The management mantra of the 1990s has been cost reduction. A combination of recession in Western markets and increasing international competition has kept the focus of most European and US companies on containment rather than expansion. But the mood is changing. Companies unable to trim their fat have been pushed aside by rivals, while those that have achieved the required cost base are wondering how best to apply their new-found strength.

Companies that enjoy a competitive cost structure will have to look for further profit increases from growth. Strategic or geographic growth—expansion into new or related businesses through acquisitions, partnerships, or start-ups at home and abroad—is an obvious route forward that can deliver rapid returns. Eastern Europe, Southeast Asia, and multimedia are all highly publicized areas to which revenue-hungry managers have flocked. But what these managers are in danger of overlooking are the lower-risk opportunities of operational growth that lie much closer to home.

Operational growth—achieved by improving volumes and margins in existing businesses—is an area over which managers have seemed hesitant to take control. "It all depends on market conditions and what our competitors are up to," is a common response to suggestions that a company look to improve its sales margins. Yet just as cost reduction can be approached in a systematic and targeted fashion, so too can volume and margin increases.

Programmed expansion aims to raise both revenues and margins, predominantly in existing businesses and with existing products, over a two- to four-year period. If it is to succeed, corporate focus needs to change from pursuing volume at any cost to precisely targeting the most attractive customers. This implies that customers can no longer be treated more or less equally: differentiated strategies are required.

Programmed expansion offers strategies to improve margins and revenue from three different groups of customers

Programmed expansion offers strategies to improve margins and revenue from three different groups of customers: those who are unprofitable or barely profitable for the business; those who are already attractive customers; and potential customers. Our work on over 50 projects in the industrial sector, ranging from basic materials to engineered systems, indicates that programmed expansion can lead to an absolute profit increase of as much as 40 percent.

Unprofitable customers

About 30 to 40 percent of a typical company’s revenue base is generated by customers who, on a standalone basis, do not earn their keep. A customer’s economic attractiveness is measured by pocket contribution margins. The pocket contribution is the actual sales price minus all discounts, direct costs associated with the customer (such as technical support and delivery costs), indirect customer costs (such as salesforce costs), and the production costs of the goods or services sold.¹

Unprofitable customers frequently remain in the portfolio because of the assumption that any revenue is good revenue and the often unfounded concern that dropping a customer might harm the supplier’s image. In many cases, however, suppliers have simply failed either to look at the true costs of serving their customers or to differentiate between them. Unprofitable customers fall into three categories:

First, turnaround customers that can be expected to become profitable given a concerted effort on the part of the supplier. Second, customers unlikely to show profitability, either because they do not sufficiently value the attributes of a given product or because a competitor is better positioned to supply them. Ceasing to serve these customers is a tough decision since it offers hard-fought-for territory to competitors and eliminates revenue on a marginal basis, but short-term pain is often preferable to maintaining unprofitable relationships. Third, there are unprofitable but strategically important customers that show long-term profit potential. Although it can be tempting to promote undeserving customers from the second group to the third, the result is a customer portfolio with lots of potential but little performance. A variety of approaches can be used to raise profit margins for the first group of turnaround customers:

Improve salesforce productivity

Although spending time with a customer is often the best means of stimulating enquiries or sales, surprisingly little company time is devoted to it. In many industrial companies, 15 to 20 percent of personnel on average work in sales. Typically, about 5 to 10 percent of these are salespeople with customer contact, spending about 20 percent of their time in front of the customer. That comes to a grand total of at best 0.4 percent of company time spent with customers. Exhibit 1 and Exhibit 2 show the degree to which extra time spent with the customer can boost sales. Salespeople can increase the amount of time they spend with customers by improving their productivity. Possible measures include making better use of telecommunications; obtaining mobile access to whatever information they need; employing automated systems for bid preparation, order entry, and processing; and gaining access to industry and company databases. Such changes allow the salesforce to increase the overall number of sales calls it makes, thereby reducing the cost as well as improving the quality of each call.

Exhibit 3 shows how the salespeople at an industrial electronics company used their time prior to embarking on a plan to boost productivity. The productivity gains that followed implementation of the plan released sales capacity that was used to expand into new customer and market segments without the need for additional salesforce resources.

Some of the extra capacity released through higher productivity can be used to spend more time with unprofitable customers—though this does not mean going over the sales catalog for the umpteenth time. Instead of this, salespeople should take more time to understand how their product can influence the customer’s economics and performance. Few products are so standardized that nothing differentiates suppliers except price.

If all else fails, a company can take the decision to devote less time to specific or unprofitable customers, perhaps switching to a lower-cost alternative approach such as telephone marketing. This change will cut the cost of the sales effort for those customers, again freeing resources to pursue more profitable business elsewhere.

Improve channel management

The supplier’s share of total value-added—the difference between the final sales price and the sum of production and distribution costs—varies dramatically between and within industries. The manufacturer of a premium brand ice-cream might receive between 80 and 90 percent of the total value-added, while the retailer of own-brand products pockets nearly all of it. Sales channel value-added for industrial products, meanwhile, lies in the range of 15 to 35 percent of the final sales price—often as much as the manufacturer’s share.

Companies frequently fail to capture the maximum possible share of the total surplus created in the chain because they choose the wrong channels or manage them badly. Exhibit 4 shows the extent to which channel costs vary for a single product: gasoline. Factors such as frequency of delivery, the size of storage tanks, and the degree to which fixed costs are covered by the sale of other products or services mean that it can cost twice as much to sell a gallon of fuel at a self-service station as at a convenience store—leaving ample room for raising supplier profitability.

A rigorous process of channel management—optimizing efficiency and effectiveness while ensuring sustainability—will improve profitability both by reducing the cost of bringing products to the final customer, and by increasing market coverage. Companies can look for ways of improving returns through channel management by asking themselves questions about the effectiveness, efficiency, and sustainability of their present systems (Exhibit 5).

Effectiveness. Do your channels meet your customers’ needs? A champagne supplier would do well to retail in stores that are open late at night; a supplier of cable for local networks needs distributors that are able to cost-effectively cut the cable to the length required by installation customers.

Are your channels equipped to capitalize on your competitive advantages? One high-performance stereo and hi-fi manufacturer found that sales staff in ordinary retail stores lacked the knowledge to be able to differentiate between the products on sale and communicate their value to customers. In specialty outlets, however, qualified sales personnel regarded the brand as a key element of their own differentiation strategy.

Efficiency. Take a close look at the costs and benefits of your system. Could you be getting a better cut of the total system surplus via a different channel? How do your total system costs compare with those of competitors?

Sustainability. If you and your channel are both contributing to your product’s success, the arrangement is likely to be sustainable. If there is an imbalance, however, you are heading for trouble. For example, who "owns" the customer? If a customer is contemplating buying your product and wants some advice, will he or she contact you or your channel? If the answer is the channel, you have forfeited influence over what the customer will buy, and you could lose touch with market needs.

Of course, the more mundane the product, the less likely it is that you will "own" the customer, but for products with clear differentiation criteria other than price, maintaining customer links and feedback is essential, even if the product is physically distributed by an intermediary.

Improve transaction pricing

Up to 30 percent of revenue is "lost" between a supplier’s original list price and the actual pocket price. Oversights by the supplier when pricing the contract, a change in customer specifications, or exchange rate fluctuations can all eat away at margins. Yet concerted internal efforts can reduce these losses, with every improvement going down to the bottom line.

In the case of a manufacturer of metal treatment systems, almost all of the 31 percent of revenue lost from one unattractive customer could be managed down (Exhibit 6). The company improved its freight billing, handling charges, and volume rebate structures as well as management processes such as claims management, foreign exchange management, and order freeze points. These changes were codified into clauses in the standard contract; a minimum order value was established, foreign exchange contracts had to be countersigned by the finance department once exposure had been hedged; and new guidelines concerning customer-initiated changes after contract closure were introduced.

Attractive customers

It is likely to cost an industrial supplier five to eight times more to win a new customer than to retain an old one

It is likely to cost an industrial supplier five to eight times more to win a new customer than to retain an old one. The cost of acquiring a new customer includes marketing, cold calling to potential customers, preparing proposals, possible modifications to the product to meet customer requirements, and perhaps the introduction of different production, quality control, and testing procedures. Divide these costs by the actual "hit" rate, and it is not difficult to understand why acquiring customers is so much more expensive than keeping them.

A key part of programmed growth must thus be to retain and increase the profitability of already attractive customers. This can be done by:

Improving account management

Adopting key account management rather than regional management can lead to improved customer service, reductions in the costs of serving accounts, and more rapid development of innovative, customer-oriented solutions. Key account management is, however, not always appropriate. Customers most likely to yield results from the extra attention are those with large accounts and complex needs, or those in which several different functions, often in different locations, are involved in purchasing decisions.

For one supplier, the shift to key account management led to the rapid discovery of a solution to similar technical problems at four different plants owned by the same customer, and to a lucrative development and supply contract. When the account was handled on a regional basis, neither the supplier nor the highly independent customer plants recognized the breadth of these problems.

Improving customer loyalty

Losing a profitable customer is an economic catastrophe. Not only does it mean lost revenue, but the cost of acquiring a new customer far exceeds that of retaining an old one. Since customers face equally high costs when finding a new supplier, they are usually reluctant to change supplier once a close relationship has been established. If they do so, it is generally in response to what they regard as neglect, poor service (unreliable delivery, weak technical support), or poor quality sales staff. Suppliers should therefore take steps to assess and improve their customers’ satisfaction with the service they offer.

Convinced that speed and reliability were the keys to success, Dell Computer built its entire business system around these principles. In Germany, it cooperates with a shipping company that delivers and installs its equipment and liaises about installation problems, and with a media company that visits and telephones customers to assess satisfaction. Dell offers a telephone diagnosis and 24-hour repair service and a telephone order system, and is prepared to install any software at the customer’s request. Dell’s customer loyalty management has been a major factor contributing to its 50 percent annual growth in Germany since 1988.

Reevaluating incentive schemes

Though most suppliers have introduced quantity or loyalty discount schemes, the gains originally intended for the supplier tend to get eroded over time as prices change and companies fail to reexamine the benefits. Quantity discounts that are meant to encourage customer loyalty instead end up being used by the customer for forward buying.

Reexamining the costs of these incentive schemes is important. But suppliers should also consider alternatives to the straight financial giveaway. Installing online terminals for customers, for example, would cut the cost of order processing, which could then be reflected in a discount for customers. Such initiatives can produce an upward spiral of more purchases, better system economics, and an improved value proposition. One cable and connections manufacturer established a direct computer link to the engineering and production departments of one of its customers, which led to faster response times by the supplier and lower processing costs. Over the course of three years, an increasing percentage of the customer’s orders shifted to this supplier.

Potential customers

Without changing its actual products, there are two ways in which a supplier can attract customers that are currently buying some or most of their products from competitors.

Expand the scope of customer interactions

Even if the original equipment sale was made by a competitor, suppliers should exploit the after-sale market. Apart from improving service and support at the initial start-up of machines or systems, industrial suppliers can earn more revenue and profit from supplying spare parts and providing external preventive and reactive maintenance.

The installed product base represents one of the largest sources of potential custom for industrial companies. In aerospace, for example, the after-sale market can represent a larger share of net present value than the initial sale (Exhibit 7). However, companies often capture only about 20 percent of this market, partly because salespeople tend to consider it less demanding, preferring to make new equipment sales. Even this 20 percent is seldom fully exploited, being priced in line with the cost of supplying the product or service rather than according to its (usually much higher) value to the customer.

One ambitious approach to expanding customer interactions is to instigate "build and operate" schemes, whereby the supplier of equipment also operates it on behalf of the customer. Such schemes are still comparatively rare, but are likely to grow in the future.

Improve the quality of customer communications

A high-performing sales team is one that is nearly always contacted when a potential customer is considering a purchase. High performance is often driven by individual selling skills, which will vary between simple and complex sales but must always be driven by customer needs. Excellent salespeople will recognize how a customer arrives at a decision to buy: first by recognizing a need to make a purchase, next evaluating the options, then resolving concerns, and finally purchasing. Effective salespeople have superior questioning skills allowing them to detect a customer’s needs, and superior listening skills enabling them both to understand where the customer is in the buying process and to offer something the customer will value.

Going for growth

As with cost reduction, successful programmed expansion will call for the setting of clear targets based on the performance of the very best competitors. It will require process improvements such as the management of service levels or measures to boost customer loyalty. And it will demand employees’ commitment to ensure that this is not a one-off effort, but the start of a continuous improvement process.

Programmed expansion is likely to require more effort than managing cost reduction. To a large degree, cost reduction measures occur within the boundaries and under the control of a company, while achieving growth in volumes and margins means convincing customers to place more of their orders with your company, almost always at the expense of a competitor. But the extra effort should prove worthwhile, with a greater number of customers who find the supplier attractive (higher volumes), and a greater number of attractive customers for the supplier (higher margins). Many companies have reduced costs in pursuit of short- and medium-term financial targets; now is the time to focus on growth through a customer orientation for long-term success.