customers they could serve. Is this a common mistake companies make and what are the consequences of this?
RK: First you have to make a strategic choice. Are we are going to be the low-cost distributor, offering the lowest-cost buying experience?
That would be on price but also on reliability of delivery and no errors in products we ship and invoicing and other aspects. Generally that would mean you have a less extensive product line because the more scope you have the more expensive you are.
Or are we going to be customer-intimate, and understand our customers’needs and work with them as a partner as their total solutions provider?
That’s a more expensive relationship. It means we assign account managers to the customers to understand them and work with them and then arrange our operations to meet their needs. It’s very plausible and can be a very successful strategy but it’s very different from being a low-cost strategy. You have to find customers that value that relationship.
Or you can say we’re going to be on the upper end and tell customers they can order what they want whenever they want it. You will carry all the SKUs. That’s expensive and very high-end service.
In a way those are three generic strategic choices. What you typically can’t be is all three. One should be your dominant position. You can optimize your operations and people around that value proposition.
The second part of this is that within one of these strategic themes, you will have customers that deviate. They still may want special services or want to be more efficient. It goes back to having a good costing system.
Distributors operate with low margins, and so it would be easy for a customer behaving in a different way -with smaller order sizes, manual vs. electronic ordering and payment, special delivery requirements -to take a profitable relationship to unprofitable.
Ultimately you do have to measure your cost-to-serve at the individual order level and the individual customer level. Sometimes the cost system done well can mediate making a complete strategic choice and allow you to serve different classes of customers.
MDM: How do you feel about firing customers?
RK: I usually say firing customers is the last thing we do. So if you find you have unprofitable customers, first examine your own processes. The customers may be unprofitable because your internal processes are not efficient in working with them.
So the first message is heal thyself and make sure your processes in serving that customer are reasonably efficient. If you’re persuaded that you are efficient, the reason the customer is unprofitable may be because of the special services the customer is asking for, which are inherently more expensive.
Then you try pricing those special services. Often the customers’behavior will change when you get the pricing correct. They’ll see the benefits of ordering in larger quantities, giving more lead time, more standard ship arrangements, and more standard packaging. They have the choice now as to how much they value the special features and services vs. how much they are willing to pay for them. That usually solves the problem.
Sometimes you can say to the customer that maybe if you just increased your average order size by 15 percent it would take an unprofitable relationship and make it profitable. Or you try to get a higher share of that customer’s spending.
Those are the options you have -only if these don’t work do you start to think of raising the price or encouraging the customer to find another supplier that can meet their needs better. But there are a whole series of things you can do to transform unprofitable customers to profitable ones.
MDM: Today’s distributor is focusing more on profitability. In doing so, many distributors are looking at improving their pricing. How can distributors be sure they are making the right changes?
RK: First, be sure you have the right data and instrumentation before you move forward on re-pricing. And the second is strategic orientation, which relates to how you think of your various customers or suppliers.
If you’ve thought about your strategy you probably have identified those suppliers and customers that are most important to your growth position.
With pricing you need to be cautious. If you are too aggressive you risk losing important suppliers and customers. If you’ve identified some suppliers and customers as non-strategic -or nice to have if you can make money with them but not central to your position -the short-term economics play a greater role in how you approach that group on pricing.
Strategic customers may not be as profitable as you like, but if you think you can build business with them because they are part of your strategy then you might want to give some time for that relationship to expand because the profitability may increase as they order more from you or order in better ways.
The data and instrumentation actually takes me back to my other interesting methodology, Activity Based Costing, which has been applied a great deal in distribution companies. As you look at major pricing initiatives you have to really make sure you understand your cost-to-serve.
Pricing should not be across the board. It has to be very rifle-like and targeted. Unless you really track the costs of working with the customers, you can end up making some big mistakes in the way you price. The same story goes for suppliers -it depends on how the suppliers work with you and your cost of maintaining relationships with them -two suppliers with the same purchase volumes could have vastly different profitability.
MDM: The last chapter of your book focuses on the creation of an Office of Strategy Management, with a small group of professionals focused solely on ensuring a company’s strategy is carried out. How can a smaller company approach this idea?
RK: It’s a specific set of roles and responsibilities to make sure there are resources provided for strategic initiatives and that employees’objectives and incentives have a strategic component. In the last chapter we identified all of the processes associated with strategy execution. We do believe somebody has to make sure that gets done.
In a larger company you can have a team of two or three people, but in a smaller company you have to ask someone with an existing job to find some extra time to help you do that.
Or maybe you take two people -the chief financial officer and the chief human resources officer -and they accept that as their night job to keep the organization moving forward and focused on effective strategy execution.
Robert Kaplan and David Norton’s book, The Execution Premium: Linking Strategy to Operations for Competitive Advantage, is available through Harvard Business Press at hbp.harvardbusiness.org, amazon.com and national bookstores.
Many leaders understand the importance of matching strategy with operations, but few companies have systems in place to actually do so, according to Robert Kaplan and David Norton, creators of the widely used Balanced Scorecard performance measurement tool and leading advocates for customer profitability analysis. Kaplan recently spoke with MDM Editor Lindsay Young about the challenges inherent with effective strategy implementation in a wholesale distribution company.
In their latest book, The Execution Premium: Linking Strategy to Operations for Competitive Advantage, Kaplan and Norton present a formal systems approach to implement strategy at every level of an organization. The authors’six steps, as shown in the graphic on page 4 of this issue, are:
· Develop the strategy by clarifying goals and conducting strategic analysis.
· Plan the strategy by selecting theme-based measures, targets and initiatives, along with accountability for performance.
· Align organizational units and employees to your strategy.
· Plan operations through priority setting and resource allocation.
· Monitor and learn from operations and strategy.
· Test and adapt the strategy.
The book integrates strategies outlined in the authors’four previous books as well as other management tools, such as activity-based costing and strategy development.
MDM: How do you believe economic conditions -good or bad -affect or motivate managers in developing and monitoring strategy implementation?
Robert Kaplan: In good times business is expanding, and it’s easy for managers not to pay much attention to strategy because they are making money and markets are expanding. So it becomes more important when times get tough.
At that point you have to cut back some of the capacity and spending that you’ve been doing during the growth stage. If you’re not careful you end up not just slashing waste and inefficiency and excess capacity but you end up slashing into the building of capabilities that you need to come out of any economic slowdown in even stronger shape.
It’s important to distinguish between your spending on operations providing internal capacity from the spending you do that is building strategic capability.
During the slowdown you have to look much more closely at all the spending programs and all the capacity you have put in and hold onto only those that you want to sustain into the future. That’s where strategy helps you focus.
MDM: Many distributors have anywhere from two to hundreds of branch locations spread throughout a region or the country. How do you effectively involve branch leadership and employees in applying strategy to operations knowing that branch managers are constantly juggling so many roles?
RK: You talk about a juggling act, and it is. The word balance comes in here. They have to be excellent locally. They have to be excellent branch managers and have efficient local operations. But the balance is they also have to deliver on the corporate strategy and the value proposition to the customers. That is what managers get paid for: to keep operational efficiency and strategic direction in a good balance. And you can do both.
When you have a dispersed organization, that’s when communication becomes extremely important. The customer thinks you are one company. They don’t think you are hundreds of companies.
If you’re trying to create a value proposition to customers, it’s important that the value proposition is supplied by every one of your outlets. And having a local operating manager not following the corporate brand or strategy just undermines your positioning.
It’s important to have awareness by every branch manager that they are operating under the umbrella of the parent corporation and have to follow the value proposition in how they work with customers, employees and suppliers.
I recognize that communication is not easy, but in today’s age with the Internet and other enhanced communications, it’s a lot easier. It’s critical for the corporate leadership to establish not just a clear vision and mission but a clear strategy and communicate that so that every branch manager understands it.
Using a system like the Balanced Scorecard is a way of reinforcing that because the Balanced Scorecard is not just about short-term operational efficiency. It’s about creating customer loyalty, creating value for customers, upgrading employees and working effectively with suppliers. The Balanced Scorecard is a great way of communicating the strategy of the company even when there are hundreds of dispersed branches around the country.
MDM: In your new book, you talk about putting as much thought into communicating strategy to your employees as you would with advertising to new or current customers. How do you recommend distributors approach this?
RK: We do advocate that you treat your internal communications as importantly as your external marketing messages. Ultimately the strategy is not implemented by the executive team at corporate headquarters. It is implemented some by the branch managers but also by the front-line employees. They are closest to the process, to the customers and to the orders. They are working with the manufacturers.
It’s so much more powerful when every employee is not just doing their job but understands that the way they do that job is contributing to the overall success of the company. It really empowers them to align and do their jobs differently or better to help the company achieve its strategic goals.
This is why you have to understand whether the company is trying to be lower cost to its customers or trying to be more of a strategic partner at solving a set of needs or trying to give the customers a lot of options and flexibility. Employees that understand that can work better in their day-to-day jobs in helping the company realize the strategy. They can’t do that unless first they’re aware of the strategy, and they understand the strategy.
MDM: How should distributors view their channel partners in developing strategy?
RK: We’ve seen that companies are starting to extend their measurement and management systems to strategic partners such as suppliers and customers. You can’t do this with 10,000 suppliers and 10,000 customers. But if you can identify those that you feel are really strategic, you can work with them to develop a sense of a shared strategy to make both of you better off by working together.
It enables the relationship to be governed by more than financial measures -such as cost or price -and you can talk about what each group is trying to achieve using the Balanced Scorecard. You can agree on metrics that both parties will work to achieve.
Talking about the measures that will govern the relationship is a great way to forge partnership with key suppliers and key customers. Then you should periodically monitor how you are doing on that relationship.
It’s another tool a manager can use to talk more intelligently with strategic partners. The strategy will help to tell you who those are so you can go from the 10,000 to the 10 or 20 that are important to moving your organization forward.
MDM: You say businesses cannot attempt to meet the expectations of all the existing and potential