is simply a tool; the strategy is to strengthen the four value drivers. David Whitwam, then CEO of Whirlpool, said, I don’t know how many times I’ve had to emphasize this. Innovation is not our strategy. Our strategy is brand-focused value creation.… Innovation is a critical enabler of the strategy.10 As it implemented the strategy mapped out in the migration paths, the KitchenAid team was able to grow its business considerably and raise prices by more than 3 percent over the first five years of brand-focused value creation. Quite an accomplishment, considering that, industrywide, prices fell by 7.7 percent.

Value Proposition for Employees

As important as a differentiated value proposition for customers are advantages in WTS. This was a process for us, says Liday. We knew we had to have a business strategy, of course. But it took some time to come to the conclusion that we needed the same view of customers and employees. We ran through an intensive exercise, trying to understand what is important to our employees, how they find meaning in their work. To identify and heighten differences in WTS, you can use the exact same process described earlier

A comprehensive strategic plan includes customer and talent value propositions. If your company relies on critical suppliers or works closely with important complementors, you will also want to develop value maps for these relationships

Taken together, the maps will point to numerous opportunities for creating value. Because every initiative that flows from this process is directed at raising WTP or lowering WTS, activities in the organization remain closely aligned, and you avoid a situation where hundreds of initiatives would pull the organization in different directions

Value maps are a powerful tool that facilitates the transition from strategy formulation (how you plan to move WTP and WTS) to strategy implementation (the specific activities and initiatives that make the proposed changes in WTP and WTS real). In my experience, the tool provides several key advantages

• WTP and WTS are summary statistics. An understanding of your customer’s WTP informs competitive moves and pricing decisions, but it does not tell you much about the reasons for this valuation. Understanding value drivers completes the picture. The prospect that you are just average is very scary, says Liday. We know we need to be different. But we need to know how. Value maps are a perfect tool to help us navigate through this complicated world.
• Value maps are data driven. It is tempting to rely on one’s intuition and anecdotes to get a sense of customer WTP and talent WTS. But when I see companies undertake a serious value curve analysis, there is almost always a surprise—a value driver that turns out to be less critical than commonly assumed, or an unexpected level of performance in some dimension. The method is continuous and research-based, says Expedia’s Anand
• Seeing your organization through the lens of value maps is an exercise that is radically customer-, talent-, and supplier-centric
• Most companies collect extensive data on customer perceptions of their organization and the engagement of their employees
• Value drivers live midway between the rather abstract notions of WTP and WTS and the specific attributes that describe your current product or service. This has two advantages. On the one hand, value drivers are specific enough to be actionable. It is a straightforward task to link them to operating models and KPIs. On the other hand, value drivers do not specify in any detail how you will meet a particular customer need. They help you explore new ways to satisfy clients. Focusing on value drivers, you are less likely to fall into the trap of adopting a narrow mindset that equates business success with selling more of what you already offer

Part Six Value

19 Connecting the Dots

In practice, however, it is unlikely that a strategic move will influence only one of the two levers. Most real-world strategic initiatives affect both ends of the value stick, so it is essential that you think through all the changes—WTP, price, cost, and WTS—before you embark on a new strategic course. This is all the more important because the four elements are often interconnected. In the best of all worlds, an increase in WTP lowers WTS, creating what strategists call a dual advantage. In other instances, however, an increase in WTP lifts WTS and reduces supplier surplus, forcing companies to decide whom to champion: customers or suppliers.

To take stock of the consequences of a particular strategic initiative, we will account for all the value drivers and for their connections

Integrated Strategic Thinking

In building the Adaptive business, the team at Tommy Hilfiger exhibited a mindset that I admire in many successful strategists. They were laser focused on value creation, developed deep empathy with their target customers, and excelled at carefully thinking through the many consequences of competing in the adaptive market

WTP and Price

The brand’s early research showed that an adaptive collection would lift WTP in three ways. Customers with disabilities were willing to pay an extra 10 percent for functional modifications of their wardrobe

To be competitive, Sheinbaum and his team concluded, Tommy Adaptive needed to match existing clothing in comfort and fit

A third value driver, the team discovered, was a sense of respect and inclusion

After more than a year of extensive research and more than 1,500 in-depth interviews, Sheinbaum and his team created a customer journey that reflected the three main drivers of WTP: adaptive clothing with a multitude of functional modifications, all of which were designed in close consultation with disabled persons (steps 1–6 in figure 19-4); fashion concerns (steps 8 and 9); and a sense of inclusion and belonging (steps 10–14).9

The launch of Tommy Adaptive did not disappoint. The impact has been fantastic, says Sheinbaum. In the very first quarter, two of our five top-selling styles on Tommy.com were from this collection. And 20 percent of our kids’ business was driven by Adaptive

WTS and Cost

Producing the Tommy Adaptive collection is about 20 percent more expensive than regular Tommy Hilfiger clothing. The increased cost reflects additional materials—each magnet cost about $1, for instance—and the extra time it takes to produce the modifications. Tommy Hilfiger asked its suppliers to absorb the extra manufacturing cost. D’Onofrio recalled, When we first showed them our video of customers with disabilities wearing Tommy Adaptive clothing, the vendor reaction was incredible. Some had tears in their eyes. Everybody asked how they could help. And we said, ‘Charge us what you would normally charge us. This is how you can help

The Adaptive team encountered a similar passion among Tommy Hilfiger employees

Spillovers and Value Capture

Tommy Adaptive not only raised WTP and lowered WTS for employees (and perhaps the participating vendors), the collection also influenced the brand’s principal business. There is no doubt that the line has created positive spillovers and a halo effect, says Sheinbaum

Dual Advantages

Taking stock of all the value drivers in your business allows you to see how they depend on one another. For Tommy Adaptive, every advantage ultimately rests on customer delight. If the brand were less generous with its target customers, employee engagement and vendor enthusiasm for the project would suffer. Customers would also be less likely to shop across adaptive and regular products. Sheinbaum and his team are keenly aware of these connections

Tommy Adaptive’s dual advantage—higher WTP and lower WTS—might come as a surprise to some strategists. Many believe that it is challenging, perhaps even impossible, to raise WTP and lower WTS at the same time

Beginning the Conversation

When I visit companies, I make it a habit to ask executives why their company achieves its current level of success. I often find that my hosts hold very different views. Without a shared understanding of success, however, guiding investments and securing a long-term competitive advantage is challenging, perhaps even impossible. Value-based strategy, as I argue throughout this book, is ideally suited to developing a common view of performance and identifying opportunities for enhanced returns

To begin this conversation in your company, take a piece of paper, draw a value stick, and ask three simple questions. What do we do to move WTP? How do we change WTS? What are the connections between our value drivers, prices, and costs? The preceding chapters provide you with all the core ideas and considerations to successfully lead this conversation. Here are some of the benefits you can expect

• Recognizing value—Most firms use financial analyses to decide which initiatives to pursue. These analyses reflect the company’s ability to capture value, but they generally do not show the value that is being created
• Identifying value drivers—It is nice to know that your company has an advantage in WTP or WTS, but it is even more important to understand where this advantage comes from
• Seeing the connections—Some strategic initiatives create a dual advantage, while many others have more mixed effects
• Coordinating investments and aligning activities—Companies that have only a shallow understanding of how they create and capture value are forced to spread their investments across many domains and activities.

My hope is that this book has encouraged you to put pen to paper, draw that value stick, and begin the conversation

20 Value for Society

At this point, it is too early to judge the Roundtable’s long-term commitment to stakeholder capitalism, and unfortunately I do not have a crystal ball. It is possible, however, to identify benchmark behaviors, to draw up a list of decisions and actions that corporate boards and CEOs would take if they genuinely valued the well-being of all stakeholders. Value-based strategy is uniquely positioned to help create this list because the framework provides a sharp definition of value and a precise means by which we can determine how value gets shared. Here is my list of expectations

• Stakeholder-focused corporations will take no credit for increasing customer willingness-to-pay
• Stakeholder-focused corporations will take no credit for lowering the willingness-to-sell of employees and suppliers
• Stakeholder-focused corporations will share the value they create more generously than competitive concerns would lead us to expect
• Stakeholder-focused corporations will take account of the true cost of economic activity, and they will support policies that adjust prices where this is necessary
• Stakeholder-focused corporations will not use political influence to soften competition

Applying a value lens to stakeholder capitalism, two ideas strike me as particularly important. First, business creates substantial value for customers, employees, and suppliers even if its only goal is to maximize financial returns.

Second, shareholder capitalism is at its shakiest if prices fail to reflect the true cost of economic activity

The key to progress is a relentless focus on value creation, not value capture. Fortunately, there is no contradiction. Financial success, as we have seen time and again, will follow true value creation

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