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www.digitalinvestor.com.au | 5/45 William St | Melbourne | Australia | 3000 Profitably Serving Customers Customer Lifecycle and The Service- Profit Chain Walter Adamson June, 2003 Version C Contact: [email protected] Tel: +61 403 345 632

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The Service Profit Chain Customer Lifecycle Profitably Serving Customers Followed by: Part One – Linking the Customer Lifecycle and Business Logic Part Two – Developing the Customer Value Package Part Three – Developing Service Products to fill the Value Package Part Four – Understanding Service Pricing Strategies Part Five – Improving Margins through the Service Value Chain

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Page 1: Service  Product  Profit  Model - FULL

www.digitalinvestor.com.au | 5/45 William St | Melbourne | Australia | 3000

Profitably Serving Customers

Customer Lifecycle and The Service-Profit Chain

Walter Adamson

June, 2003Version C

Contact:

[email protected]

Tel: +61 403 345 632

Page 2: Service  Product  Profit  Model - FULL

Slide [email protected] | June 2003 |

Introduction

The Service Profit ChainCustomer Lifecycle

Profitably Serving Customers

Followed by:Part One – Linking the Customer Lifecycle and Business LogicPart Two – Developing the Customer Value PackagePart Three – Developing Service Products to fill the Value PackagePart Four – Understanding Service Pricing StrategiesPart Five – Improving Margins through the Service Value Chain

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Slide [email protected] | June 2003 |

The Service Profit Chain

Connected through Value

Employee Productivit

y

Internal Performance

Employee Loyalty

When we have this .....

Employee Satisfactio

nProfit & Growth1

Customer Loyalty

Customer Satisfaction1

Customer Value1

Service Value1

External Performance

1Focus of This Presentation

Page 4: Service  Product  Profit  Model - FULL

Slide [email protected] | June 2003 |

Customer Lifecycle

Represents the total potential touch-points and profit capture

The Customer Lifecycle

Phase 1 Pre-sale

Phase 5 Value

Creation

Phase 9Disposing & Upgrading

Phase 2 Value

Identification

Phase 7Customer

Value Gain

Phase 8 Value

Improvement

Phase 3 Meeting Needs

Phase 4 Obtaining

Commitment

Phase 6 Customer Learning

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Slide [email protected] | June 2003 |

Profitably Serving Customers

A systems thinking approach optimises: Value creation for the customer Value capture and sustainability for the provider

Customer Value Model

Customer Value

Package

Whole Product

Value Chain

Business Logic

When we have

this .....$$

Customer Lifecycle

Service-Profit Chain

Profit & Growth

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Slide [email protected] | June 2003 |

From the market into the business strategy Drives the business logic and value packages Reflects industry trends and competitive forces Without this analysis the business has no grounding

A value package is a customer-oriented offer It includes a value proposition for specific customers Without this offers will be only features or advantages Requires an associated move to solutions selling

The Customer

Understanding the Customer Value Model drives the development of the

Customer Value Packages

Customer Value Model

Customer Value Package

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Slide [email protected] | June 2003 |

The totality of what a customer buys Includes all touch-points, resources, and emotions Closely synchronised with the customer value package Required to understand pricing, costing and competition

The lifecycle represents the lifecycle touch-points Customer value packages must reflect different phases Whole product and business logic link to lifecycle Understanding required as a key part of solutions selling

The Service Product

Understanding the Whole Product concept allows business to be captured

and value created through the full Customer Lifecycle

Whole Product

Customer Lifecycle

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Slide [email protected] | June 2003 |

The process of delivering the whole product Describes the activities and resources and interfaces Closely synchronised with the customer lifecycle Required to reduce inefficiencies and increase net profit

How the business operates and makes money Driven from the strategy and customer value model Measured by business targets and key result areas Without clear understanding the business is suboptimal

The Delivery

Understanding the Whole Product concept allows business to be captured

and value created through the full Customer Lifecycle

Value Chain

Business Logic

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Slide [email protected] | June 2003 |

The Lifecycle Link to Profit

Understanding the complete Customer Lifecycle is essential in order to the satisfaction required in the Service-

Profit Chain

Customer Lifecycle

Service-Profit Chain

A satisfaction cycle

Reflects total costs and potential profit

If broken then breaks satisfaction

Customer satisfaction drives profit Value package drives satisfaction Solution selling meets value needs

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Slide [email protected] | June 2003 |

Profitability and Sustainability

Successfully delivering service profits requires an understanding and

enablement of the linkages across the complete system

Profitability

Sustainability

Understand customer value

Sell value propositions that matter Effective resource deployment Efficient distribution of whole product

Satisfy customers and employees Capture fair share of value created Re-validate customer value & lifecycle

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Slide [email protected] | June 2003 |

The Lifecycle Sales Approach - 1

Moving Sales from HOW & WHAT WHO & WHY

Solution(Why)

Product(What)

Advantages Promoter

Transaction,Product PusherSalesperson

Needs

Relationship,Value Provider

Problem Solver

Customer Needs(Who)

Stages of Sales Maturity

focus

process

4321

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Slide [email protected] | June 2003 |

The Lifecycle Sales Approach - 2

The primary objective of the salesperson shifts FROM: Close the sale, and Sell the advantages and get through the process, TO: Solve the problem of why the customer needs the product Create customer value and capture a fair share of it

Solution(Why)

Product(What)

Advantages Promoter

Transaction,Product PusherSalesperson

Needs

Relationship,Value Provider

Problem SolverCustomer Needs

(Who)

focus

process

4321

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Slide [email protected] | June 2003 |

The Service Profit Chain

Connected through Value

Employee Productivit

y

Internal Performance

Employee Loyalty

When we have this .....

Employee Satisfactio

nProfit & Growth1

Customer Loyalty

Customer Satisfaction1

Customer Value1

Service Value1

External Performance

1Focus of This Presentation

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Slide [email protected] | June 2003 |

The Service-Profit Model

Linking the Customer Lifecycle and Business Logic

Customer LifecycleBusiness LogicCustomer ValueCustomer Value Model

Customer Value PackageCustomer Value Audit

1

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Slide [email protected] | June 2003 |

Customer Lifecycle

The objective is to optimise the creation and capture of value

The Customer Lifecycle

Phase 1 Pre-sale

Phase 5 Value

Creation

Phase 9Disposing & Upgrading

Phase 2 Value

Identification

Phase 7Customer

Value Gain

Phase 8 Value

Improvement

Phase 3 Meeting Needs

Phase 4 Obtaining

Commitment

Phase 6 Customer Learning

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Slide [email protected] | June 2003 |

Business Logic

To service customers you need operational business logic ‘The logic that organises a business’s approach to things’

Revenue Model

Marketing & Sales Logic

Service Product Design

Delivery & Customer Support

BusinessStrategy

CustomerValue Package

Resources

Customer’s NeedsCustomer Value Model

Profit Targets

Competition

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Slide [email protected] | June 2003 |

Lifecycle and Business Logic

To maximise return on investment: The customer lifecycle is supported by the Business Logic

Business Logic

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Slide [email protected] | June 2003 |

Business Logic Basics

Describes how a business operates and how it makes money

Business Logic

Value Creation

Value Capture

Value Chain

Customer Value

The Value Proposition

Marketing Model

Revenue Model

Core Competencies

Funds and Investment

People Management

Operations Model

Systems Management

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Slide [email protected] | June 2003 |

Business Logic and Strategy

Business Logic is the essential logic of the business Needed in order to optimise value creation and capture Expressed in terms of a major action premise that can:

– Maximize market share, revenue, short-term-profit, ROI, or,– Whatever focus the Business Leaders have chosen

The Logic aligns the action premise and the people’s energies:

– Marketing and Sales Logic– Revenue Model– Service-Product Development Logic– Customer Delivery and Support Logic

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Slide [email protected] | June 2003 |

Business Logic and Strategy

Marketing & Sales – how to we gain access to our customers?– Niche, vertical, horizontal, alliances, distribution

Revenue Model – how do we use and make our money?– Market share, growth, acquisition, cost performance

Service-Product – what value package will we take to market?– Commodity, uniqueness, speed, trend, lifestyle, informational

Customer Delivery & Support – how do organise ourselves to make the other logics work together?– Product focus, geography, function, matrix, account

You need to test the total business logic to see that it makes sense!

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Slide [email protected] | June 2003 |

Strategic Model

The Strategic Model drives the Business Logic and the Customer Value Package – using the Customer Value Model

Vision

Customer Value Model Mission

Business Logic and Strategy

Business Targets

Customer Value Package

Core Values and Philosophy

Operating Environment

Key Result Areas

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Slide [email protected] | June 2003 |

Customer Value

Customer Value Model

Customer Value Package

Business Logic and Strategy

Customer Value has three major

components

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Slide [email protected] | June 2003 |

Customer Value Model

A set of critical factors that define customer value

– From the customer’s point of view– Requires detailed engagement and research– Input from the market– Drives the business logic– Drives the customer value package

Tells us what value we have to provide in order to win, and keep, the customer’s business over the complete lifecycle.

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Slide [email protected] | June 2003 |

Competitive edge– Salespeople who understand their customer’s value model better than

their competitors have a better chance to win the business How do your customers define value?

– Must be derived from the minds of the customer• Effective engagement• Communication• Develop Value Propositions

– Must be validated in solid customer research• Who has best performance in the industry – key metrics, and why?

Must be able to implement the path to the customer’s ‘truth’

Building the Customer Value Model

The customer value model is an ‘invisible truth’ used by the customer to evaluate the quality of outcomes you provide.

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Slide [email protected] | June 2003 |

There is a hierarchy of customer value satisfiers:– Base value – the fundamental components of the customer value

package you need in place just to stay in business– Expected value – what your customer considers ‘normal’ for you and

your competitors– Desired value – added value features that customers know about but

don’t necessarily expect because of the current level of performance of your competitors

– Unanticipated value – going beyond the customer’s expectations and desires – provided that the customer really values these “surprises”

You must go beyond ‘base’ and ‘expected’ to make a difference

Hierarchy of Customer Value

You must have mastered the first two levels in order to satisfy the customer on the higher levels. Failings in the first two levels will

waste the effort and investment in the higher levels.

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Slide [email protected] | June 2003 |

Customer Value Package

The enterprise infrastructure for value creation PLUS, the Whole Product

1. Marketing & Sales Logic

2. Service Product Design

3. Delivery & Customer Support

4. Revenue Model

5. Branding & Reputation

6. Informational

7. Interpersonal

Enterprise Components

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Slide [email protected] | June 2003 |

Customer Value Package

Enterprise capabilities are needed to deliver the Whole Product:

Post-Sales

Support

Life-Cycle Support

Pre-Sales Support

Integration

Services

Software

Consulting

Hardware

TheProduc

t

1. Marketing & Sales Logic

2. Service Product Design

3. Delivery & Customer Support

4. Revenue Model

5. Branding & Reputation

6. Informational

7. Interpersonal

The Whole Product

plus

Enterprise Capabilities

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Slide [email protected] | June 2003 |

Customer Value Package

A multidimensional logic for managing the customer’s experience with your company, and with the value it creates

The customer value package must be right if you hope to build in the customer’s mind an impression of quality and value for money

Customers’ expectations vary enormously even in the same line of business

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Slide [email protected] | June 2003 |

Customer Value Expectations

Potential value expectations are broad e.g. a fashion store

Customer Value Criteria

Supplier reputation and experience Branding Warranty package Information Quality specification and control Parts and service coverage

SECURITY

Continuity of benefits and costs profile Continuity of supplier support

RELIABILITY

Cash flow Operating compatibility Operating flexibility Status/prestige‘ Fashion’ currency

PERFORMANCE

AESTHETICS

Style Design Conformance Longevity Design/style continuity

CONVENIENCE

Transaction facilities and process Product service and parts availabilities Warranty service processing Sales and service response Time Location Information

ECONOMY

Acquisition costs Installation costs Set up and training costs Maintenance costs Disposal value and costs Supplier information Opportunity costs

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Slide [email protected] | June 2003 |

Customer Value Audit

Does the design of your CVP reflect the customer’s value model? Or does it reflect just the convenience of your organisation? Cross-match Customer Value Model, to Customer Value Package

Customer Value Package Customer Value Factors

Marketing & Sales Logic

Service Prod Design

Delivery & Support

Revenue Model

Branding & Reputation

Informational

Interpersonal

CVM1 CVM2 CVM3 CVM4

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Slide [email protected] | June 2003 |

Customer Value Audit

Will these Customer Value Packages lead to success? Where are the gaps, how to fill them?

Customer Value Package Customer Value Factors

Pre-Sales Support

Software

Hardware

Consulting

Integration Services

Post-Sales Support

Life-cycle Support

CVM1 CVM2 CVM3 CVM4

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Slide [email protected] | June 2003 |

Market Value Audit

Determine the “defining features” by cross-referencing the value packages with the customer types – the market segment benefits

– Customers on one axis – cluster customers into sets– Value packages on the other axis – cluster value packages– The clusters (sets) represent meaningful defining features

1 2 3 4 5

Customer Types

CustomerValue

Packages

5

4

3

2

1

Look for Niches

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Slide [email protected] | June 2003 |

The Service-Profit Model

Developing the Customer Value Package

Understanding ValueDeveloping a Value Proposition

Integrating the VP into a Customer Value Package

1 2

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Slide [email protected] | June 2003 |

Understanding Value

Value is “mindware” created by the product/service you sell The end condition a customer deems worthy of their approval

eMotion-Value End Condition Approval

Emotional Reaction

Value Package

Customer’s Perception

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Slide [email protected] | June 2003 |

Value is in the mind of a specific client

Value = Benefits – Cost

Benefits exist only with a particular client or set of clients in a particular business setting. Therefore, if there is no specific client and business setting you cannot promote value1.

Features are an objective characteristic of the product or service.Advantages indicate how the features might help sets of clients.

1In that case you will be promoting “features”, “advantages” or just technology.

Understanding Value - 2

AdvantagesLead ToFeatures BenefitsLead To

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Slide [email protected] | June 2003 |

Understanding Value - 3

Perception of value is tied to emotion, and personal values

eMotion-Value = eMotion-Benefits – eMotion-Cost

The outcomes, which are stated as benefits, are as much perception as measurable factual reality.

Both facts and perception are reality. But interestingly, while facts belong to organisations, perceptions belong to individuals.

The eMotion Value Proposition Model1 explains:

– Why 'good' proposals stall – Why high return (high ROI) proposals are blocked – Why the 'best' proposal does not always win – How personal distraction and effort mould perceptions of benefits – How individual recognition and reward mould perceptions of value.

1For full details of the eMotion VP Model go to www.digitalinvestor.com.au

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Slide [email protected] | June 2003 |

Developing a VP - Asking Questions

Start with good sense of the business situation– Industry– Company and its issues– Personal (relationship)

It is about the art of questioning and analysis

– What is the business’s perspective of the situation?– What are they doing now and why?– What are the tensions in what they are doing now?– What is the ideal or “tomorrow state” as currently perceived?– What barriers are faced in getting there?– Which barriers have the biggest impact and where?– What are their investment criteria?– What is the decision-making process?– What has been agreed to now and and in the past in IT initiatives?– How do they perceive the value added by IT so far? Why?– What is their ideal solution and how do they know when they achieve it?

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Developing - Discovering Needs 1

The objective is to uncover the business’s specific needs– Concentrate on identifying the real needs:

• Place yourself in their shoes• Place yourself in their customer’s shoes

– Work on improving your questions and interaction– Be aware of “knowing too much” - let the business talk!

Then, move to offering a credible solution– Float options, build and test your solutions– Work in parallel to action the needs into an IT strategy

Do not spend time or energy– “Selling” features, unqualified advantages, and technology– Turning the needs analysis back to a generic IT solution– Disparaging alternative IT solutions from the business

Work to generate business ownership of the proposition

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Slide [email protected] | June 2003 |

Developing – Discovering Needs 2

The most powerful tool is the “Day in The Life”:– Live a day in the life of the business and their customers

It is powerful because– The business commits to spend time and energy– You commit to contribute and report– It brings ownership through joint generation of the VP– It BUILDS WIDER RELATIONSHIPS

Focus on your customer’s customers

Workshop the outcomes to generate the VP– Build a case which delivers “ladders of value”– Also build ladders of compelling IT investment strategy

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Slide [email protected] | June 2003 |

Developing – Generating the VP

A useful technique

When we have this .....

We will be able to do

these things ...

Which means this in

business terms ......

And we’ll be able to measure the benefits this

way .....

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Slide [email protected] | June 2003 |

Testing the Value Proposition

Is there a common understanding of the central need?

Why should anyone want to use the proposed solution?

What genuine business value does it return?

Examples of things to consider:– What problem does it solve for potential customers?– Does it open a new market?– Does it better exploit an existing market?– Does it eliminate or reduce inefficiencies?– Does it solve the same problem as competing systems but at less

cost?

How does the value proposition fit into the development of the Customer Value Package?

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Slide [email protected] | June 2003 |

Integrating the VP into a CVP

The VP guides development of a Customer Value Package:

Post-Sales

Support

Life-Cycle Support

Pre-Sales Support

Integration

Services

Software

Consulting

Hardware

TheProduct

1. Marketing & Sales Logic

2. Service Product Design

3. Delivery & Customer Support

4. Revenue Model

5. Branding & Reputation

6. Informational

7. Interpersonal

The Whole Product

plus

Enterprise CapabilitiesValue Proposition

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Slide [email protected] | June 2003 |

Integrating the VP into a CVP

The Whole Product plus Enterprise Capabilities need optimisation:

The Whole Product must be tailored to include the VP

The Enterprise Capabilities have to support delivery of the VP

This combines to produce a specific Customer Value Package

Examples of things to consider– How does the Whole Product mix need to be modified?– How does the organisational infrastructure need to be modified?– What role do channels and does distribution play?– How does this CVP fit or blend with other CVPs which need support?– What is the revenue model associated with this CVP?– How can IT support and improve profitability of delivery of the CVP?

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Slide [email protected] | June 2003 |

IT Support of the CVP

How can systems support the Customer Value Package:

What is the timing, sequence, priority and risk?

Can they be built and implemented within a reasonable time?

At an acceptable cost?

Examples of things to consider– Are the necessary skill sets available, and the technology?– Should it be insourced or outsourced?– How do they fit the current systems architecture?– Do they have to be integrated with other systems and data?– Do they improve the underlying technology fabric?– Do they improve the company’s overall operations?

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Slide [email protected] | June 2003 |

The Service-Profit Model

Developing Service Products to fill the Value Package

Service-Product DevelopmentWhole Product Concept

Whole Product ValueTechnology Adoption Lifecycle

1 3

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Slide [email protected] | June 2003 |

Service-Product Development

The fundamental elements of service-product formulation are coordinated market value propositions and delivery at a profit

Service Delivery

Value Proposition

Activity Costing/Profit

Go to Market

CustomerService ProductDesign

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Slide [email protected] | June 2003 |

Integration Logic

Which Customer?

The model points to a customer, but which customer? This requires market segmentation including technology

lifecycle

Service Delivery

Value Proposition

Activity Costing/Profit

Go to Market

Customer?Service ProductDesign

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Slide [email protected] | June 2003 |

Service Product Design Audit

The Customer Value Models are customer pulls Match those pulls to the Service-Product Design Elements

Lifecycle Adoption Phase Customer Value Factors

Value Proposition

Service Delivery

Go To Market

Activity Costing/Profit

Integration Logic

CVM1 CVM2 CVM3 CVM4

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Slide [email protected] | June 2003 |

Whole Product Definition

Service-Products are complex - they have many dimensions The Whole Product is the totality of what a customer buys A whole product is the physical object, software or service from

which customer gets direct utility, plus other factors, services and perceptions that make the product:– Useful– Desirable– Convenient– People– Brand attractiveness - “Intel Inside”

For example Computer Operating System is:– Software + development + environment (hardware and software) +

documentation to use it + training program + reseller’s service & troubleshooting capabilities + availability of hardware drivers + suppliers enhancement plans, + reliability + interface design appeal + brand appeal (Mac) etc.

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Slide [email protected] | June 2003 |

Whole Product Concept

The “whole product” gives the customer value satisfaction The cost of creating a complete product is often many times the

cost of developing the generic product or service

Generic Product

Expected Product

Augmented Product

Potential Product

Value

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Slide [email protected] | June 2003 |

The Expected Product

A step above the Generic Product

The Expected Product represents the customer’s base expectations Delivery conditions, installation services, post-sale services, spare parts,

training, packaging conveniences Other examples of the minimum expectations:

– The bank: the loan officer who is cooperative – The realtor: who is on your side – The lawyer: who protects you– The retailer: who sells you products which work and are reliable

The expected attributes vary by customers and industries They could be sources of product differentiation

– Depending on how well vendors implement their value packages

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Slide [email protected] | June 2003 |

The Augmented Product

Augmentations are means of product differentiation

Customers may be offered more than they expect:– Computer that comes with “Office 2000” already installed– Optical store that replaces customer’s lost contact lenses nights &

weekends and delivers them to customer’s home

Augmentations can also bring about customer dependency They can educate customers about what it is reasonable to expect This raises the competitive bar since augmented benefits may turn

into customer expectations (and move into the inner circle) Not all customers can be attracted by an ever-widening circle of

augmented benefits

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The Potential Product

The Potential is everything feasible to get and keep customers– what can be feasibly done with the existing product & service– what is possible in the future– what is needed in the future

Suppliers, and customers, can compete more effectively with the Potential Product in the changed conditions of future

In high tech markets, customers desire extendibility for the product so that the platform and basic technology can last over several generations of technology lifecycles– e.g. semiconductor technology cycles

Building and maintaining a Product Roadmap is important

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Product Lifecycle

Products are marketing inventions Product invention / definition is a continuous process

– Starts at the intersection of new technology capability and perceived market opportunity

– Continues past product introduction thru to discovery of new applications (not envisioned by the original developers)

Continues further– As product marches down the Technology Adoption Life Cycle and it

is redefined for new groups of customers– As the company diversifies into new market segments to capture

more market share

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Whole Product Value

To the potential customer, value satisfaction is the “product” The generic “thing” or “device” is not itself the product. It is the

minimum necessary to get into the “game” Whole Product value has meaning only from the viewpoint of the

customer or the ultimate user - only they can assign value

Customers’ needs and wants define whole product value– Depending on the targeted market segment, the whole product offer

must change to meet different value expectations When positioning against competition, it is important to compare

complete whole product customer value packages The whole product must be defined differently in different

phases of the Technology Adoption Life Cycle

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Slide [email protected] | June 2003 |

Technology Adoption Lifecycle

The Customer Value Package must be different for each stage At different stages customers buy and perceive value differently

2.5 %Innovators

13.5%Early

adopters

34%Early

majority

34%Late

majority16%

Laggards

Time

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Technology Lifecycle Value Audit

Rate the Customer Value Packages against the adopter stage Look for gaps and misalignments in the offer and the adopter

Lifecycle Adoption Phase Customer Value Factors

Innovators

Early Adopters

Early Majority

Late Majority

Laggards

CVP1 CVP2 CVP3 CVP4

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Customer and Technology Lifecycle

Effort and resource expenditure through the customer lifecycle needs to be optimised against the technology adopter lifecycle

2

1

1 2

1

1 2

2

1

Earlyadopters

Earlymajority

Latemajority

Laggards

These buyers1 need less selling and more confidence

that you will support the product they are willing to try

These buyers2 need more selling and confidence that

others have bought the product and are satisfied

Customer Lifecycle

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Slide [email protected] | June 2003 |

The Service-Profit Model

Understanding Service Pricing Strategies

Service Pricing StrategiesPrice-Value Perceptions

Value Strategies for Service PricingService Costing

Activity-Based Costing

1 3 4

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Pricing Strategies

Begin with costs and work towards selling price

Begin with selling price and work towards costs

Cost factorsPrice

Customer Value

Competition

Cost-based Pricing

Demand-based Pricing

Combination Pricing

Competition-based Pricing

Begin with Competitors’ Pricing

Above The Market

Below The Market

At The Market

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General Pricing Challenges

Pricing strategies and challenges

Demand-Based

Cost-BasedCo

mpe

titio

n-Ba

sed

Cost-based problems: 1. Costs difficult to trace 2. Labor more difficult to price than materials 3. Costs may not equal value

Competition-based problems:• Small firms may charge too little to be viable• Heterogeneity of services limits comparability• Prices may not reflect customer value perception

Demand-based problems: 1. Monetary price must be adjusted to reflect the value of non-monetary costs 2. Information on service costs is less available to customers, hence price may not be a central factor

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Service Pricing Strategies

What makes it difficult and different? Hard to calculate financial costs of creating an intangible

High ratio of fixed to variable costs - cost to serve one extra customer may be minimal (but must still recover fixed costs)

Variability of inputs and outputs - how to define a “unit of service” and establish basis for pricing?

Many services hard for customers to evaluate--what price can they put on the ‘value’ which is delivered?

Importance of time factor - same service may have more value to some customers when delivered faster

Use of physical or electronic channels - may create differences in perceived value

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Pricing Strategies

Choice of strategy depends on: The technology, refer to the technology lifecycle (part three) The market and your customer power Your cost structure The competitive environment

– Threat of substitution– Threat of new entrants

Keys to Demand-based Pricing: Set prices consistent with customer perceptions of value Prices are based on the whole product value package

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Incorporating Value into Pricing

You must fully understand what value means to customers:

What benefits does the whole product package provide? How important is each of these benefits as to the others? How much is it worth to the customer to receive a particular

benefit in a service product’s value chain? At what price will the service be economically acceptable to

potential buyers? In what context is the customer purchasing the service? What is the customer’s perception of ‘value’?

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Price-Value Perceptions

Four customer-definitions of value:

Value is low price. Value is everythingI want in a service.

Value is thequality I get for the price I pay.

Value is all thatI get for all that I give.

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Value Strategies for Service Pricing

Pricing strategies to reduce uncertainty– service guarantees– benefit-driven (pricing that aspect of service that creates value)– flat rate (quoting a fixed price in advance)

Relationship pricing--incentives to patronize one supplier– non-price incentives– discounts for volume purchases– discounts for purchasing multiple services

Low-cost leadership– Convince customers not to equate price with quality– Must keep economic costs low to ensure profitability at low price

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Pricing Questions - Services

How do you calculate the total potential profit of offerings? Can you rank service-products by margin, by total profit? Can you rank service-products in the technology lifecycle? What does each function and process contribute to profit? How can you reduce costs by 20% in the service-product chain? What mix of service-products yields the highest profits? What new blends of services yield the potential best profits? What is your maximum possible revenue given the resources? What are the key ingredients of the offers that drive profits up? What continuing investment is needed to support current offers? What investments are needed to create new offers? Can costs be better distributed through a channel strategy?

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Service Costing

Service costing is an application of strategic cost analysis, for: Modifying product mix and pricing

– Repricing customer value packages– Substituting services and offers– Eliminating elements and resulting excess capacity

Improving service-product design and development– Redesigning service-products– Improving delivery and whole product support processes– Investing in technology support

Improving customer relationships– Changing operating policies and strategy

Improving channel relationships

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Strategic Cost Analysis

Strategic cost analysis uses activity costing to: Identify distorted service-product costs Determine unprofitable Customer Value Packages Highlight areas for different channel strategies Explain undercosting and overcosting of products and services Give management insight into the cost structures for making and

selling diverse products

Particularly, it must focus on whole product and the value chain: Assigning activity costs to whole product customer value packages:

– calculating the activity cost per unit of activity driver– preparing a bill of activities for each whole product

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Strategic Cost Analysis Benefits

Particular benefits relate to service-product development:

Management can identify and evaluate new service-productsto improve performance by evaluating how service

and process designs affect activities and costs.

Companies can work with their customers toevaluate the costs and prices of alternative value packages.

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For Service Firms

The general approach is very similar to that in manufacturing: Costs are divided into homogeneous cost pools and classified

as output unit-level, batch-level, product- or service-sustaining, and facility-sustaining costs

The cost pools correspond to key activities: Costs are allocated to products or customers using activity

drivers or cost-allocation bases that have a cause-and-effect relationship with the cost in the cost pool

Resources

CVP 1

CVP 2

CVP 3

Activities

Activities

Activit

ie

s

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Service Costing - 1

Service costing is a critical element of performance management

Identify the processes for each CVP value chain Allows you to answer key questions:

What does it cost to deliver these services? Are we delivering our services cost-effectively? How do our service costs compare? How much should we charge for these services? Is there is an alternative, less costly, way to deliver these

services?

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Service Costing - 2

How do you find the processes to analyse?

Organisations are managed vertically, however: Work gets done horizontally via business processes Processes cut across functions and layers of the organisation Processes consume all types of the resources of an organisation Process measures help resolve friction and take out costs Processes provide feedback for continuous improvement

Process measures enable customers of the processes to be served more effectively and efficiently

Processes consist of activities– measure through activity-based costing

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The Logic of Activity Costing

Products and Services are consumed by customers Activities are consumed by products and services Resources are consumed by activities

It is the Customers

That buy our Services

Which makes us conduct ActivitiesThat consume

ourResources

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Basic Activity Cost Allocation

The costing process is simple in theory:

FundamentalCost Objects

Activities

Costs of Activities

Assignment to OtherCost Objects

Product Lines Individual Products

Customers Distribution Channels

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Implementing Activity Costing

Follow four stages to assign overhead costs to products:

Calculate a cost-driver rate for each activity. Assign activity costs to customer value packages using the cost-driver rate.

Identify and classify cost objects (activities).

Customer Value Package 1Customer Value Package 2

Identify cost drivers relevant to each activity in a whole product value

package: Marketing & Sales

Corporate Services Lifecycle Support

Step 1 Step 2

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Activity-Based Costing

The logic of ABC is simple: It is a methodology to calculate the cost of activities (such as

train employees), and cost objects (such as products and services)

It assumes that services create needs for outputs which create the demand for activities which, in turn, consume resources.

By tracing costs to services/outputs according to the activities required to provide them, ABC provides a more accurate picture of costs and performance.

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Cost Drivers

Knowing the cost drivers is an integral part of ABC

Drivers apply to activities or factors that cause costs to be incurred

There are volume-based drivers and non-volume-based:

Volume-based cost drivers– Assumes all costs are driven, or caused, by the volume of

production (or sales) Non-volume-based cost drivers

– Costs are not directly related to production volume

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Activity–Based Costing - 1

The key principles are that:

Cost are assigned to activities Costs driven by volume are at ‘unit level’ Cost drivers are identified for batch-level and product-level

costs, but not for facility-level costs Unit, batch and product-level costs vary proportionally with their

cost drivers

Managers need to see “whole product” costs as an integral part of the firm’s effort to create value for customers.

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Activity-Based Costing - 2

The ABC process relates activities to the resources they consume Classifies costs into four levels: Unit level

– Activities performed for each service-product unit Batch level

– Activities performed for a group of service-product units Product level

– Activities performed for service-product families Facility level

– Costs incurred to support the whole enterprise

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Activity-Based Costing - 3

Other costing factors to consider are:

Customer Lifecycle Costs – Customer-level costs -- things like preparing bids, processing

orders, answering questions, expediting rush orders, designing products, providing support

Net Margin Realized– Difference between the revenue and unit and batch level

costs of manufacturing the item. The profit on the actual goods sold, without consideration of the specific costs to selling them to the customer

– Influenced by the price demanded by the customer (related to their bargaining power) as well as the inherent profitability of the item

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When to Use ABC - 1

An option when one or more of the following conditions exist:

Indirect costs are significant in proportion to direct costs and use only one or two cost-drivers

Goods are complex, requiring many inputs and processes. Simple, high-volume products perform more poorly than

complex, low-volume products Different departments believe costs are assigned inaccurately. The company loses bids it thought were low, and wins bids it

thought were high Operations have changed significantly, but the costing system

has not changed

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When to Use ABC - 2

When organizations find themselves on a crisis course:

Selling (funding) the wrong products or services Serving the wrong customers Designing costly products Instituting cost cutting programs that fail, and/or Obtaining the wrong (unnecessary) parts from outside suppliers

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Strategic Cost Analysis Benefits

ABC benefits will be greatest where:

Overhead costs are a significant proportion of total cost, and a large part of overhead is not directly related to production volume

The business has a diverse product range, and individual product’s use of support resources differs from their use of volume-based cost drivers

Production activity involves diverse batch sizes and product complexity

There are likely to be high ‘costs’ associated with making inappropriate decisions, based on inaccurate product costs

The cost of designing, implementing and maintaining the ABC system is relatively low due to sophisticated IT support

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Typical Revelations

The application of strategic cost analysis typically reveals:

Higher-volume products/services are overcosted Lower-volume products/services are undercosted Unexpected differences in customer profitability Opportunities to improve processes 25-35% of activities don’t contribute to organizational goals 80% of costs are consumed by 20% of the activities

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Limitations

However, ABC can be difficult to implement in service firms:

High levels of facility costs cause problems with costing services Individual activities are difficult to identify because they are non-

repetitive A non-repetitive production environment makes it difficult to

identify service outputs

Challenge:

ABC systems require management to estimate costs of activity pools and to identify and measure cost drivers for these pools.

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The Service-Profit Model

Improving Margins through the Service Value Chain

Customer Lifecycle and ProfitabilityLifecycle Sales Approach

Increasing Net Value

1 3 4 5

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Customer Lifecycle Costs

The lifecycle incurs costs in delivering through the value chain

The Customer Lifecycle

Phase 1 Pre-sale

Phase 5 Value

Creation

Phase 9Disposing & Upgrading

Phase 2 Value

Identification

Phase 7Customer

Value Gain

Phase 8 Value

Improvement

Phase 3 Meeting Needs

Phase 4 Obtaining

Commitment

Phase 6 Customer Learning

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Whole Product Value Chain

The Customer Value Package offer is a value chain

Is each extension feasible, achievable, sustainable?– Investment and resource allocation?– Market competitiveness and positioning?– Ability to make a profit?

Value/Cost DValue/Cost CValue/Cost BGeneric Product

Value/Cost A

Expected Product

Total Solution

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Value Chain Analysis

Value chain analysis helps to understand (at a high level) how each of your business activities adds value to your company

The objective of value chain analysis is to maximise the profitability of your business activities in a sustainable manner

Value chain analysis can also be applied to the Whole Product offer to understand the value offered to the customer and your costs associated with each element of that offer

The chain comprises the activities and functions performed by a company to deliver value to its customers.

Are you profitably delivering value to your customers?

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Value Chain

Consider a value chain for the "Recruitment" business activityThe links in the value chain could be:

Identify - a list of all of the candidates that applied Select - those candidates that meet the basic criteria Screen - identify the best two/three for the vacancy Interview - determine who should be offered the job Offer - the job to the best candidate Train - the new employee when they join the company

Each step in the chain adds value and adds costs

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Value Chain Analysis - 1

A Value Chain Analysis:

Summarises your customer value package activities as distinct value chains - one for each package

Outlines and analyses the key links in each of your customer value packages

Defines the metrics you will measure to determine performance of your customer value packages

Identifies opportunities to improve the profitability of your customer value packages

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Value Chain Analysis - 2

Distributors’ and forward channels partners’ value chains:

Change costs and margins of distributors and forward channel partners influence price paid by ultimate consumers

Therefore these activities must be analyzed as part of the chain: The quality of activities performed by distributors and forward

channel partners influence the quality of products/services of the company to the end-user

The activities have a direct impact on the profitability of the customer value packages and the lifetime customer value

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Growing the Bottom Line

Value chain analysis and activity-based costing are tools to grow the bottom line and the quality of earnings:

Activities

Costs of Activities

Product Lines Individual Products

Customers Distribution Channels

Value/Cost DValue/Cost CValue/Cost BGeneric Product

Value/Cost A

Expected Product

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Increasing Net Value

Reduce resource expenditure at each stage of the value chain Minimize interpersonal blockages Optimize informational sharing and transfer Decrease intra-enterprise engagement friction Understand the Whole Product cost and value chain!

Share a common intent about the customer value package

Value/Cost DValue/Cost CValue/Cost BGeneric Product

Value/Cost A

Expected Product

Total Solution

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Margin Improvement

Margins can be improved through process improvement: Time and motion studies (1940s) Workflow analysis (1960s) Technology-based approaches (1970s) Business process reengineering (1980s) Process mapping (late 1980s)

Differences between activity-based and processed-based approach: The activity-based view reveals how resources have been

consumed The process-oriented view cuts across the entire organization

and reveals all resources and costs expended on producing a process output e.g. a customer value package

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Service Process Chain - 1

The CVP is delivered by a “process” chain, or value chain:

xxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxx

Service Product

Marketing & Sales Support

Customer Value & Your Profit

xxxxxProcess

Activity

A Customer Value

Package

DeterminingService-Product

Mix

DeterminingMarketing & Sales Effort

Support & Lifecycle Effort

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Service Process Chain - 2

There is a different chain for each part of the customer lifecycle:

xxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxxxxxxx xxxxx xxxxx

Service Product

Marketing & Sales Support

1

5

9 2

7

8 3

4

6

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What To Measure

Process improvement uses many measures: Activity-Based Cost – the cost of resources consumed by each

activity performed Rework – the cost of non value-added activities to correct things

not done right the first time Cycle Time – length of time it takes to get an outcome for a

process Touch Points – number of times an item is touched as it moved

through a process Cost per Process Output – process cost divided by a volume of

items produced by a process Customer Satisfaction – the degree to which customers are

satisfied with the performance of the process

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Service Process Improvement - 1

A methodical approach is required, focused on processes:

Firstly, identify the activities behind the customer value package Determine the cost of resources used to perform each activity -

some allocation may be required using resource drivers (labor, capital, materials, energy)

Allocate secondary activity costs to primary activities if needed Combine activities with similar drivers/behavior into cost pools

based on process, activity level, consumption ratio Identify a cost driver for activities Calculate the budgeted cost per unit of the cost driver for each

activity Collect information about cost driver usage for value package Allocate costs to customer value package

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Service Process Improvement - 2

Analyze the process chain for the total Customer Value Package:

Post-Sales

Support

Life-Cycle Support

Pre-Sales Support

Integration

Services

Software

Consulting

Hardware

TheProduct

1. Marketing & Sales Logic

2. Service Product Design

3. Delivery & Customer Support

4. Revenue Model

5. Branding & Reputation

6. Informational

7. Interpersonal

The Whole Product

plus

Enterprise CapabilitiesValue Chain - Processes

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Customer Profitability - 1

The most common problem in determining customer profitability:

Selling, marketing, distribution and administrative costs are not assigned to products or customers

This is not necessary for financial reporting Management considers them ‘fixed’ It is considered too expensive to do so

As a result, the behavior of these costs is not well-understood and cannot be easily managed

Value-chain analysis identifies and allocates these costs

Costs are allocated to each customer value package

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Customer Profitability - 2

Knowing the customer-profit profile determines value packages

A mismatch between the value package and customer profile:

Erodes profits Misses the chance to capture extra profits Consumes resources managing the mismatch

The matching of value packages and customers is step one

Value chain analysis, and profitability analysis are step two

From there margins can be improved

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Customer Profitability - 3

Types of Customer-Profit Profiles

Aggressive Leverage their buying power

Low price and lots of customized service and

features

SensitivePrice-sensitive and few special

demands

ImpressiveCostly to service, but pay top

dollar

Passive Product is crucial

Good supplier relationship

Net

Mar

gin

Rea

lized

Low

High

Low HighCost to Serve

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Gaining Internal Balance

There are often significant disagreements between staff about the costs and profitability of products and services.

Products& R&D Delivery Consulting Sales

CEO & Finance

Technology

Quality

Top-line

Profit 1

3

2

4

1

1

1

12

2

2 3

3

3

4 4

4

43

2

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Summary – Improving Margins

By following the value chain analysis process:

The profitability of each Customer Value Package is known The Value Packages are matched to the customer profiles Margins will be improved for each value package Alignment will be gained between all parties to the value chain

and service product about its contribution to profit

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Profitably Serving Customers

Contact:

Walter Adamson

Digital Investor Pty ltd5/45 William St, Melbourne 3000

Office: 0500-500-321, Cell: 0403 345 [email protected]

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