NET GAINS – Profit from Transparency

The Internet has ushered in the age of information democracy by shifting the balance of power toward customers. Nowadays, customers can compare prices through shopping engines such as DealTime and PriceGrabber.com. They can pit sellers against each other through reverse auction services like FreeMarkets. And they can get unbiased feedback on products and services through third parties like Amazon.com, BizRate.com and CNet. Information transparency is here to stay.

Transparency is a good thing for customers, but it seems to threaten suppliers. One of my favorite questions for executives is: If your customers knew everything about your products, your costs, your prices and your competitors’ offerings, would you be better off? Judging from the uncomfortable silences I usually encounter in response, most executives believe that transparency is an enemy of profit. Their reasoning: Customers will take advantage of better information to drive down prices and profit. Harvard Business School’s management guru Michael Porter echoes that thought. “The great paradox of the Internet,” he says, “is that its very benefits?making information widely available; reducing the difficulty of purchasing, marketing and distribution; and allowing buyers and sellers to find and transact business with each other more easily?also make it more difficult for companies to capture profits.”

But is transparency always a threat to profit? Will it set off a spiral of lower prices, intensified competition and commodified products? Not necessarily. I believe that transparency can be good for profit. To profit from transparency, companies need to understand two key principles about customer decision making. First, customers never buy solely on price, even though companies might think they do. Second, prices may be transparent to customers, but value often remains opaque. By making their value propositions visible to customers, companies can benefit from the democratization of information.

I recently participated in a conversation between the CEO of a midsize pharmaceutical manufacturer and a supplier of plastics who was trying to get the pharmaceutical company to switch to plastic bottles instead of glass. Plastic bottles seem to be as close to a commodity as one could imagine. Naturally, the conversation began with the pharmaceutical CEO asking if plastic bottles were cheaper. Being a good marketer, the plastics manufacturer pointed out that the price of the bottle should not be the sole focus of attention. First of all, he said, plastic weighs less than glass, so the transportation costs for the drug company would be lower. Second, plastic is not as fragile, so the breakage loss would be lower. Third, plastic bottles would save on labeling cost because labels could be imprinted directly. Fourth, being a local supplier, the plastics manufacturer would deliver more frequently in smaller batches, resulting in reduced inventory holding cost. On the negative side, the production line would run somewhat slower with plastic.

As the conversation progressed, it became evident that the drug company’s value equation for packaging included a number of considerations besides price. After accounting for variable costs, such as inventory, breakage, logistics and line efficiencies, the plastic bottles would be a better value even at a higher price. The moral: There is no such thing as a true commodity.

While suppliers should make their value propositions transparent to customers, customers are also realizing that it is in their interest to make their value equations transparent to suppliers. I spoke with a purchasing executive from a petroleum company about reverse auctions. Suppliers tend to hate them because large buyers use auctions to beat competing suppliers down on price, leaving the winners with a Pyrrhic victory. The purchasing executive said, “We provide all bidders in our reverse auction with the formula we use to weigh variables among competing suppliers. With this information, suppliers are able to make trade-offs among price and nonprice variables as they participate in the auction.” In that case, transparency is good for suppliers who have superior value propositions, even if their prices aren’t the lowest.

The key, then, to profiting from transparency is to sell on value, which involves three key steps.

1. Understand what customers really value. The pharmaceutical company mentioned really cared about the total cost of producing, packaging, shipping and promoting their drugs. The CEO of Freightliner, a truck manufacturer, noted that customers don’t want to just buy trucks. They care about “keeping ’em rolling.” That insight spurred Freightliner to offer a diagnostics service for its trucks that predicts breakdowns, and a speedier process for delivering parts. You may find that the product cost is a small component of the customer’s total costs, and that price is only one of many variables that customers should consider.

2. Develop flexible market offerings. No company can satisfy all customer segments with the same offering. To cater to different segments, companies need to create what Jim Andersen, my colleague, calls “flexible market offerings.” These are bundles of products, services and information that customers can configure and customize to suit their priorities. I often find that companies bundle services with their products as value-added services. The problem is that not all customers value all the services. A software customer who has a strong IT organization may not value support as much as another customer who relies more on outsourced IT support. Allow customers to choose the services they value and to pay for only what they use.

3. Communicate your value proposition. You need to educate customers about the elements of your value proposition. Customers often may not even know what variables they ought to be thinking about and how you stack up against competitors. Internal communication is equally important. The sales organization will tend to use price as its only competitive weapon if it doesn’t really understand the company’s value proposition. Obviously, the sales force has to be able to quantify the economic benefits of nonprice variables.

By following those steps, companies that truly provide better value will profit from transparency?they’ll move the conversation with customers away from price to value. So, transparency is not necessarily an enemy of profit. But it is an enemy of profit based on customer ignorance. The sobering question you need to ask yourself is, Is an informed customer really a better customer for my company? If the answer is yes, you should embrace transparency by making your value proposition explicit to your customers. If the answer is no, you need to find another way to make a living.