The Three Key Reasons to Keep Innovating

Everyone can agree that innovation is import--for every type of organization. I was reading the "Innovator's Solution" the other day and Christensen made an interesting observation in one of his footnotes that I think is worthy of further discussion, which are the three key reasons to keep innovating: to keep investors happy, to keep employees, and to enable the adoption of technology.

First the traditional view: keeping investors happy. I did a hasty search on the web to see what other bloggers are saying about why innovation is important and from what I can tell they give several reasons that support only this one. Frankly, I think growing profitability and market share are what the general population generally thinks about as the ONLY reason to innovate. Out of the three reasons, this one is the only one that is directly measurable--the hard reasoning--but there are two soft reasons which are dependent on this first one.

Innovation is important for keeping employees also. So long as the company is growing the employees will have a sense that there are opportunities for career opportunities. As growth slows the sense that career opportunities lie outside the firm will be perceived more and more frequently. Unfortunately, it will be the top employees that will have the greatest opportunities, which means it is the less capable employees that are left to shoulder the firm's growth.

The third reason to keep innovating is that investment in new technologies becomes more difficult. When the firm stops growing it will have to do more with what its got because it will be less capable to support the capital investment required to bring new technologies into the organizational architecture.

No one needs to be reminded why innovation is important--the idea is intuitive. Nevertheless, as you are looking at new companies to invest in or work for you can ask yourself if the pace of innovation in the firm under inspection can be sustained to keep the top talent AND whether they are able to invest in new innovations. The two soft reasons to innovate support the major reason to innovate and are the key to impacting the fundamental metrics of innovation: product value, costs and the pace of innovation. 

How Product & Service Innovation Works: Disequilibrium, Discovery and Entrepreneurship

Full Speed Ahead
"The only way to beat the competition is to stop trying to beat the competition."1 In Blue Ocean Strategy, the authors describe the insanity of traditional strategic management logic which guides managers to fight head-on battles with competitors; to fight for the same customers; and to take actions that ultimately commoditize products and services. Blue Oceans are lucrative market spaces with a relative absence of direct competition. Although traditional strategic management definitely has its place, they do offer an attractive line of thinking.

Tactical and Strategic Entrepreneurship
If you believe as I do, that the landscape of the industries never really stand still, then you might also believe as I do that businesses have continuous opportunities to discover "blue oceans". Nevertheless, in order to navigate the complexity, managers need special tools to help them detect and harness the opportunities that are out there. Clearly, the best tools for evolving the enterprise's strategies are those that detect disequilibriums, aid the discovery of alternative strategies, and uses entrepreneurial analytics to harness value. In this posting, I'd like to delve into how disequilibrium, discovery, and entrepreneurship are the essential components to innovation.

Disequilibrium
In How Markets Work 2 (the inspiration for this post), Kirzner highlights the importance of disequilibrium to entrepreneurship. Kirzner is a proponent of "Austrian economics", which dismisses the mainstream economics notion of market equilibrium:

The set of assumptions required by mainstream theory to demonstrate how a smoothly operating market might work are far too demanding in terms of the economics systems we know. the empirical unrealism of that theory's assumptions suggests that it conclusively demonstrates that real-world markets should not be able to spontaneously co-ordinate. Thus the obvious co-ordinating properties of real-world markets turn out to be counter-intuitive phenomena crying out even more desperately for an explanation.

Austrian economics places a large emphasis on "entrepreneurial discovery", where decentralized decision makers take advantage of disequilibrium to improve upon that individual's future prospects. Namely, "[m]ovements in prices, production methods, choices of outputs, and resource owner incomes generated by entrepreneurial discovery tend to reveal where current allocation patterns are faulty, and to stimulate changes in the corrective direction." Therefore, when an entrepreneur perceives a disequilibrium he/she will make decisions that ultimately affect the entire market dynamic...., which generates new disequilibriums because ultimately the decisions are made based on imperfect information. Alternatively, this concept of disequilibrium brings light to the fact that opportunities may go unnoticed and therefore ungrasped. Indeed, "Boldness, impulse, and hunch are the raw materials of entrepreneurial success (and failure); they seem to render the possibility of systematic, determinate chains of events unlikely."

Discovery
The tools of discovery are both qualitative and quantitative, where the qualitative tools are akin to maps on a submarine which can be used to plot the general path and the quantitative tools are the sonar devices that help to identify and navigate obstacles along the way. An example of a qualitative tool for discovery is the business model canvas offered up by Osterwalder & Pigneur in Business Model Generation.3  Many manager talk about business models, but have a difficult time explaining their business models in a way that everyone shares the same conception. The business model canvas is a great way to represent business models in a visual way such that all the interactions and implications can be made clear. Indeed, the business model canvas was the inspiration for one of the primary tools used by the Wissmann Group, called the Enterprise Value Map. Another example of a powerful qualitative tool was offered in Blue Ocean Strategy, which is referred to a "value curve". Value curves are a graphical technique for comparing alternative business strategies, which make it clear if the business will be engaging competition directly or if they have a strategy that will guide them towards "blue oceans".

Qualitative methods are definitely useful, especially when it comes to pointing the metaphorical ship in the right direction. Nevertheless, quantitative analytics also have a role to play and with the advent of business intelligence (BI) systems there has never been a better time to integrate them into business management systems. Three examples of quantitative tools that can be used to discover disequilibriums are (1) Demand-Price Analysis, (2) the Direct Value Method, and (3) Attribute Value Curve Analysis.4 Demand-Price (DP) Analysis uses point of purchase data to yield estimate of product value (a metric to estimate the market's average willingness-to-pay for a product). Monitoring product value using this technique can make product managers aware of changes to market tastes, competitor offerings and aid in effective value based pricing. The Direct Value Method (DVM) is a survey based tool that helps identify product changes that could improve product value, which can improve profitability and market share. Attribute Value Curve Analysis examines each product attribute for its ability to impact product value. As consumer's preferences are non-linear over the range of an attribute's performance, sometimes making small improvements to an attribute can make huge impacts on overall product value. The key is to know which knob to turn! (see "Value Driven Product Planning and Systems Engineering" to learn more).

Entrepreneurship
Entrepreneurship is about allocating resources in the best way possible to take advantages of perceived disequilibriums in price and supply. Kirzner offers the following key insight to entrepreneurship as it relates to disequilibrium and discovery:

• At any given moment, businesses are likely to be suffering from unawareness of the true plans of other businesses.
• This business awareness may take the form of undue optimism leading to a disequilibrium price for a good that is too high or too low to clear the market. Disequilibrium prices generate direct disappointment of plans. Such disappointments can be expected to alert entrepreneurs to the true temper of the market. Prices that were too high will tend to be lowered; those that were too low will tend to be bid upwards.
• Unawareness may also take the form of undue pessimism. Sellers may underestimate the eagerness of buyers to buy. Buyers may underestimate the eagerness of sellers to sell. Such unawareness leads to more than one price for the same good. Such price differences constitute opportunities for pure profit and therefore attract the attention of entrepreneurs. 
• In the course of the market movements achieved through disequilibrium, not only will resources and product prices be modified, but resources will be shifted continually from less important uses to more important uses; and undiscovered sources of new resources will tend to be discovered.
• In the real world of incessant change in underlying consumer preferences, resource availabilities and technical possibilities, these corrective tendencies may be partly or wholly frustrated or interrupted. In addition, these tendencies, operating in different parts of the ever-changing market may interrupt and confuse each other. 
• The direction of the powerful forces of entrepreneurial discovery will be shaped and moulded by the above-described systematic and corrective processes of error, disappointment, discovery, and surprise.

Here is the key insight as it relates to entrepreneurship:

In order to innovate, the business must offer superior solutions, which are only made possible through superior abilities to detect new ways to harness value.













1. W.C. Kim and R. Mauborgne (2005). Blue Ocean Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant. 
2. I.M. Kirzner (2000). How Markets Work: Disequilibrium, Entrepreneurship, and Discovery.
3. A. Osterwalder and Y. Pigneur (2010). Business Model Generation.
4. H. Cook and L. Wissmann (2007). Value Driven Product Planning and Systems Engineering.

Systematic Genesis and Obsolescence-A Product Management Mantra

Product Managers can't sit on their tails even when they believe they're winning the goodwill of the market. In this respect, Product Management might be the second most thankless job in industry after that of an operations manager, where even if you make the production numbers for the month, upper management and executives shift their focus to the next period and cast doubt on the manager's ability to hit the numbers for that period. Both these jobs are a treadmill where accomplishments are made and forgotten.

In the "Building Product Value-Guidance for Product Managers" blog-post I listed several truths of product management and offered a framework of enabling capabilities for building product value. In this post I want to focus on the most basic truth of Product Management:

Truth #1

Product Managers must be willing to cannibalize old products with new products. If managers aren't willing to give up on old products, competitors will make the products obsolete for the manager.

Sustaining and Disruptive Innovations
In product management (products are bundles of goods and services), there are two ways to characterize innovations made to products: sustaining and disruptive [1]. The sustaining innovations utilize a single genetic code for their products to which incremental changes are made to yield performance improvements. Alternatively, disruptive technologies utilize a completely different genetic code that produces a slightly different value proposition to the customers' fundamental needs. Ironically, disruptive technologies often yield products that perform worse, at least in the near-term, to the incumbent products, but over time may actually dethrone those products due to performance/cost advantanges.

Businesses can fail for many reasons, such as poor execution of plans, poor plans, poor leadership, poor processes, and even bad luck. But Christensen [1] showed that businesses can fail even when they do the right things from a traditional management theory standpoint. Many businesses invested aggressively in new technologies, listen to their customers, and did market research only to lose their leadership position to another business that was shrugged off as a niche player. One of the most recent examples of a disruptive business that was shrugged off might be NetFlix, who swiftly dethroned Blockbuster with a new way to deliver home entertainment.

Systematic Genesis and Obsolescence

Businesses that were able succeed in the face of disruptive innovations did several things right [1]:

1. They funded disruptive technology projects when they could align customers with the innovations.
2. They scaled disruptive innovation projects so that staff could get excited and demonstrate small wins.
3. They planned to fail early and inexpensively and made it organizationally acceptable to do so.
4. They developed new markets for their technology rather than go head to head with sustaining technologies.

One of the best examples of success through cannibalization is how Hewlett-Packard developed and introduced ink-jet technology. In the mid-1980's the laser jet technology dethroned the dot-matrix printers and HP developed the leading market position. Even though ink-jet printers were slower, resolution poorer, and the cost per page was higher; evidence was there that the printers themselves were cheaper to manufacture. To investigate the opportunity, HP created a separate organization to take responsibility for making ink-jet printers a successful business opportunity. Now HP is the major player in the ink-jet printer market.

Avoiding the Innovator's Dilemma

The Innovator's Dilemma, as put by Christensen [1], is that "logical, competent decisions of management that are critical to the success of their companies are also the reasons why they lose their positions of leadership."So should product managers throw their hands up in the air and regress to a shoot-from-the-hip management style? My position is that the innovator's dilemma doesn't have to be a dilemma at all because those "logical and competent decisions" would have been dismissed with the proper use of Value Driven Product Management tools.

Value Driven Product Management (VDPM) is the organization, coordination, and execution of activities focused on growing the net-value of products. One of the core enabling capabilities of VDPM is the ability to quantify the critical value metrics as depicted in the chart below as they are the key to managing the fundamental metrics of product value, product cost, and pace of innovation.

VDPM advocates the planned obsolescence of products by including disruptive technological innovation in the product plan. As shown in the figure below, net-value improvements begins with innovations that lead to product performance improvements that yield product value gains. Although searching for process innovations should always be sought to reduce costs, they generally lag the product performance curves. Nevertheless, when net-product value improvements are coming primarily from process innovations, businesses should begin investing in projects to identify new product architectures that have the potential to produce either more net-value (as shown in the figure) or to add a product to the portfolio that addresses an underdeveloped market.

VDPM tools are used to measure the fundamental metrics of product value, product cost, and pace of innovation. All three metrics can be shown in the S-curve figure above and can be used for predicting product obsolesce and the need for a new technological architecture (sometimes referred to as a platform). The VDPM not only measure the current state, but can be used to detect product value opportunities and forecast market performance (predictive analytics) to make sure incremental profit is not left on the table.



[1] Christensen, C.M. (1997). The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail. Harvard Business School Press. Boston, MA.

Building Product Value-Guidance for Product Managers

In life we talk about building personal wealth. In business we talk about building shareholder value. It's time for product managers to start talking about how to build product value. Value Driven Product Management (VDPM) is the organization, coordination, and execution of activities focused on growing the net value of products and just like there are principles for growing wealth and shareholder value, there are principles for growing product value. In this post I offer a framework for understanding the essence of VDPM.

The Value Driven Product Management Pyramid

I recently reread "Building Wealth" where L. Thurow lists what he believes to be the truisms that provide the foundation for societies, companies, and individuals to build wealth. I couldn't help but see the parallels between building individual/social wealth and building product value. I looked at Thurow's  truisms through the Value Driven Product Management lens and found that much of the framework and principles apply to improving the value of products.

There is an unfinished pyramid on the pack of the dollar bill with a glowing eye at the top. The symbol was placed there by President Roosevelt in 1935 to represent economic strength and durability during a time when America's wealth was anything but that. The unfinished pyramid symbolizes the possibilities of the future and the glimmering eye represents the ability to see what must be done next.

Here are the layers of the Product/Service Value Pyramid

The Eye: Value Driven Product Management

Social and Environmental Consciousness

Value Driven Decision Approach

Product Value Advocates

Innovation and Knowledge Management Systems

Value Driven Culture

Base of Pyramid: Value Delivery Systems

Before we get into the layers themselves, there are a few truths that we posit from the beginning:

Truth #1

Product Managers must be willing to cannibalize old products with new products. If managers aren't willing to give up on old products, competitors will make the products obsolete for the manager.

Truth #2

Product Managers can attain high profit margins and large rates-of-return by exploiting product value disequilibriums that result from technological innovations, under-serviced markets, and evolving social trends. All other prospective product management actions yield marginal results with a low rate-of-return.

With these fundamental truths in place let's look at each of the pyramid layers to see what other truths we can find that can help product managers attain the top of the pyramid.

The Base: Value Delivery Systems

Every organization has a way of doing things. The small business will likely have the efficiency and style of the business owner. The larger organization is build upon legacy processes, methods, and culture. If we think about these characteristics as "business genes", we might say that businesses are predisposed to have certain strengths and weaknesses that are very dependent upon their market. If the business moves to a new market, some strengths might become weaknesses, and visa-versa.

Truth #3

Every organization has a genetic code for delivering their products and services. The secret to success is finding markets where the products' strengths make them exotic and where weaknesses are irrelevant.

Value Driven Culture

There is no shortage of literature that talks about continuous improvement. Lot's of business say that it is part of their culture and in the drinking water. The major distinction of a value driven culture is that continuous improvement activities are not pursued based on perception, but because there is strong evidence that the actions will have a direct impact on the customer's willingness-to-pay (product value) and/or reducing costs to yield a positive change in the net-value of a product offering.

If an action reduces cost, but also reduces the customer's perception of value by more than the cost savings the result is a negative net-value change, which results in less profitability because prices must drop to yield the same demand and results in customers seeking out other alternatives for the same price.

Truth #4

There is no institutional substitute for individuals who know how to grow customer value (see figure below), which is done by improving willingness-to-pay metrics (product value) and/or reducing costs to yield a positive net-value change.

Innovation and Knowledge Management Systems

An innovation in the truest sense is an artifact or concept that is new to the world and improves upon a legacy artifact or concept by either improving performance (think product value) or reducing cost (think product cost). Innovations can come about by accident or systematic discovery, but in nearly all cases they come about through the use and/or the application of knowledge. Businesses need systems to keep track of lessons learned and accumulated knowledge whose immediate implications may not always be clear to ensure the wheel doesn't need to be continuously reinvented.

Truth #5

Innovative ideas come from both knowledge and creativity. Any organization that values structure, policies, and rules above all else will not be creative, but without the right degree of order, innovative ideas and knowledge vanish. 

Product Value Advocates

"There are more cowboys in Detroit than all of Texas!" This is what one automotive industry expert had to say about the cavalier style of auto executive decision making throughout the last several decades. The data were there to suggest that reliability and fuel economy were becoming ever increasingly important in the decision calculus of auto consumers, but because auto companies lacked the proper analytical tools to sense and assign the proper level of sensitivity for these automotive attributes the opportunity was lost.

There are many studies that suggest that people often fall into decision traps because of our limited working memory, limited abilities in cognitive reflectiveness, and limited abilities related to comprehending the true probabilities of uncertain events. When decisions get complicated and we don't have a decision framework we use over-simplistic decision heuristics. Sometimes the result of these poor decisions yield a good result, but what we really want is a good decision based on a framework that gives clarity of action.

Although analytical tools have their place in decision making, the use of intuition is critical to check assumptions. If the analytical tools are to be trusted (and used) by decision makers, models must be transparent so they can be checked with intuition. Balancing analytics with intuition is the job of a skilled analyst who has the proper analytical tools and a solid understanding of decision analysis. I like to call these individuals Value Advocates because they can use their specialized knowledge to detect and communicate value improvement opportunities in a credible way.

Truth #6

Use intuition AND analytical tools to make good value driven decisions because either used alone can be very risky. Product Management teams need both experienced managers to provide intuition and value advocates who know the analytical value tools to reduce risk and provide clarity of action.

Value Driven Decision Approach

A decision is an irrevocable allocation of resources. You don't actually decide to buy a pair of shoes until you pass money to the shoe store. You don't actually decide to go on vacation until you're on the airplane and past the point of no return even though you've purchased the ticket-you could change your ticket to make a trip for reasons other than vacation.

We make decisions every day ranging from what to wear to work to what home to purchase. Whatever the decision, it is clear that the level of consideration that a decision warrants is based upon the level of risk associated with that irrevocable allocation of resources. Will your taste in fashion change after you purchase the shoes? Would you rather spend your money on a new pair of skis rather than go on vacation to the Caribbean? In our personal lives there is no escaping the results of our decisions and therefore we are very careful when making big decisions-those that require a significant amount of our resources.

When it comes to product management, the level of decision analysis should also be directly related to the level of resources to be allocated. While working for a manufacturer of specialized aircraft I often heard complaints from managers that information gathering for decision analysis was "too much work", but if you asked the executives whose careers depended on flawless strategic decision making, their response would be, "That's the way its must be!"

Truth #7

Managers who are interested in building value into their products and services will use Value Driven Decision Analysis. Managers who are on rotation, have plans to move on after decisions are made, or who don't have a true stake are more comfortable making decisions with a limited level of consideration.


Social and Environmental Consciousness
Now more than ever, companies are being held accountable. This accountability is directly related to the ability of stakeholders to organize and get messages out when companies take actions that negatively impact society and the environment-even if these results were unintended or unknown.

In the past it took investigative reporting to get the word out, but with the advent of social networks and media, the message gets out and the implications to the business can be swift and unforgiving.

Truth #8
Negative social and environmental externalities must be understood and quantified when possible so they can be included in the product planning decision calculus. Failure to do so leaves the business open to legal liabilities, political controversy, and societal backlash.

The Glowing Eye: Value Driven Product Management

It should be clear that Value Driven Product Management (VDPM) is more than just a few neat ideas, its more than neat analytical tools, and it applies to all types of products and services. Indeed, to be a value driven product management requires that several modern day management principles be interwoven into the culture and organization. Specifically, VDPM is the organization, coordination, and execution of activities focused on growing the net value of products. 

One of the core enabling capabilities of VDPM is the ability to quantify the critical value metrics as depicted in the chart below as they are the key to managing the fundamental metrics of product value, product cost, and pace of innovation.

What I've offered in this post is not meant to be all inclusive of what VDPM is supposed to be, but simply a framework for understanding the essence of VDPM.

Value Driven Six Sigma-So What's New?

Traditional Six Sigma Mantra
Six Sigma has always been about reducing variation. Traditional Six Sigma strove to reduce process variation and its success at doing so has been well documented. Traditional Design for Six Sigma (DFSS) strove to utilize quality tools in the design processes to yield products that meet customer expectations. DFSS successes have been less prevalent, which might be the case because it can be more difficult to quantify and demonstrate veritable results.

Criticisms of Traditional Six Sigma
The critics of traditional six sigma often cry: sure you've reduced process errors, but how has that influenced the customer perceptions of product/service value? Sometimes the influence on customer perceptions are direct as in the case of reductions in call center wait times or paper work cycle time (which makes the organization more responsive to customer requests), but is the customer really receiving more value when callers are routed through a complex call filtering system for the sole purpose of reducing variation of in-call handing times?

Then there's DFSS, with tools such as the Voice of the Customer (VOC), Quality Function Deployment (QFD), Analytical Hierarchical Process (AHP), etc. Well...., these tools as proposed and traditionally used are good in theory, but..., well..., they're difficult to use in practice and often collapse under their own weight, which ends up forcing managers to shoot from the hip anyway.

Value Driven Six Sigma
The mantra of Value Driven Product Management is to use product value, product cost, and pace of innovation to guide variation reduction decision making. Value Driven Six Sigma and Value Driven DFSS looks at variation reduction through a new lens: reduce process and product variation so long as the result is positive net-value creation. The net-value of any product management decision is the change in product value minus the change in product cost. The third fundamental metric of product management is pace of innovation, which is a measure of how fast the product/process changes can be made.

Further Reading:
Design for Six Sigma as Strategic Experimentation

B2B Value Capture: Shattering the Commodity Perception

Lost Opportunity in the B2B Sale
Many suppliers make the mistake of believing they are selling only their core products in a B2B sale and use this as the basis for negotiating price. In today's world of complex products that contain multiple sub-systems, it is often the case that unknown interactions produce new performance issues or yield unintended consequences. What the supplier must do is unbundle the core product which might be interchangeable from the competition, from the supplementary services that are often given away without limit to the customer.

Value in Supplementary Services
Supplementary services are often seen as very valuable by the customer and could be used as the attributes of difference (differentiators) that could be used to capture more value in a B2B sale. The authors of "Value Merchants" (see link below) offer several examples of supplementary services that could be used to capture more value:

Services

• Fulfillment: availability assurance, emergency delivery, installation, training, maintenance, disposal/recycling
• Technical: specification, testing and analysis, troubleshooting, problem solving, calibration, customer productivity improvement

Programs

• Economic: terms and conditions--deals, discounts, allowances, rebates/bonuses; guaranteed cost savings
• Relationship: advice and consulting, design, process engineering, product and process design, analysis of cost and performance, joint marketing research, co-marketing and co-promotion.

Systems

• Supply Chain: order management intranet, automated replenishment and vendor-managed inventory, enterprise resource planning, computerized maintenance management
• Efficacy: information and design assistance intranet, expert systems, integrated logistics management, asset management

Think Naked Solutions and Supplementary Services

A naked solution is the basic out-of-the-box product and the supplementary services are the extra services that can be offered to make the customer's life more easy. Some customers won't need supplementary services, so don't give them and charge a lower price than the competition who still have these services bundled into their offer. Don't force customers to pay for services they don't need.

Before you can decouple supplementary services from the naked solutions, the supplier needs to unbundle the value and costs. The following table gives some direction on what to do next:

As you can see, we want to drive supplementary services to become options and let the customer decide what they value for themselves. What could be better than giving the customer what they want, for a price they're willing to pay, for a price that is profitable for the supplier?

Further Reading:

"Value Merchants" by Anderson, Kumar and Narus

Quantifying Value in B2B Transactions

Value, Value, Value
Value is a word that can have many meanings based on the conversation at hand. To clarify, I offer the following graphic representation of the different types of value from the supplier's perspective that are important in B2B transactions:

The way you capture value in B2B transactions is by calculating the value the customer puts on your product (good and/or service)--calculating the product value. When we create B2B value calculators through Economic Value Analysis, we systematically quantify the value drivers for a particular customer. This is the major difference between Value Driven Management in a B2B market versus a B2C market where a product value metric is calculated and used to represent the worth an entire market gives to a particular product.

As the chart shows, if you know product value and product cost, its easier to understand what price is equitable for both the supplier and customer. Ultimately, product value and price don't change much. Price is therefore changed to give more or less incentive to the customer to go forward with a purchase. This difference between Product Value and Price is called Customer Value and in B2B transactions Customer Value usually translates directly into economic value (profit) for the customer.

What to Expect

As you work with your customers to create the value calculation, each Critical-to-Value Attribute will fall into one of the following categories (see Value Merchants below):

1. Attribute of Parity
2. Attributes of Difference
3. Attributes of Contention

An attribute of parity is an attribute that performs essentially the same as a competing alternative. An attribute of difference is an attribute that performs either better or worse than a competing alternative. Alternatively, an attribute of contention is an attribute where it is not clear whether a the competing alternative is better or worse, so more data is required.

Value Propositions from Value Calculations

Value propositions might actually vary from customer to customer due to different product use situations. Nevertheless, value propositions become clear as the value consultant and customer develop a shared mental model of how value is delivered. The attributes that perform better than the competition form the basis for the value proposition and the two or three attributes that deliver the most value become the focus. These high value earners WILL likely be what sets the supplier's products apart from the competition and ultimately become the foundation for brand building.


Additional Reading:
"Value Merchants: Demonstrating and Documenting Superior Value in Business Markets"

Book Review: "Design for Six Sigma as Strategic Experimentation: Value, Cost, Pace of Innovation" by H.E. Cook

5 Stars (out of 5)

The following is a book review of "Design for Six Sigma as Strategic Experimentation" by Harry Cook. The book was first published in 2005 by the American Society for Quality, Quality Press.

Actually, the book gets 10 out of 5 stars. Don't be fooled by the title, this book is much more than traditional DFSS. "Value Driven Strategic Experimentation: Product Performance Optimization" might have been a better title because the methods and tools described in this book address the major criticisms of traditional DFSS (too much focus on cost, value to the customer is not quantified, the tools are not integrated). Unlike traditional DFSS, VDSE uses BOTH product value and product cost to find the optimum design variable settings to maximize net-value, make tradeoff decisions between product performance attributes, and minimize performance variation. VDSE is what DFSS was intended to be, but never could be because of its reliance on "old" tools that were shoehorned together.

This book, like Cooks other book "Product Management" is the result of  an academic collaboration with industry which strove to provide tools to guide product managers through decisions that involve both technical and commercial feasibility. The book is written for the scientifically minded and mathematically inclined audience and is a seminal work for other "Value Driven Product Management" books. The specific contributions to the domain of product management include: (1) explains the role of product value in product management decisions, (2) offers analytical models for calculating product value, (3) offers analytical models for calculating the value of continuous product attributes, (4) offers analytical models for calculating the value of qualitative product attributes, (5) includes a methodology for creating experiments to find optimal settings for design variables, and (6) provides rigorous support for models based in economics, econometrics, game theory, and psychology. The book is clearly written, has an excellent bibliography, and uses real-world examples to illustrate main points.

In summary, "Design for Six Sigma" is an excellent contribution to the area of Value Driven Management and is highly recommended for quality engineers interested in being on the cutting edge.

Book Review: "Product Management: Value, Quality, Cost, Price, Profit and Organization" by H.E. Cook

5 Stars (out of 5)

The following is a book review of "Product Management: Value, Quality, Cost, Price, Profit and Organization" by Harry Cook. The book was first published in 1997 by Chapman & Hall.

"Product Management" is the result of  an academic collaboration with industry which strove to provide tools to guide product managers through decisions that involve both technical and commercial feasibility. The book is written for the scientifically minded and mathematically inclined audience and is a seminal work for other "Value Driven Product Management" books. The specific contributions to the domain of product management include: (1) explains the role of product value in product management decisions, (2) offers analytical models for calculating product value, (3) offers analytical models for calculating the value of continuous product attributes, (4) offers analytical models for calculating the value of qualitative product attributes, and (5) provides rigorous support for models based in economics, econometrics, game theory, and psychology. The book is clearly written, has an excellent bibliography, and uses real-world examples to illustrate main points.

The models that Cook offers have been criticized for requiring large amounts of data. This is not the case however, as what makes the models so powerful is that they can be initially parameterized using best guesses and continuously

refined by investing in market research to reduce risk. The organization not only benefits from the model's predictive power, but also by going through the process of model parameterization as it focuses the team on the important variables and assumptions.

One area where the book is particularly unique is Cook's chapters on quality improvement. The product management models are tied together with concepts such as Taguchi's methods and Statistical Process Control (SPC) to show how value can be included in the product management decision calculus (traditionally the focus is on cost reduction in quality). 

In summary, "Product Management" is an excellent contribution to the area of Value Driven Management and is highly recommended for marketing and general managers of products with either high price tags (auto, computers, etc.) or high volume who compete in highly competitive markets. This book would also be a good addition to the library of quality managers because of the attention given to the link between product value and quality.

Four Steps to Deliver Product Value

Businesses must be responsive to how customer's tastes change. For example, in the early days of cell phones customer's wanted small and light-weight phones. Today's phones must possess a balance between functionality, usability, size, and durability. What makes the task increasingly difficult is that there are several different markets of consumers with different expectations and willingness-to-pay for each of these attributes. The many cell-phone manufacturers have come up with their solutions over time and the consumers show their preferences with their purchase decisions. Some of the manufacturers have found ways to satisfy certain target markets, but these guys fight hard for every point of market share.

Product planners can make deliver big gains in market share and profitability by taking four major steps:

1. Identify sources of product value
2. Make changes to goods and services that increase net value (product value minus product cost)
3. Promote the changes
4. Assess the product value delivered

Identify Sources of Product Value

The first step in identifying sources of product value is to measure the current product's value to the customer. Measuring product value is how the business measures how its solution measures up against the competition and serves as a source of ideas for integrated communications to the customer to remind them of the solution's benefits. The key to Step #1 is exploring the voice of the customer for adding or changing attribute levels for which consumers are willing to pay. Although many product planners and executives use their gut to identify the sources of product value, it doesn't have to be this way. The competitive landscape is just too tough to rely on gut feels alone.

Increase Net Value

Competing on both product value and product cost is the key to creating value for the customer and value for the business. Studies have shown that successful businesses (in terms of profitability and market share) are the ones that focus on creating valuable products AND keeping costs down simultaneously. Generally, when making these tradeoff decisions, analysts will come up with cost forecasts and leave it to the product planner to use "the gut" to figure out if the change will be a net value winner (net value losers are the ideas where the change in willingness-to-pay does not cover the change in product cost). Again, making the net value decisions doesn't have to be this way. There are ways to make these calculations rapidly to support better decisions.

Promote the Changes
If changes are made that give the consumers more for the money--TELL THEM. The metric of product value is based largely on perception, so its important the product changes are communicated so that the consumer know how your product is better than the competition (and how to explain it to their friends).

Assess the Value Changes
The last step is measuring the value changes using actual purchase data. Actual sales data is the only way to obtain a metric of product value that truly measures how consumers vote with their dollars. Using survey data to forecast value changes is a necessary step in determining what product changes will help net value, but using real sales data to measure changes in product value is the only way to assess the innovative power of product changes.

Book Review: "Know Your Customer" by Woodruff and Gardial

5 Stars (Out of 5)

The following is a book review of "Know Your Customer: New Approaches to Understanding Customer Value and Satisfaction" by Robert B. Woodruff and Sarah F. Gardial. The book was published in 1996 by Blackwell Publishers Ltd.

"Know Your Customer" is for the intellectually curious marketing manager who wants to gain a foundational understanding of the differences between customer satisfaction and customer value (how customers value products). Although this book might be a bit much for the general manager who is interested in the results of satisfaction and value studies only, the general manager will benefit from an enriched view of how customer value insights can lead to innovation and the limitations of customer satisfaction metrics.

The authors lay down a framework for satisfaction and value and explain why analyzing both is key to business intelligence. The book is clearly written, uses a formal voice, has a good bibliography for the time that it was published, uses examples from industry to help illustrate important concepts and accomplishes what it sets out to do--explain the relationship and differences between customer satisfaction and value.

The book serves well as a foundational piece, but may fall short for those interested in the latest analytical techniques that include quantifying and forecasting value in terms of a willingness-to-pay metric in dollars (called product value). Product value is particularly helpful when making tradeoff decisions that influence product cost and when it is necessary to dedicate precious resources to a list of possible product innovations.

In summary, this book is perfect for managers interested in a foundational understanding of customer satisfaction and value. This book is not for those interested in the latest analytical concepts and tools.

Customer Satisfaction Versus Product Value

Many companies have systems in place to measure product satisfaction (the more popular term is customer satisfaction) and use the information to aid decision making. Alternatively, very few companies have systems in place to measure product. I share the belief with others that satisfaction and value metrics are different, they tell different kinds of stories and that together they provide the complete story. In this post I'd like to explain the following:

• The difference between satisfaction and value metrics.
• Show that both satisfaction and value metrics are necessary for decision making.

Customer Satisfaction and Value Defined

Customer Satisfaction is a customer's perception of how well a product (good or service) performs in specific situations or in general relative to their expectations. 

Product Value is a metric that is a property of a product (good or service), similar to product cost in that it is measured in $, but measures the worth of a product (customer's willingness-to-pay) for a specific market and is independent of use situations.

Below is a table that compares satisfaction and value in more detail.

Customer Satisfaction and Value in Decision Making

Both measures are needed to get a complete picture of how the business is doing and neither alone is a substitute for the other. Below is a table that shows how the metrics aid different types of decisions.

Five Disciplines for Creating What Customers Want

“Risk comes from not knowing what you’re doing.” – Warren Buffett


Carlson & Wilmot say that businesses must address at least the following types of value:

• Customer Value
• Company Value
• Shareholder Value
• Employee Value
• Public Value

Many folks use the words "customer value" to mean "value to the customer". I like to use the words "product value" because for me it represents a property of the product just like "product cost" (a product can be a good, service, or combination of the two). Whatever you call "value to the customer", everyone can agree that it is the center around which all other types of value are based. Everyone can also agree that product value fluctuates over time as the tastes of customers change.


Using product value as a metric to manage the business is about creating what customers want. Carlson & Wilmot list five disciplines for doing this:

1. Focus on important needs
2. Have a system for creating value
3. Make sure your organization has innovation champions
4. Use innovation teams
5. Align the organization around creating value

It should be clear that being able to measure product value is key to all five disciplines, but let's role up our sleeves and take a look.


Prioritizing Important Needs


Products satisfy the needs of people who purchase them. My car not only takes me from point A to point B, but it carries me safely, it moves my groceries, my friends, it provides excitement by accelerating swiftly, and so on. The car possesses several critical-to-value (CTV) attributes for which I'll pay. Quantifying how my willingness-to-pay changes as the level of CTV attribute changes is one of the best way to prioritize important needs.


Value Creating Systems


To be successful in the long term, businesses must have a system for making improvements. The best systems are based on the principles of value driven innovation, which focuses on building the net-value of a product over time. Net-value is the difference between product value and product cost and its growth has been linked directly to growth in market share in several studies.


Innovation Champions 


Innovation champions are individuals in the business that encourage and support product and process improvements in the organization. In The Tipping Point, Gladwell listed three important roles of innovation champions:

1. They share knowledge
2. They influence others to take action
3. They connect the right people to enable action

Of the five disciplines, this is the one where quantifying product value may be nice, but not that important. The innovation champion may just need to have an intuitive sense that an opportunity exists and have the innovation team quantify the innovative power of an idea when it comes to obtain funding from upper-management.


Innovation Teams


Kaizen teams are a well known approach for gathering a cross-functional team to attack innovation opportunities. These teams are often formed to focus on process improvements, which can result in cost savings and improved service. Although improving service is one way to increase product value, it is often a secondary objective of Kaizen teams and there exist opportunities to improve the "economic good" part of product value. This is a view held by some of the Six Sigma thought leaders. Indeed, it is my view that Kaizen event charters should quantify the expected change in both product value and cost as a way to understand the projects true innovative power.


Product Value and the Organization


A consistent theme throughout my blogs is that improving the net-value of products and services is everyone's job. Nevertheless, unless businesses learn how to quantify product value, net-value will remain a fuzzy metric and the it will be difficult to set targets and monitor progress. One of the key benefits of measuring product value for the organization is that it is an outward looking metric, which tells you how you are doing with respect to your direct and indirect competition. Ultimately, quantifying the fundamental metrics is what helps the entire organization play the same sheet of music, to set targets, and innovate.

Know Where You Are, Know Where You Are Going

“If we could first know where we are, and whither we are tending, we could then better judge what to do and how to do it.”  –Abraham Lincoln

Every day we are getting better at managing the mounds of data that our businesses produce. The size of databases tend to double every 12 to 18 months according to an InformationWeek article. Not only are the data sets getting bigger, they're becoming more real-time, where Wal-Mart is adding a billion records daily. With this explosion of data, how do we bring order to guide the business?

A Single Version of the Truth

Business Intelligence strives to deliver a single version of the truth based on trusted information to help business leaders make better decisions. To give our leaders clarity of action, we need to simplify the masses of data into manageable metrics that let us do the following:

• Know Where We Are: Understand the competitive landscape
• Know Whither We Are Tending: Identify opportunities and trends
• Know What To Do: Set targets and monitor results so we can see what works
• Know How To Do It: Create a common context and objectives for decision making across the organization

Business Intelligence for Driving Innovation

In the case of Wal-Mart, the focus is on managing a gigantic supply chain and identifying tactical moves to improve sales and minimize costs. "Supply Chain Management" is not the only area of business that can benefit from improved business intelligence. R&D and Product Managers can use sales data to obtain a single version of the truth using Voice of the Customer Exploration tools that monitor customers' willingness-to-pay for products (what I call product value) in a portfolio. A generic representation of what this would look like is shown in the figure below.

If your product is A and your competitor's is B, don't you think it's important to know when the consumers in your market become willing to pay more for your competitor's product? Total Product Value Analysis is about "Knowing Where You Are". One of the major benefits of this form of analysis is the ability to compare how you are doing against the competition (an outward looking metric). 

Product Cost is traditionally the metric that can be measured, so this is the metric that gets managed. Unfortunately, this isn't the way to make your products more valuable to your customers. However, if your Business Intelligence Systems gain the ability to measure and monitor Product Value, value driven product management becomes possible because you "Know What To Do". Ultimately, the product manager evaluating new innovative ideas by understanding how to balance the increased value to the customer with the possible increases in product cost. The only way to do this without a product value metric is to use intuition or "gut feel", which is no way to be competitive in todays ultra-competitive global economy as I discussed in a previous blog.

How It Would Work

The Business Intelligence System will be able to drill down and role up to identify trends within markets, within regions, and as a whole. Performance bands can be placed at each level so that product managers can be alerted to major changes in value that could be attributed to successful advertising campaigns or new product introductions introduced by competitors. With these alerts it becomes possible to react both tactically and strategically to drive product value back into your products via additional promotion or making tweaks to products and services.

Guidelines for a Value Driven BI System

Transforming processes into a system begins by integrating the right information and being able to summarize the data so that it is useful in supporting decisions making. Here are some guidelines:

• The system should aggregate product value and customer satisfaction data
• Managers should be able to drill down and roll up the data by product, market, segment
• The database should be able to show trends

This data should be made available to executives, general & product managers, brand managers, sales, quality, product development, R&D and customer service.

Find the Voice of the Customer Signals, Ignore the Noise

“An expert is someone who has succeeded in making decisions and judgments simpler through knowing what to pay attention to and what to ignore.”  -Edward de Bono

Product managers often must determine what aspects of the product that consumers value. The marketing folks will use their qualitative and quantitative techniques to try and understand the voice of the customer and pass on what they learn. If the product is a car, the respondents will tell you that they want better fuel economy, better acceleration, improved safety, comfortable seating, room for the luggage, etc. Since the beginning its been up to product managers to understand their target market and strike the right balance between product performance and cost.

The challenge in today's marketplace is making the performance/cost tradeoff decisions for evermore complex product, increasingly diverse consumer tastes, and increasing sophistication of competitors in making the same decisions. Moreover, the technology required to make the necessary leaps in product performance must be planned and developed, which ties up precious capital. Indeed, now more than ever, it is critical that the business is able to "Find the Signals and Ignore the Noise". 

If product managers want to be experts in their domain, they must be able to make decisions based on the "true" voice of the customer. By quantifying the voice of the customer in terms of product value, product managers can make high quality decisions about future product because they'll be able to develop solid business cases for future product concepts and ultimately R&D expenditures.

Clarity Please-A Product Value Metric for Decision Making

In "Clarity Please-Customer Value for an Individual"  I defined the metric to measure a single consumer's willingness to pay, which I labeled VI. Nevertheless, because a market is composed of many consumers, this single estimate of value does us no good when it comes to make decisions involving the whole market. What we need is an overall metric of product value that summarizes the willingness-to-pay of the entire market of consumers. This overall metric is critical to modeling how the market will respond to alternative product and service offerings.

According to Harry E. Cook (an expert in the area of measuring customer value), there are three properties that an overall measure of value for an economic good must possess (Cook 1997):

1. It must have the same units as price
2. The net value of an economic good to the consumer decrease as price approaches value
3. If a product change creates an increase in demand while holding price constant, value has been increased.

Let's say our TV manufacturer wants to determine an overall metric that sums up the willingness-to-pay of those consumers that actually purchased his TVs and he wants to call this metric VB (buyer's value).

Let's also say that the TV manufacturer was able to get a representative sample of the market to participate in a survey that was able to discern the VI of each respondent (idealistic I know, but work with me) and when he graphs out the results it looks like the maroon curve in the figure below. The demand curve between the green and the yellow dots represents the consumers who wouldn't take the TV unless you paid them (maybe its unfashionable to own a TV in their neighborhood!). The demand curve between the yellow and the red dots represent the consumers that believe the TV is a positive economic good (they'd pay for it). The red dot represent the market's reservation price (no one will buy the TV if it is priced larger than the red dot).

Now, for any given price we can draw a line that is tangent to the demand curve and this line will intersect the dollars axis. Let's call this intersection VB (labeled as such in the figure above). This my friends is our metric that provides the TV manufacturer with an overall metric for the willingness-to-pay for those consumers who would actually buy the product. Over the course of this blog we will talk about VB (total product value or just product value) and how business leaders can use it to drive innovation, drive revenue growth, drive profitability, and drive customer satisfaction.

Clarity Please-Product Value for an Individual

Every marketing textbook I look at defines product value as the relationship between the consumer's perceived benefits in relation to the perceived costs of obtaining those benefits. The relationship is generally expressed as the following ratio:

Value = Benefits / Costs

I know we can measure costs, which might be transportation costs, storage costs, maintenance costs, delivery costs, etc. But someone, anyone, please give me an example of when a marketer has actually taken the time to list out and quantify the tangible AND intangible benefits..... I fear I'll be waiting a long time. Now let's say someone actually went through the trouble of quantifying these metrics, I would like to meet an executive who used the resulting ratio to make a decision. If the ratio was less than 1 (indicating costs were larger than benefits), who's to say the analyst didn't forget a benefit or two that might tip the scale???

Can we please dispose of this nonsense and move onto a metric that allows us to make decisions? Let me propose an alternative definition of product value, which has been tested in major automotive and heavy equipment companies and has shown to be rigorous and worthy to be included in the decision calculus. Rather than give a mathematical derivation (you can find this in a book), I'd like to get there using our intuition (let me know if I can make some improvements).

Let's start with the illustration below. Here we have a buyer with a sack of money and a seller holding a TV (both men and smiling) with a lady in the background who is clearly disappointed about something. If the seller's price was equal to the buyer's Individual's Customer Value (let's call this VI, where I stands for individual), then there wouldn't be a deal as this would meet the buyer's willingness-to-pay threshold. Conversely, the seller wouldn't sell the TV for a price that was equal to his cost (let's call this CS). Therefore we know that price needs to be somewhere between VI and CS. The closer that the price is to CS, the happier the buyer will be; and the closer the price is to VI, the happier the seller will be. Let's say the buyer and seller were honest and fair in their dealings, for them to share equally in the deal they would set price as follows:

Price = (VI + CS) / 2

Let's define "Net Value" as  (VI - CS), so the buyer and seller are both happy because they split net value 50/50.

The challenge with real markets is that every potential customer has a different VI so it's impossible to charge a single price to split the net value in each transaciton. It's also rare that the seller divulges his costs and/or the seller divulges his/her willingness-to-pay. In the next post I'll tell a story about a customer value metric for a market of individuals. Don't worry, I'll also talk about the angry lady in the background in a future post.

The Product Value Torque Wrench

I was have lunch with some friends of mine yesterday and they asked me why having a quantifiable metric for product value is important, because businesses and managers have been making decisions since the beginning of business based on their intuition. I answered by offering an analogy which I'll call "The Product Value Torque Wrench"and it goes something like this:

Early on in the days of nuts and bolts it was just fine for the mechanic to swing the wrench around until he felt that the nut was secure. Automobiles had plenty of redundancy and their performance was relatively slow and forgiving.

As automobiles became more sophisticated and adopted by the masses, auto companies needed to improve weight and reliability to become more competitive. Walter Percy Chrysler developed the first beam type torque wrench in the late 1920's/early 1930's for the Chrysler Corporation and licensed the Cedar Rapids Engineering Company to manufacture and distribute the invention, which was patented in 1938. Torque wrenches allowed assemblers and mechanics to swing the wrench around until the device said the nut was tightened to its proper torque as identified by engineering calculations.

Today, the automobile market is hyper-competitive and everything in the automobile is expected to operate perfectly well into high mileage. Torque wrenches are used routinely to assemble cars because there is just too much to risk by having assemblers and mechanics swing the wrench until it "feels right".

For product managers who must make decisions in today's hyper-competitive markets, choosing innovations to pursue or how to price products based on gut feelings is just to risky. One slip and your competitors will sweep your feet from under you. Not only that, if you aren't taking product value into consideration when you price your products, you might be leaving money on table!

In comes the "Product Value Torque Wrench". It is now possible to measure product value based on historical purchase data and to forecast future product value using special attribute value analytics. The time is right, especially in the automotive business. I was speaking to a former automobile executive who told, "When it comes to making decisions about product planning in the automotive world, sometimes I think there are more cowboys in Detroit than all of Texas.... everyone is shooting from the hip!"