INTERSCIENCE, B. V.

: SEEKING A NEW MARKET FOR GAS CHROMATOGRAPHS

James A. Narus

James C. Anderson *

May 2002
*

James A. Narus is Professor of Business Marketing, Babcock Graduate School of Management, Wake Forest University. James C. Anderson is the William L. Ford Distinguished Professor of Marketing and Wholesale Distribution, and Professor of Behavioral Science in Management, Kellogg Graduate School of Management, Northwestern University. He is also the Irwin Gross Distinguished ISBM Research Fellow at the Institute for the Study of Business Markets (ISBM), located at Penn State University, and Visiting Research Professor, Department of Technology Management, Eindhoven University of Technology, the Netherlands. The significant contributions of Marcel van den Bosch, Ren van Asch, Ad Honders, and Bert Willemsen in gathering and analyzing case information are gratefully acknowledged. Please note that we prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. We have disguised some information about the company, its competition and market conditions, and altered some cost and usage data. Send correspondence to: James A. Narus Babcock Graduate School of Management Wake Forest University Suite 150, One Morrocroft Centre 6805 Morrison Boulevard Charlotte, NC 28226-3551 USA +1.704.365.6717 (telephone) jim.narus@mba.wfu.edu (e-mail)

2002, James C. Anderson and James A. Narus. All rights reserved.

INTERSCIENCE, B. V.: SEEKING A NEW MARKET FOR GAS CHROMATOGRAPHS

"It is impossible. It cannot be done!" Pete Willemsen, a five-year veteran of the Interscience sales force, responded emphatically to his sales manager's suggestion that the company target the contract laboratory market in the Belgium-Netherlands-Luxembourg (Benelux) region of Europe for growth in sales of gas chromatographs. "Purchasing managers in the contract labs market view the gas chromatograph as a commodity item. They buy solely on price and squeeze suppliers for extra discounts and special deals. The two North American firms that dominate that segment, Agilent (a spin-off of Hewlett-Packard) and Varian, sell only no-frills equipment at low prices and thrive on these customer preferences. Currently, the average price for a gas chromatograph in the contract labs segment is 40,000 and the industry price bandwidth is + 3%. In contrast, our lowest priced basic model sells for 45,000, more that 10% higher than the industry average! Even our highly touted product customization and value-added services have no impact on purchasing decisions. For example, I have tried on several occasions to promote our patented, Cold-on-Column injection system, which eliminates sample decomposition problems, to no avail." "Instead, I believe that Interscience should pursue growth in the research and development (R&D) laboratory market in the Ruhr-Rhine region of Germany. The sales and profit potential in that market is roughly equal to that in the contract lab market in Benelux. Geographically, the region is close to our current operations. More importantly, we would be able to draw upon Interscience's core capabilities and successful strategies for marketing to R&D lab customers. And, as a sales person I would prefer giving a technical sales presentation to a scientist in an R&D lab than pitching special deals to purchasing managers at contract labs. Thus, I strongly believe that the R&D lab market in the RuhrRhine region constitutes a superior opportunity for Interscience. Marketing to contract labs -- that strategy will never work!" With these strong words, Pete left his sales manager's office. Interscience sales manager Marcel Honders leaned back in his desk chair and reflected on Pete's blunt appraisal of his proposal. "My twenty years of experience selling gas chromatographs for Interscience tells me that the contract labs market cannot be so easily dismissed. There is a gold vein there that we can mine," Marcel thought. "The task will not be easy as we will have to re-invent our selling approach. As part of this process, we will have to craft a persuasive value proposition for the contract labs segment. With the long list of product features and services that Interscience offers, there must be a few that can deliver significant value to contract labs. As for the R&D lab market in the RuhrRhine region, it too has potential; however, with limited resources Interscience will not be able to simultaneously pursue both opportunities. My concern with the Ruhr-Rhine market is that there are more than 15 local competitors that have served those customers for over 30 years. It will be difficult for an unknown Dutch firm to make inroads into the nationalistic and loyal German marketplace. To sort this out, I will conduct a customer value assessment to evaluate the contract lab option more fully."

BACKGROUND
Interscience B.V. is a 25-year-old trading company with 50 employees based in Breda, The Netherlands. As a value-added reseller, the firm markets a limited variety of life sciences equipment, primarily gas chromatography systems, to laboratories within the Benelux region. It serves as the exclusive marketer of gas chromatographs in the Benelux area for Thermo-Finnigan, a United States (U.S.) manufacturer of scientific measurement equipment. Senior management of Interscience sees the firm's primary core competence as the provision of knowledge in the form of value-added services to scientific laboratories. Rather than just serving as a distributor of equipment and related consumables, Interscience customizes gas chromatographs to precisely meet the requirements and preferences of its

2 customers. This entails not only designing and adding innovative product features but also offering a wide variety of support services such as preventative maintenance, emergency repairs, and analytical process consulting. The firm also prides itself on the extensive educational seminars it offers both at customer and Interscience facilities. Through such courses, Interscience makes customers aware of the latest developments in gas chromatograph technology as well as assists them in improving the productivity of their scientific analyses. Gas chromatographs constitute Interscience's principal product line. Russian botanist, Mikail Tswett, invented the chromatograph in 1906 as a means of identifying chemical components of plants. He introduced ground-up plant matter that had been suspended in petroleum ether into a glass column coated with calcium carbonate. As the liquid migrated down the column, each chemical substance progressed a different distance. Through repeated experimentation, Tswett and other scientists discovered that each chemical left a distinctive pattern of movement in the column and that that pattern could be used as a fingerprint in the chemical identification process. They quickly developed liquid chromatographs as chemical identification and measurement instruments. During the 1950's scientists discovered that gas chromatography was a superior and more efficient means of identification and separation. In gas chromatography, the sample is vaporized and injected with a syringe into a specially coated column that is mounted inside an oven. When heated, each substance in the sample moves through the column at a different rate of speed. A detector at the end of the column measures the time each chemical has taken to reach it and identifies the substance through a series of complex mathematical formulas. In years past, a mechanical printer would plot results. Today, data are more likely to be recorded automatically in a personal computer (PC) file for further analyses and display. Exhibit 1 contains a diagram of the components of a typical gas chromatograph system. The three leading manufacturers of gas chromatographs in terms of market share in Europe and North America are Agilent, Thermo-Finnigan, and Varian. While both Agilent and Varian maintain their own sales offices in Europe, Thermo-Finnigan markets its products in some European countries through trading companies. Each trading company has an exclusive territory. For the most part, Agilent and Varian manufacture basic models and sell them at low prices to routine-applications laboratories, amongst which contract or commercial laboratories are most numerous. Contract laboratories are small to medium sized companies that perform routine and standard analyses of water, soil, and air samples for companies, institutions, and governments. For example, a local water board might hire a contract lab to test ground water for chemical contamination. With the proliferation of environmental (i.e., "green") legislation across Europe, demand for such testing is growing rapidly and contract labs are a booming industry. In fact, over two thirds of all unit sales of gas chromatographs go to contract labs. However, when it comes to purchasing gas chromatographs, contract labs are extremely price sensitive. Until recently, neither Agilent nor Varian gave much attention to a second segment, R&D laboratories. Comprising about a third of all gas chromatograph purchases, R&D laboratories use the equipment in highly demanding technical experiments and new product development. R&D labs require highly customized and specialized equipment and for the most part are not price sensitive customers. Major corporations, universities, and government bureaus commonly operate R&D labs so their scale of operation is far greater than that of contract labs. Agilent and Varian traditionally approached R&D labs indirectly and unsystematically, selling basic models on a non-exclusive basis to trading companies and value-added resellers. For the most part, Agilent and Varian treat trading companies as final customers. However, trading companies frequently customize the gas chromatographs and market them to R&D

3 labs. Currently, some 5 trading companies, including Interscience, compete for sales to R&D laboratories across the Benelux region. Thermo-Finnigan relies upon a somewhat different strategy in Europe, choosing instead to pursue the top-end R&D lab segment. The firm focuses on producing state-of-the-art gas chromatographs for demanding applications. Due to historical reasons, Thermo-Finnigan management had decided to retain trading companies in some European countries rather than set up its own operations. The strategy had several advantages. First, Thermo-Finnigan could gain economies of scale from producing a limited variety of gas chromatographs. Second, the firm could postpone customization of the equipment until it reached trading companies that better understood local applications and requirements. Third, Thermo-Finnigan could reap high profit margins in the segment where chromatograph prices often top 150,000. During the past 25 years, the relationship between Interscience and Thermo-Finnigan had been highly profitable for both firms and they jointly hold a commanding market share lead in the Benelux R&D lab segment. Each makes complementary contributions to the relationship -- Thermo-Finnigan provides first-rate products and Interscience augments them with high value-added features and services. Recently, Interscience had gained an important marketplace-equity advantage. Within the past eight years, two progressively larger companies had acquired the manufacturer, changing its name each time. In a recent survey of gas chromatograph customers in Benelux, respondents had rated their brand awareness of Interscience significantly higher than that of Thermo-Finnigan.

THE VALUE ASSESSMENT PROCESS

Within one week of his discussions with Pete Willemsen, Marcel Honders had assembled a customer value research team. First, he gained the cooperation of Interscience marketing manager, Bert van Asch. Bert would supply data on customer preferences, product costs and prices, and competitor activities from government and trade association data, multi-client studies, and customer surveys. Second, he sought the assistance of Alex Bosch, the head of Interscience's R&D group. Alex would provide technical data and test the performance of competing gas chromatograph models. Finally, Marcel asked Gerard Tromer, the general manager of a major contract laboratory, Dordrecht Labs B.V, to participate in the analyses. Gerard agreed to provide relevant cost and usage data as well as test competing models at his lab in exchange for an open and honest summary of findings. Through this cooperation, Gerard hoped to learn ways to improve the productivity and profitability of his contract lab. At their first face-to-face meeting, the customer value research team agreed to limit their evaluation to a comparison of the TRACE GC, Thermo-Finnigan's basic and lowest price model augmented with a bare minimum of Interscience product features and service, and the Varian 3800. Exhibit 2 contains photographs of these two products. The team selected Varian as the comparative model for several reasons. Varian holds the largest market share in the Benelux contract lab market. Its products are similar to Agilent models in terms of product features, performance, and price. Lastly, Varian had made overtures in the R&D market segment recently and Marcel saw them as a direct threat to Interscience's core business. As for application, the team decided to concentrate on the so-called "mineral oil test" (i.e., the examination of soil and water samples for contamination) as it is the most common use of gas chromatographs among contract labs. At the conclusion of the first meeting, Marcel gave the team its first assignment -- identify possible value and price elements for gas chromatographs. Once they assembled a comprehensive list of elements, the team would divide them into points of difference and points of parity. Subsequent investigations and analyses would concentrate on meaningful points of difference.

Interscience TRACE GC Advantages Following a two-week fact finding hiatus, the group assembled once again at Interscience's Breda headquarters. Marcel and his marketing colleague, Bert van Asch, proudly summarized a long list of Interscience TRACE GC advantages. They began with the product's patented, Cold-on-Column injection system. As contrasted with the Varian model, which operates its injector at room temperature or higher, the TRACE GC cools its injector far below the ambient temperature and injects the sample directly into the capillary column. The patented process enabled technicians to maintain sample integrity by avoiding high temperature vaporization, eliminating the risk of thermal degradation, enhancing test discrimination, permitting the use of volatile solvents, and preventing contamination from external sources. Next, Marcel and Bert described Interscience's product customization capabilities. Based on customer requirements, Interscience's manufacturing center could add specialized detectors (e.g., gas and leak, thermal conductivity, electron capture, and photo-ionization), a thermal desorption system, a variety of capillary column sizes, and analytical software, among others. The pair further believed that education constituted another competitive advantage of Interscience. The firm maintained a stylish 50seat classroom, demonstration lab, library, and breakout rooms at its facility in Breda. Periodically, Interscience invited customers and other gas chromatograph users for seminars on such things as technical developments, proper product usage, and routine maintenance. Interscience also gave training courses at the customer's laboratories. For the most part, Interscience offered these in-house and on-site seminars "for free" to interested parties. The firm also provided at no charge, on-line and in hardcopy format, newsletters and technical brochures. To improve customer productivity, Interscience offered maintenance and consulting services. The former entailed a 24x7 telephone support desk, scheduled preventative maintenance (i.e., three onsite calls per year), and on-site emergency repairs guaranteed within two working days.1 The latter included such things as analytical process design, parts and consumables ordering and inventory management, cost management, and general business consulting advice. Marcel emphasized that Interscience had a long-standing policy of bundling the costs of all its customized product features and augmented services into one, final price. He felt that this was important to the customer in that without extra fees, the price the customer saw on the invoice represented the total cost of the Interscience gas chromatograph solution. Points of Parity and Difference "That was quite an impressive list of product and service advantages," Gerard Tromer stated while rolling his eyes. "However, as the general manager of a contract lab, I can tell you that we really dont need most of them in our operation. While we will gladly take them if you are going to give them to us for free, we would rarely, if ever, pay a price premium or extra fees to obtain them." "Let me quickly run down your list and comment on each so-called advantage. The Cold-onInterscience guaranteed that in the case of breakdowns, a technical representative would arrive at the customer's facility within two working days of a reported incident to begin repairs. Interscience defined a working day as the period from 8.00 in the morning through 17.00 in the afternoon. So, if a customer reported an incident at 14.00 one afternoon, Interscience guaranteed that a technician would arrive before 14.00 in two working days. The firm did not dispatch technical service reps between 17.01 in the afternoon and 7.59 in the morning.
1

5 Column injection system sounds wonderful; however, we are testing soil and water samples, not specialty pharmaceuticals. We run a limited range of standard and routine tests that government agencies and industry practices dictate. Maintaining sample integrity is not a significant concern and room temperature sample injection serves our requirements adequately. On paper, product customization sounds desirable. Yet, we only run basic tests. All we really require is a reliable instrument that can perform a handful of tests day-after-day, over-and-over again," Gerard stated emphatically. "Your educational facility and seminars are truly outstanding; however, our procedures are so basic and tests so routine that we just don't need further training", Gerard said bluntly. "The same can be said about your consulting services. They really are not necessary in our operation. As for pricing, I like the idea of one, final invoice price. On the other hand, Dordrecht Labs would be willing to pay extra for a value-added service if and only if you could clearly demonstrate that it either reduced our total costs of operation or increased our revenues and profits. For example, emergency repair services are essential and our firm would be willing to pay extra for a contract that featured more rapid response time." "So, what differences between the Interscience TRACE GC and the Varian 3800 are important to my firm?" Gerard asked. "Over the years, we have owned and operated both products, so, I am speaking from experience. Let me begin by eliminating the points of parity, which turn out to be quite numerous. For our applications, both gas chromatographs are roughly equivalent in terms of: the variety of tests performed, reliability, precision, accuracy, durability, result reproducibility, rate of system failures and breakdowns. The relevant points of difference boil down to these value and price elements. The cycle time (i.e., time to run a test) and septum change time (i.e., time to change column seal) for the Interscience TRACE GC appear to be significantly lower than those for the Varian 3800.2 In addition, we change the Interscience TRACE GC septa less often. These three elements are important to us in that they allow us to run more jobs and hence increase our revenues. Your product has a sleek and stylish design and appearance; however, I'm not sure that is relevant to most lab technicians. On the other hand, the Varian 3800's price is 5,000 less (i.e., 40,000 versus 45,000) and maintenance costs are lower. Brand awareness for Varian is far greater than that for Interscience in the contract lab market." "This has been quite a revealing exercise for me," Marcel observed, "We have managed to identify what seems to be the most important value and price elements for this segment. During the next few weeks, let's gather as much performance and cost data as we can that relate to this handful of elements within the standard, mineral oil testing application. I request that Gerard and Alex undertake a series of side-by-side tests of the Interscience TRACE GC and Varian 3800 at their respective company laboratories. Bert, I ask that you interview other contract lab managers and gather as much cost and performance data on both models as is possible." Summary of Cost and Performance Data The side-by-side tests run at the Interscience and contract lab facilities yielded similar results. The job time for the Interscience TRACE GC was indeed shorter. The average job time for the Interscience TRACE GC entailed 3.2 minutes for analysis and 2.8 minutes for cooling. The Varian 3800 took average of 6.2 minutes for analysis and 3.8 minutes for cooling. The job time differences could be attributed to a patented, proprietary feature of the TRACE GC oven. Septum change time for the TRACE GC was similarly quicker. On average technicians took 3 minutes to replace the septum plus 6 minutes for system recalibration on the Interscience TRACE GC. For the Varian 3800 technicians A cycle represents the steps required to perform one gas chromatograph test. A job is a cycle for which the firm is compensated. As all contract lab cycles are done for compensation, we will refer to all cycles as jobs from this point on.
2

6 required 3 minutes to replace the septum and another 10 minutes for recalibration. Although technician time was worth 45 per hour, the team was not at all certain whether or not any of the labor cost associated with septum change was recoverable. On the other hand, the team did note that technicians had to replace an Interscience TRACE GC septum every 1500 jobs and a Varian 3800 septum every 200 jobs. The number of septa changes per year might be an important consideration, as a TRACE GC septums price was 1.50, while a Varian 3800 septums price was 2.00. Bert van Asch and Gerard Tromer provided the following cost and performance information. Given the booming demand for environmental testing, contract lab business was expanding rapidly. As a result of the simplicity of the tests required and the fact that a gas chromatograph could run unattended for hours on end (i.e., a revolving carousel could be programmed to automatically feed samples into the injection system throughout the day), contract lab management sought to run as many jobs as possible throughout the year. The reason was simple. The average revenue per job was 20 and the average operating profit per job was 3. As an example, Dordrecht Labs currently operated 240 days a year, 24-hours a day. Gerard sought to increase not only the number of days in operation. A number of competing contract labs reportedly operated 365 days a year. "In order to increase the credibility of our findings among potential customers, let's be conservative and use Dordrecht Lab's numbers," Marcel opined. "In the future, we can always increase the number of operating days in our calculations to better approximate the performance level of specific contract labs." Factors that reduced the amount of working hours available per day related to maintenance downtime. Typically, the system would have to be shut down temporarily to change samples, clean and sanitize the unit, and replace consumables. In addition, three times a year, the unit would be stopped for preventative maintenance. Examining his maintenance records, Gerard found that on average the Interscience TRACE GC was out of service for 60 minutes per day while the Varian 3800 was out of service for 50 minutes for routine and/or preventative maintenance.3 Thus, the maximum available working hours for the TRACE GC averaged 23 hours per day and for the Varian 3800, 23 hours and ten minutes. Bert's interviews with the managers of other contract labs supported these estimates. According to Gerard's records, total maintenance costs (i.e., routine and preventative maintenance) on the Varian 3800 averaged 2,800 per year. As the Interscience TRACE GC required more expensive parts and labor, its maintenance costs were slightly higher averaging 3,600 per year. Using results from side-by-side tests conducted at the Interscience R&D laboratory, Alex Bosch projected annual maintenance costs comparable to those Gerard provided. Information from Thermo-Finnegan, Bert's customer usage studies, and Gerard's experience suggested that the useful lifetime of both the Interscience TRACE GC and the Varian 3800 was five years. No salvage value was anticipated. Finally, trade association studies estimated the average cost of capital for a contract lab to be 10%.

PROCESS INSIGHTS AND CALL FOR ACTION

As Marcel waited for Bert van Asch to run a spreadsheet analysis of the cost and performance data, he took the time to reflect. "Regardless of how the numbers turn out, I have learned a lot during the value assessment process. One of the most important insights I've gained concerns the Cold-on-Column injection system. I was pleasantly surprised to learn that the Interscience TRACE GC requires a septum
3

This figure is an average; so, in practice some days will incur more downtime and other days less.

7 change only once per 1500 jobs. I asked Alex and his colleagues in the R&D lab to identify the cause of our superior performance. It turns out that the reason our system outperforms the Varian model is due to the Cold-on-Column injection system. A septum is a specialty polymer disk that seals the capillary column from the outside environment. Each time a job is initiated, a sample of material is injected with a needle through the septum into the column. Almost magically, the polymer reconstitutes the septum disk leaving almost no penetration mark or scar on the surface. This is critical in that it keeps out contaminants and allows the gas chromatograph to conduct an accurate test. Eventually, the septum does degenerate and must be replaced. With the Cold-on-Column injection system, the septum is kept at a significantly lower temperature. As a result, the septum tears to a lesser extent enabling it to function far longer. Thus, the Cold-on-Column injection system yields two distinct benefits -- sample integrity, which is of great value in the R&D lab segment and of little value in the contract lab segment, and septa change frequency, which is critical to contract labs and not that important to R&D labs. During our infrequent and casual sales calls on contract labs in the past, we've sold the right product feature (Coldon-Column injection system) but the wrong benefit (sample integrity). No wonder that contract lab managers trivialized or ignored our value proposition!" Along similar lines, Marcel realized that while the Interscience sales approach worked well at R&D labs, it was inappropriate at contract labs. "At R&D labs our long-standing strategy has been to cater to scientists with benefits in the form of customized products and value-added services. Because R&D labs tend to be relatively price insensitive, we could readily bundle all related costs into the final price and still reap significant profit margins. In contrast, company and product advantages that are legitimate value elements in the R&D lab segment turn out to be value drains in the contract lab segment! Thus, to profitably serve the contract lab segment, we will need to eliminate most of these elements from our standard offering to them, perhaps selling a handful of services as for-fee options." One for-fee option that Marcel was considering was a One-Day Emergency Response Guarantee. Currently, Interscience guaranteed that in the case of a reported incident one of its technical service engineers would arrive at the customers lab to initiate repairs within two working days. Interscience offered the labor on such emergency repair service for free but charged for repair parts and materials. If the engineer failed to appear within two working days, the customer would receive the parts and materials for free. This was not a trivial guarantee in that the parts could be quite expensive. To obtain guaranteed one day emergency response, a customer would have to sign a contract agreeing to pay 125 per hour for technical service engineer time. Customers also would be charged for repair parts and materials. In return, the customer would be moved to the head of the service queue and if an engineer failed to appear within one working day of a reported incident, Interscience would provide labor and repair parts for free. On average, repairs took 3 hours to complete, with reasonable variation around this average repair time. According to Intersciences accounting department, emergency technical service engineer time, including travel to and from the customer site, cost the firm around 100 per hour. Searching trade association data, Marcel found that this cost figure matched the industry average. Thus, if Interscience charged 125 per hour, its profit margin would be 25 per hour for the service. Customers that did not want to pay extra would receive emergency service within two working days with free labor. Marcel looked to the road ahead, "Once the value assessment calculations have been completed, we will have several related decisions to make. First, we must use our findings to craft a persuasive value proposition for the contract lab segment. Second, we must reformulate our selling approach for the contract lab segment based on this value proposition. Third, we must gauge the likelihood that our new selling approach will be successful and decide whether to initiate a coordinated effort at penetrating the contract lab segment. If our prospects among contract labs turns out to be bleak, we can always seek growth from R&D labs in the Ruhr-Rhine region of Germany."

Exhibit 1 An Illustration of the Components of a Gas Chromatograph

syringe carrier gas column

pneumatics

injector

oven

detector

data-storage

Exhibit 2 Photographs of the Interscience TRACE GC and Varian 3800

The Interscience TRACE GC

The Varian 3800