Wednesday, September 20, 2017

The Sustainable Zone

Any firm that wishes to have longevity must serve two masters: the customers who benefit from the good or service it provides, and the stakeholders who furnish capital and labor that enable the product to be previsioned.    It seems a simple enough concept, but I find that I often need to sketch out a Venn diagram to explain it to both sides: those who wish to create value to the customer at a loss of income to the firm and those who wish to create profit for the firm at the loss of value to the customer.   Neither of these is a sustainable strategy.

In its naissance, most firms are targeted toward providing value to the customer.   The founder generally recognizes that “people need [product]” and arrangements are made to provide it to them in an affordable manner.  The focus is entirely on the customer, and very often with little regard to the financial interests of the firm.   Hence, most new businesses fail: they are wildly popular with customers who are getting more than they pay for, but ultimately cannot be financially sustained.

As a firm grows, it becomes inclined to seek value to the stakeholders, generally more toward the providers of capital than of labor, but there are instances in which a firm has been nibbled to death by its own workforce.  The focus is on the profit of the firm, and customers are expected to accept compromises to the benefits they receive.   Eventually, even the most loyal customers recognize they are getting less than they pay for and leave.  The firm may be highly efficient, but becomes unprofitable and cannot be sustained not because of waste, but because of insufficient revenue.

In practice, there are few situations in which a firm is entirely aligned to one side or the other.   A firm devoted to customer service still recognizes it needs sufficient income and efficiency to maintain its operations, and a firm devoted entirely to profit still recognizes it needs to provide some level of value to its customers to have revenue at all.   The difficulty lies in striking the proper balance in its operations.

And in that regard, firms are inclined to drag customers over the border into serving its interests rather than being willing to take a loss to serve the interests of the customer.   This is the reason that so many products on the market are imperfect – customers begrudgingly accept that the product is barely capable of serving their needs, or that they are getting a satisfactory product but paying a significant premium over a generic solution to get marginally better quality.

And then, there is the matter of mutability, as firms pendulate into the areas to either side of the sustainable zone.   The firm realizes it is financially unsustainable and swings away from serving its customers well, then loses so many customers that it becomes panicked about its revenues and swings back to service at a financial loss.   It can play this game for decades if it earns enough loyalty during its customer-oriented years to keep them from defecting in droves when it enters a profit-oriented era.

It can usually be seen when a company changes executive management: the CEO who was brought aboard to solve the company’s financial woes is ousted when the measures he takes drive away customers.  He is replaced by a new CEO who is service oriented, and who brings back the customers, until this results in a diminished financial performance for the firm, at which point he is ousted to make room for a finance-oriented CEO.   Lather, rinse, and repeat.

Wednesday, September 13, 2017

Functional Familiar Trumps Optimal Unknown

In doing research in personal finance and money management, I’ve learned that people are highly idiosyncratic in the way they manage their personal spending and saving.   Some engage in what seems to he entirely irrational, but when asked follow-up questions, there is usually some twisted logic that they use to justify the bizarre things that they do – and when a different course is suggested, their reaction is to cling to their current habits, typically supported some variation on the phrase, “It works for me.”

This is true whether the subject has millions of dollars in savings and investments and is merely being inefficient in managing his surplus, or the subject is living paycheck-to-paycheck and barely scraping by.   Because their behavior has not led to a disaster, they feel that they are doing as well as can be done – or as well as they need to do – and see no reason to make a change for the better. 

It’s only those in crisis who admit, somewhat reluctantly, that they might be doing something wrong – but most often, there is something to blame for their situation and that they can continue with their usual habits as soon as they recover from this temporary setback that was inevitable and beyond their control.  Because what worked in the past will work in the future.

The irony is that it is the very same attitude that decision-makers tend to take in their business affairs.   What they have doing has made their firm successful, or perhaps just barely sustainable, in the past and their intention is to keep doing what they have been doing – and any inefficiency or failure is seen as the consequence of circumstances beyond their control.  

“It’s the way we’ve been doing business for decades, and it works for us.”   And this is regardless of how the firm is doing at the moment, regardless of the glaring inefficiencies, regardless of opportunities to make a change for the better.   And when a committee gets involved, the mantra of “works for me” becomes all the more pronounced.   It is not until the firm is ion obvious crisis that they see a need to do better – and more often, it’s seen as a temporary measure before the firm can return to its old habits, which made it successful in the past.

And I don’t know the cure for it – either in my function of helping to change the behavior of consumers, nor in my function of helping to change the behavior of my organization.   What works now, and what has worked in the past, is invariably preferred to a better course of action.   And while you can describe the crisis that is inevitable unless a change is made, the change will not be made until the crisis is manifest – often, when it is too late.

If ever I find the solution to this problem, I’ll post it – or maybe not, because solving that problem is the source of tremendous competitive advantage.

Wednesday, September 6, 2017

Vetting Experience Concepts

Lately, I’ve had rather too many conversations with interns and junior employees who are upset or dejected that their brilliant ideas for new products or product improvements are not gaining any traction.   Sometimes, this is conservatism – a well-established firm tends to assume its success means it’s already doing everything it needs to do to be successful – but in most instances there is an obvious flaw with the idea itself.    I find myself saying the same things, over and over.

What new outcome will this idea achieve for the customer?

This question is the foible of many bright ideas: they are intrinsically interesting, but do not achieve a new outcome for the customer.   It may be an interesting way to do something that people don’t want to do, or a new way to do something that people are already doing by more effective or more efficient means.  In sum, an idea is sustainable only if it offers genuine value to the customer.   Novelty has a very limited appeal.

An effective way to vet an idea for value is to show the idea to a small number of customers (half a dozen is sometimes sufficient) and ask them what outcome they could achieve by using it.   Rather than telling them what you think it is good for and asking them to agree, let them discover the value on their own.

Does the idea have sufficient and sustainable appeal?

If the idea clears the first hurdle, a more intensive investigation should follow to determine the extent of the appeal: how many customers would use this, and how often would they use it?   It may take a sizable panel to get quantitative results – but once you have them, you have a basis for estimating revenue from the product’s release: the number of people suggests market share, and the frequency of use suggests frequency of purchase.

If the idea replaces an existing means to achieve the same outcome, testing it in comparison may tell you whether the idea has a chance in a competitive marketplace (against solutions that already exist) and whether you will be cannibalizing your own sales (which is not bad if the cost to the firm is less for the new idea).

Is it legal?

Particular in heavily regulated industries such as healthcare and financial services, there are many great ideas that cannot be pursued because of legal and regulatory restrictions.   Even if the idea is completely benign, offers good value for dollar, and would be warmly embraced by an audience who’s well aware of the conditions, the precise letter of the law could be used to shut it down and possibly damage the brand if it were released.

Arguably, this should be the first hurdle – but legal advisors are fond of saying “no” without intensive diligence and business decision-makers are prone to go along with their legal advisors unless there is a compelling reason to take a risk.   The market appeal is often necessary to get an executive to tell the attorneys “thanks for the advice, but we’re going to proceed anyway.”

Is it profitable, or at least sustainable, for the firm?

Because money makes the world go around, any idea has to pass the test of financial potential: it has to generate more revenue and/or incur fewer expenses.   At the very least it has to make enough revenue to cover its own cost – otherwise it is leeching resources from more viable lines of business and must eventually be terminated for the health of the firm.  This is true even for nonprofit organizations: any operation has to be sustainable rather than feed upon the life-blood of the organization.

This can be a very difficult hurdle to leap because the cost of the idea has to be paid for out of the revenue.   It is not enough to make a million dollars in additional sales if the expense of providing the idea is $1.2 million for the same duration.   It’s easy to get excited about what happens at the register, while ignoring what is going on in the ledgers.

Caveat: Beware of Unqualified Experts and Self-Vetting

I have a sense that these four questions will help to understand the reason that exciting ideas are shot down – but this is the scope of their value: understanding why the ideas are shot down by others, not limiting your own thinking because of your assumptions.   Be prepared to hear a "no" but do not abandon an idea because you assume that's what you will hear.

Unless you are an accountant, you do not know what will be profitable; and you will think a good idea is not sustainable when in fact it is.  The same goes for market appeal and legal compliance: you are not an expert, and unless you have done a thorough investigation, you cannot say – you must defer to experts, and ensure that their deliberation is thorough.

And apply the same standard when others criticize the idea: I have very often seen a designer attempt to shoot down a product idea saying that it will not be appealing to the customer when he does not know, and until it has been properly vetted, no-one knows.   In this sense, the vetting process works both ways”: it deflates ideas that do not have merit, but may also bolster confidence in an idea that does not seem to have merit, but actually does.