Will the Real Customer Please Stand Up?

I can remember as a boy watching the television game show is “To Tell The Truth” when the weather was nasty and we couldn’t play outside. The show originated in 1956 and has been produced off and on ever since, including running in syndication.  The premise of the show was that three contestants all claimed to be same individual who had some unique distinctive profession, hobby or experience.  One of the contestants was the individual. A panel questions the three contestants to try to determine who is “telling the truth” and who is making it up.   The contestant won if they could fool some members of the panel.

Have you ever felt like this when you were developing a new product or service?  There are several people or organizations who you think would benefit from using your product or service.  You are trying to get a comprehensive list of user needs and you keep getting different answers.  And soon you are wondering, “Who is the real customer?”  Unlike the game show, we can’t stop after ten minutes of questions to ask, “Will the real customer please stand up?” 

This leads us to the fundamental question of how to determine the real customer.  Is it the person who purchases the product or service?  Is the person who uses the product or service?  Is it the person who is advising the purchaser?  Is it the person who provides the money that pays for the product or service?  Is it the user’s customer who receives benefit because of how the user employs the product or service?  Granted sometimes the answer to those questions may be the same individual, but many times it is not.

Unfortunately the answer is, “All of the above.”  Which means that understanding customer needs and providing customer value can become confusing and complex.   This is one of the reasons why so many companies don’t even bother.  Instead they have the marketing organization create a “value proposition,” push the product out to the market, and see what happens. 

  

In another post I will talk more about discovering and understanding your customer perception of value.  For now, let’s look at a few principles that should be followed if your company decides to use the approach of just pushing something onto the market to see what happens.  The key to success with this approach is marketplace feedback and rapid production and marketing iterations.  Let’s look at five characteristics your company needs to be successful with this approach (besides luck):

• Quick customer feedback.  Assuming you get customers, you need a mechanism to get feedback from your initial customers.  This is usually through direct contact by your sales or marketing departments.  You need more than just a “Like” on Facebook.  You need to understand why they bought your product or service, how they used it, and the result.  Knowing this will allow you to understand whether the product or service is creating value for your customers.  This will inform both your updated marketing and your product development iterations.    


• Investigate the “no-sales.”   To the extent possible, find out why people did not select the product.  If they viewed the website or visited the store, ask them.  If they never heard about the product, find the communication barrier.  Knowing why a customer does not buy is just as important as knowing why a customer does but a product.  Again, it will inform both you updated marketing and your product upgrade iterations. 


• Rapid product change.  The likelihood that the product or service you offer will exactly hit the market is low.  There are just too many unknowns.  So you need to be able to quickly modify the product or service to respond to the market feedback.  This has implications for both the product design and your product development process.  Your product should be modularized to allow for rapid redesign of selected modules.  In addition, you probably need to be using one of the Agile product development methodologies.


• Tailor the value proposition.  Once you find out what is working, you can tailor your message and your marketing to better fit a target audience.  Customer testimonies are examples of the use of the product are always great advertising.  In addition, you can select your market channels that best reach the market segment you are now going after.  A clearer message of the product or service value and a more focused marketing channel should lead to more potential customer understanding the value, which will drive sales.


• Be prepared for success or failure.  The last point is to be prepared for both success and failure.  Success can lead to a quick spike in demand.  While that is great, it requires capacity to meet the demand.  Have a plan for how you would add capacity.  Don’t cut corners when you add capacity.  Otherwise you may create a quality problem which leads to a quick loss of customers and creates a negative impression in the market about your product or service.  Of course, if the demand doesn’t materialize, you need to repurpose your capacity.  Set some clear thresholds at the time of market introduction that will indicate the need to add capacity or cut production and sales.  Set those while everyone is still thinking looking at the situation from a logical perspective, once you are into the day-to-day management, it is hard to remain unemotional about those decisions.

Following these principles can help you find and focus on your target market.  It will probably take one or two iterations, but soon the “real customer” will become clear. 

Intrapreneurship: Challenges of Internal Innovation

Our current business press and academia are in love with the entrepreneur.  Virtually every business magazine will feature an interview with an entrepreneur.   Blog posts are touting the spectacular rise and performance of various entrepreneurs.  Business schools and universities have created MBA and DBA tracks for entrepreneurs.  However, the role of the intrapreneur is largely neglected.

An intrapreneur is an individual, usually a manager, within an organization who promotes innovative product development and marketing.  Now you might say, “Well that sounds like the job of the R&D Manager and the Product Marketing Manager.” What makes an intrapreneur unique is that they conceive, promote, plan and implement their innovative idea.  Also their innovative idea is not just a line extension of an existing product, or a minor packaging change; it is a major innovation that either creates a new product line or transforms an existing product line.  

Most large companies have business processes that do strategic planning, product planning, new product development and product introduction.  There are policies and procedures for accomplishing the work in these processes.  Reviews and checklists are used to track progress and make decisions to ensure the new products will meet the business objectives.  The R&D Manager and the Product Marketing Manager have key roles in these business processes. 

But these processes are designed to control business risk and maximize the use and return of business resources.  Therefore, these processes normally focus on the current business product lines and markets.  When that happens, these processes suppress creating a brand new product line or breaking into a totally different market because of the high levels of uncertainty.  Add to this that the majority of the business resources are focused on running the current business.  It is no surprise that it is typically very difficult to get the needed technical expertise internally to plan and develop a truly innovative new product.  That is one reason that so many large corporations choose to expand their product lines through acquisition instead of innovation.

So the intrapreneur is faced with a daunting task, one that is similar in some respects and yet different in others from that of the entrepreneur. The intrapreneur must overcome the organizational inertia and bureaucracy to get approval and support for their innovation.  This can be much harder than the problem an entrepreneur faces since the intrapreneur cannot just move onto the nest venture capitalist if they get a “No” answer.  However, once they have support, the intrapreneur has an advantage because they have experienced resources available and existing relationships they can leverage.  In both cases they will need good analytical and project management skills to bring their innovation to market.

Let’s look at a few of the challenges a typical intrapreneur faces:

• The business already has a process for selecting strategic development initiatives.  The intrapreneur’s innovative idea will be compared to other ideas and will inevitably be a higher risk idea than most if not all of the others.
• The intrapreneur’s innovation will often cannibalize or obsolete an existing product line.  Those responsible for this existing product line will often be antagonistic towards the innovation.
• The intrapreneur must work with the management team and technical experts within the company, even if some are not supportive of the idea.  He or she cannot find their own support team that shares their vision of the innovative product.
• Innovation projects are often technically challenging with significant uncertainty that leads to project delays and overruns.  A company that is used to the certainty of low risk development projects will quickly lose confidence in the innovation project.

Which leads us to the identification of some key attributes that are needed by the leader of innovation:

• Analytical and communication skills to create and present a business case for the intrapreneurial innovation:
• Facilitation and communication skills to develop and lead a cross-functional team of experts – some of whom are not completely supportive of the innovation.
• Project management skills to plan and implement the development project and proactively manage risk within the project.
• Communication and political skills to manage the internal politics of change and innovation within the organization.

Being an intrapreneur can often be a thankless and frustrating role.  Even when the project is successful, the rewards are likely to be miniscule as compared to those of the entrepreneur.  But the advantages are that there are often significant resources available to help the project succeed and the personal risk is less than for the entrepreneur.

The Missing Customer

It is time to transform the Business Case model that is used by companies for approving projects.  I have seen hundreds of business cases. I even wrote a book on how to develop them.  But I am now convinced there is a critical weakness in them.

The customer is usually missing.

A project business case normally will evaluate a project opportunity by comparing the benefit and the cost through a Return on Investment (ROI) formula.  Most companies now incorporate the best practice of also evaluating whether the project is aligned with the business strategy.  If the project is aligned and the benefit is greater than the cost, the business case recommendation is to do the project.  

This is a company-centric approach.  The customer is missing from this evaluation.  Sure, sometimes the business strategy may be to increase customer satisfaction or grow market share and revenue, but the measures used are always internal measures.  The business case evaluates the cost to the company and the benefit to the company.  While I agree that those are important, I also believe that a better decision will be made when a company includes the consideration of the cost to the customer and the benefit to the customer.

Business Value Chain

Business transactions require a customer.  Until an individual or organization has decided that they value something more than the money in their bank account, there is no business transaction.  (I am ignoring for the time being the coercive power of government to take money through fees, fines and taxes.)  The business value chain starts with a customer decision and ends with the fulfillment of the customer order and payment for the product or service.  It is only when the chain of events that makes that happen occurs that value is created.  Creating new products that no one wants does not create value.  Offering services that no one needs does not create value.  Building facilities and systems that do not improve customer service or customer satisfaction do not create value.  These may create assets that we put on a balance sheet, but non-performing assets have no value.

To fully understand the business value chain, you must include the customer’s actions and decisions in the process.  If you expect the customer to purchase something because of this project, the value chain should start with the customer condition which results in the recognition of the need for the product or service.  The business value chain should then proceed through the steps and decisions made by both customer and your organization to get to the point of a sales transaction.  Depending upon the type of product or service, the business value chain continues through the steps of creating and delivering the product or service, including work done at your suppliers.  Of course you need to include the final invoice and payment at the appropriate step.  Even then the business value chain is not complete.  It should include the initial use of the delivered product or service and the resultant customer satisfaction or irritation as they experience the product or service.

Only when you have fully mapped and understood the business value chain will you understand where value is created or potentially where value is destroyed.  Otherwise, you may get a local optimization that improves value at one step yet decreases the value at many other steps.   A classic example of this is the phone systems where the caller has to listen to a menu of options and then select a number.  This reduces cost for the company operating the phone system, but it can be a problem for customers.  I have been on several systems where I went through multiple layers of selection, but there was no suitable option for the purpose of my call.  Eventually I get to a point where I am put on hold for many minutes waiting for a live body to pick up the phone.  This has been so annoying that there are several business that I refuse to do business with now because of this system.

Business Case Value

So let’s go back to the business case.  How does a company account for the value to the customer?  How do you calculate ROI when the “return” for the investment does not occur in your company?  I suggest that companies calculate two ROIs for each project, the internal ROI and the customer ROI.  The internal ROI would be calculated in the same way that a typical business case ROI is calculated.  Use internal costs and internal benefits to calculate whichever method your company normally uses, such as the NPV, breakeven, or payback method. 

But a second ROI should be calculated and this is the ROI for the customer.  I recommend that this be done for a single customer and that the calculation be a “static” ROI instead of the dynamic “ROI” calculations, like NPV and payback that include a time factor in the calculations.  The static ROI would be the net benefit divided by the cost to acquire, expressed as a percentage.  The most difficult portion of this ratio will be to calculate the net benefit.  Some types of customer benefits are “hard benefits,” meaning they are measurable and can be easily converted to a monetary value.  This would include productivity savings or performance improvement.  But some benefits are “soft benefits,” which are much harder to quantify and may vary significantly from customer to customer.  This would include brand affinity, peace of mind, or societal responsibility.  The only ways to place a value on these is to talk to the customer.  It is likely that there will be different customer ROIs for different customer segments.  I’ll discuss how to do this in a future blog post.

With internal ROI and customer ROI, a company can make a better decision about a project.  High customer ROI will likely lead to enhanced project impact and future benefits for all parties.  A low customer ROI will likely lead to reduced project impact and alienation from your customers.      

Project ROI Deception

Most organizations that I work with require a Return on Investment (ROI) calculation before making a decision to start an innovation or new product development project. This makes sound business sense.  We should consider the cost and benefit of a project before undertaking it. But with innovative new products, these ROI techniques can sometimes deceive us. 

The problem is that the most commonly used ROI techniques are built upon a set of project conditions that often are not valid for your innovation project.  If those conditions are not understood and accounted for, the wrong decision can be made.  You may choose to do a project you shouldn’t do, choose not to do a project you should do, or take the wrong approach for a project.  Let’s look at the most commonly used project ROI measures.

Breakeven Analysis

The Breakeven Analysis places the emphasis of the ROI calculation on the size of the market opportunity.  Breakeven Analysis answers the question, “How many units must I sell to generate enough money to pay for this project?”  It is determined by dividing the cost of the project by the gross margin of a unit of the product.  If it is likely that you can sell more than the breakeven point; do the project.  If not; don’t do the project.

The deception with this technique is estimating the size of the market.  For truly innovative products, the market size is unknown.  There is no existing product or service that can be used to estimate the size of the market.  Ken Olsen, the founder of Digital Equipment Corporation (DEC) is famously quoted as saying in 1977, “There is no reason that anyone would want a computer in their home.”  But the market forecast is not always underestimated.  Alex Lewyt, the president of Lewyt Vacuum Company said in 1955, “Nuclear powered vacuum cleaners will probably be a reality in ten years.” 

So how do you estimate the size of the market?  This is one where I recommend that you do a three point analysis, best case, worst case and most likely.  Consider the opportunity and risk with each case.  But don’t overlook the need to stimulate demand.   You can create a market with advertising, product placement, endorsements, and marketing events.  Innovative product development projects need to be about more than just the cool technology.  Include in your product development project the promotion efforts to make your product go viral in the market.

Payback Analysis

The Payback Analysis places the emphasis of the ROI calculation on time to market.  Payback Analysis answers the question, “How long until I have generated enough money to pay for this project?” It is determined by dividing the cost of the project by the amount of gross margin the new product sales generate every month (or year, or day, or fortnight).  The answer is the number of months until payback.  The business must then decide if they can wait that long to get all the money back.

There are two points of deception with this technique. The first is the cost of the project.  The easiest way to get a rapid payback is to have a very small project cost.  Of course that typically means that you won’t do a truly innovative new product, but instead just make a minor incremental improvement on an existing product.  The second point of deception is that Payback Analysis doesn’t take into consideration what happens after the payback point in time.  Do product sales grow exponentially or do they flatten out and quickly die off?  We don’t know with Payback Analysis, we only know how fast we earn our money back.

With these inherent deception points, why would anyone use Payback Analysis?  If your company is in a cash flow bind, Payback Analysis is very helpful.  But if you are not strapped for cash, using Payback Analysis to decide which project to do will almost always decide against innovation.  The Payback Analysis is the most risk adverse of the ROI calculations.  Frankly, I don’t recommend it for new product development.  It is good for incremental improvement projects and “one-off” projects; but it does not adequately consider the benefit of new innovation.

Net Present Value/Internal Rate of Return

I will discuss Net Present Value (NPV) and Internal Rate of Return (IRR) together since they use the same equation, just solving for a different variable in that equation.  These techniques consider the long term value of the project.  They are a time value of money calculation.  They sum the incremental cost of the project and the incremental benefit of the project over some period of years and discounted at some time value of money discount rate.  Using the formula you either solve for the value using a fixed discount rate, or you solve for the rate which results in the cost being equal to the benefit.  A high value or a high rate means you have a good project.

The point of deception in this technique is determining the window of opportunity.  The calculation assumes some number of years of sales that is usually based upon an estimated product lifecycle.  What is often overlooked is the effect of competition on the sales during the lifecycle.  Innovative products normally have little or no competition at the beginning of their lifecycle.  The gross margins at this time are usually higher than later in the life cycle when competition is in the market.  I have often heard the discussions about whether the product life cycle could or should be extended and additional years added to the calculation.  I seldom hear the discussion about what could be done to radically accelerate the project so that the time period in which benefits start is much sooner.  Those early benefits are during the window of no competition.  The company can dominate in the market and lock is such a commanding share that competitors look for other opportunities.

When using NPV or IRR I strongly recommend that you challenge the team to provide an alternative plan that cuts the development time in half.  Yes, this plan is likely to cost more.  But innovative projects often are multi-year projects.  Getting to market a year sooner with no competition can be extremely profitable, even with the higher project cost.  The long time frame used with NPV and IRR can lead to a lack of urgency on completing the project.  With that lack of urgency is lost opportunity.

Conclusion?

So whether it is Breakeven Analysis with its market focus, Payback Analysis with its time focus or NPV/IRR analysis with the value focus; there are potential points of deception to consider.  Understand these, account for these, and you will make better business decisions concerning innovation projects.

Project Management Failure – The Story of Centralia (Part 2)

The mine fire in Centralia, Pennsylvania, USA, had been burning for nearly two months.  In my previous blog post I covered the actions and project management failures on the part of the city.  After several months of fighting the fire, the city council has given up and turned the responsibility for fighting the fire over to the state Department of Mines and Mineral Industries (DMMI).  Let's consider how they approached this problem.

Failure #1 - Unwilling To Think Outside The Box

By the time the state DMMI got involved, there was smoke and steam coming from fissures in the ground.  In early August, 1962, the DMMI held a meeting in Centralia.  At the meeting a small mining company offered to dig out the fire for free if they could then have the rights to any coal that they dug out at the same time.  The offer was rejected because that approach did not go through the normal state procurement processes.  First project management failure by the state – unwilling to consider innovate responses to unique project problems.

Failure #2 - A Rigid Allegiance To The Project Plan Overlooks The Project Goal

Another month passed and now the state hired a company to excavate the burning portion of the mine for $20,000. (Yes, they did follow the normal procurement process this time.)  But this contractor was not allowed to test to see where the fire had moved, but was required to dig the area that was specified in the contract.  Unfortunately the contract did not correctly guess the direction and speed of the fire.  Further, the contractor was only allowed to work one shift a day and was not allowed to work on weekends or holidays.  Unfortunately, the fire did not stop burning at night or on weekends and holidays, so it grew to a size much larger than what was in the contract.  Next project management failure – a rigid focus on the scope document ignores the goal of the project.

Failure #3 - A Re-baseline Of The Project Doesn't Consider The New Project Environment

By November, five months after the fire started, a new plan was initiated.  DMMI decided that the abandoned underground mines around the fire would be pumped full of crushed rock and water to isolate the fire.  This effort would cost an additional $40,000.  But there were several problems. There was no local source of sufficient water to do the work, so it had to be pumped in.  It was now winter; and winter in the Pennsylvania mountains can get cold.  The water lines and equipment for creating the crushed rock slurry froze so the pumping was delayed and sometimes curtailed.  Meanwhile, bore holes for locating the edge of the fire were actually creating paths to let the fire move into new areas. This part of the project finally finished in March of 1963.  By the middle of April it was clear that the fire was raging beyond the enclosing circle of crushed rock.  Next project management failure – poor planning of a rebaseline over-looked obvious constraints and risks.

Rescuing injured survivors from the Centralia mine fire

Failure #4 - Inability By The Team To Explain The Project Impacts To Management

The next proposal considered by DMMI to put the fire out was a three-pronged effort that could cost over $500,000 if all three prongs were followed.  That would have to wait until the state’s new fiscal year started on July 1.  The fire had now been burning for over 13 months.  Unfortunately, the DMMI budget was cut in the new fiscal year, so this project was not funded.  Next project management failure – inability of the team to explain the project impacts (threat or opportunity) to management, leading to a short-sighted decision. 

The DMMI did eventually allocate $40,000 for fighting the fire and in July of 1963 another small project similar to the first one the DMMI funded was undertaken with the same results.  The state now ignored the fire and it continued to burn until the federal government finally decided to step in.

The State Tries And Fails

In the first blog in this series I looked at the failures on the part of the city.  This time we considered the state agency. In my last blog I will talk about the response of the federal government.  But let’s review the project management failures by the DMMI:

1. Unwilling to consider non-traditional alternatives to address risk. 
2. A rigid focus on the original scope documents ignores the project goal. 
3. Poor planning of a re-baseline ignores obvious constraints and risks. 
4. Inability of the team to explain the project impact leads to short-sighted decisions by management.

References:  DeKok, David. Fire Underground: The Ongoing Tragedy of the Centralia Mine Fire. Guilford, CT: Globe Pequot Press, 2010.  

Telling a Story

To get your project approved, you often must first present a business case to the appropriate stakeholders.  The business case provides the business rationale, normally in financial terms, of why the project should be done.  But don’t let your business case be a dissertation on market statistics or a derivation of the net present value formula.  Instead, think of your business case as a story.

Let’s look at the plot, the setting and the characters for the story.  The plot is an adventure story.  It starts with some business problem to be solved or opportunity to be realized (project goal).  This problem or opportunity, when solved, will lead to a happy ending (business benefit).  To project team will need to overcome some challenges and hurdles along the way (risks).  The setting for the story is the business conditions (assumptions) and the project management methodology being used (constraints).  The characters for the story are the project team, the business management, and if applicable, key customers (all are stakeholders).   

With the story as a backdrop, build your business case using this four step process.

Step 1: Identify the business need or opportunity.

This step is usually done by the business unit who is the primary beneficiary from the project.  Typically the need or opportunity is either implementing an element of the business strategy or is driven by a problem or issue within the business. 

Step 2: Develop option(s) to meet the need.

This step is usually done by the organization or organizations that will conduct the majority of the project work.  For instance on a new product development project, step 1 may have been completed by marketing or product management, but step 2 will be completed by research and development or engineering.  At least one high level option is identified.  Multiple options may be identified.  If so, steps 3 and 4 will be done for each case and presented to the stakeholders along with a recommendation. 

Step 3: Estimate relevant cash flows.

Estimate all the project costs or expenses for each option.  Estimate the types of financial benefits for each option, such as cost savings or new sales.  Normally detailed project planning has not been done yet, so these are just rough estimates – one or two significant digits.

Step 4: Determine ROI and make a recommendation

Use the organization’s preferred Return on Investment (ROI) technique, such as breakeven, payback, NPV or IRR.   Your spreadsheet has formulas for calculating these.  Based upon the ROI calculation, make a recommendation as to whether project should be funded or not.  If there were multiple options, recommend your preferred option.

So let your business case tell your story – but be sure it is an adventure story, not a mystery, or worse yet a horror story.