Value-based strategy for industrial products

John L. Forbis and Nitin T. Mehta

In the continuing search for new ways of securing a competitive edge, it becomes ever more important for tbe industrial marketer to be able to demonstrate tbat bis product offers measurably better value for money. Indeed, tbe concept of establishing a value advantage tbat can be shared witb tbe customer is increasingly tbe key to successful product-market strategies. Tbe EVC approacb - a metbod of analyzing, enhancing and capitalizing on to tbe customer" - has special relevance under today's conditions of "zero sum" competition.

In the struggle for sustainable competitive advantage, manufacturers of industrial products typically concentrate on improving their cost position vis-a-vis the competition. They may try to reduce manufacturing costs by consolidating an overextended product line; increase productivity through automation; cut labor costs by resorting to offshore manufacturing or assembly; explore the possibility of materials substitution; weigh the feasibility of backward integration to reduce component costs; or pursue a strategy to rapidly gain market share and eventually become a low-cost producer. In their preoccupation with cost competition, they often lose sight of an equally powerful way of gaining the desired strategic advantage - namely, offering demonstrably better value to the customer, even at a higher price. Customers are used to buying on price, which is visible and measurable. Manufacturers are used to competing on the same basis, for the same reasons. But a strategic advantage based on the total value delivered to the customer is far less easily duplicated by competitors. As companies like 3M and Hewlett-Packard have shown, a value-based strategy can be a uniquely effective way to gain, over time, a commanding lead over the competition. Recognizing this, a number of industrial manufacturers have recently been experimenting with a new method of analyzing their

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products' economic value to the customer (EVC). Through market segmentation, new-product development and pricing based on EVC analysis, they have gained significant improvements both in margins and in market position. In this article we shall explain the concept of EVC, describe how it is calculated and show how it is used. The basic concept In its simplest sense, EVC may be defined as the relative value a given product offers to a specific customer in a particular application - that is, the maximum amount a customer should be willing to pay, assuming that he is fully informed about the product and the offerings of competitors. This will normally correspond to the purchase price ofthe product he is currently using, plus (or minus) any value difference between that product and the product whose EVC is at issue. Consider Exhibit I. The bar on the left represents the full cost to the customer ("life-cycle cost") of the "reference product" - the product the customer will use as his yardstick of cost and value in his particular application. Life-cycle cost is composed of the product's purchase price, plus its start-up costs, plus all the post-purchase costs associated with it. (See the ruled insert on pages 44-45 for the calculation formula and definitions of terms.) Comparing the life-cycle costs of "our" product, represented by the right-hand bar, we see that its start-up costs and post-purchase costs are each SlOO less than those of the reference product. Moreover, it offers the customer greater value, in this case amounting to an estimated SlOO. (This "incremental value" might, for example, be derived from extra product features providing greater functional utility.) Considering that the customer is willing to pay S300 for the reference product, he should thus be prepared, in principle, to pay up to S600 for "our" product - that same $300 plus the S200 savings he gets with "our" product, plus the 5100 worth of incremental value it offers. "Our" product's EVC, then, is S600. All this, so far, is from the customer's viewpoint. Now consider that same EVC from the supplier's ("our") viewpoint. As the third bar shows, it costs " u s " S300 to make the product.* Any price in excess of S300 that we charge for "our" product will therefore return a "profit" (contribution to fixed costs). Any price under
* For simplicity's sake, only variable costs are considered here. The argument is not affected.

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Exhibit I The EVC concept

Customer's economics Supplier's economics Pricing to share benefits

Incremental^' value T Life-cycle cost

$1,100

$600

$300
Customer inducement Supplier's competitive advantage

$1,000

Purchase
price EVC

Supplier's profit ^ Selling price $475

Start-up costs

$300; Supplier's cost

Post-purchase costs (maintenance and operations)

Reference product y

Supplier's product X

$600 will give the customer a better deal than he can get from the reference product. Let us call the S300 range bracketed by these two limits the supplier's competitive advantage. The bar at the extreme right depicts a possible pricing decision. Setting the purchase price at $475 would give us, the supplier, a $175 "profit," or contribution margin, while offering the customer an economic advantage of $125 over the reference product. We call this last amount the customer inducement. Obviously, if a product is marketed to several different types of customers, and/or has a variety of applications, it is likely to have a different EVC for each customer group and each application.

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EVC analysis highlights these differences and shows why, and by how much, the same product may be more highly valued by some customers than by others. The insights it yields can form the basis for new and powerful product-market strategies. The choice of the reference product in terms of which EVC is defined and calculated is obviously of critical importance. To persuade a given customer to switch to his product on the basis of its superior EVC, a manufacturer must base his analysis on the same reference product that the customer will use, explicitly or implicitly, as the basis for his own evaluation. This need not be a physically similar product: the customer, after all, is not interested in acquiring hardware but in performing a function or meeting a need, and any product that fulfills that function or need may, for him, serve as the reference product. In the case of any manufacturer whose customers are under attack from an aggressive competitor, the identity of the reference product is obvious. In a relatively stable competitive situation, however, it will usually be necessary to calculate EVC against each competitive product whose customers the company is trying to win away. EVC analysis is particularly revealing when the product is one that delivers a stream of value or benefits over time; when sales effort, delivery reliability or similar intangibles add substantial value to the total product "package;" or when the purchase price represents only a portion ofthe product's overall ("lifetime") costs to the customer. In particular, customers who have habitually based their buying decisions primarily on purchase price present a prime sales target to the manufacturer who can convincingly claim a higher value for his product based on life-cycle costs. EVC in action Consider an example. Splicing couplers are simple devices used by cable TV companies for coupling home transmission wires without expensive soldering. They sell in bulk for roughly a penny apiece and they used to cost about 3 cents each to install. In 1975, when our story begins, a company we'll call Achilles Fasteners dominated the market for individual couplers with a 50 percent share, more than double that of any of its competitors. Then one of those competitors. Hector Electric, introduced a new line of couplers, together with a special tool that could hold and

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attach as many as 16 of them at once. Although this multicoupler tool was costly, the new system cut user labor costs substantially. Customer response was such that Hector Electric was hard put to it to expand production capacity fast enough. As its market share started to slip, Achilles Fasteners moved to protect its dominant position. Within six months it had developed and introduced a similar multicoupler system of its own with an added feature, not offered by Hector Electric, which simplified testing of the finished coupling. It priced its tool higher than Hector's to reflect the superior feature; priced the couplers low, for an overall price advantage; and concentrated its sales efforts on regaining lost accounts. At the same time, to regain its product leadership, Achilles invested heavily in research aimed at further differentiating its multicoupler system from Hector's. Eighteen months later, however, the situation had still not improved and management was demanding to know why. How significant was price in the buying decision? Were there sufficient opportunities for product differentiation to justify heavy R&D spending? Were the sales efforts focused correctly? What was Achilles' relative cost position? EVC analysis began to point to some answers. Exhibit II overleaf illustrates the favorable customer economics of Hector's product compared to the traditional connector. To begin with. Hector Electric had created a huge EVC of 42 cents per 16 couplings with its multicoupler and had priced it to give the customer 18 cents of the EVC while keeping 24 cents to cover its costs and generate profits. As a result, multicouplers were expected to increase their penetration of the total coupler market from 20 percent to nearly 70 percent over the next five years. Recognizing this potential. Hector had concentrated on persuading customers to convert to the multicoupler system. Having priced its tool lower so as to gain entry, it could price its couplers at a premium for higher profitability and still provide Achilles' customers with a potent inducement to switch. As noted already, Achilles had sought to win back its lost accounts and stymie the competitor's growth by persuading those customers to switch back to its own multicoupler system. But this strategy was futile, since - as Exhibit II shows - Achilles was offering only a 4-cent inducement to the customer. While the payback period for converting from individual couplers to multicouplers was only five

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Exhibit II Competition in couplers

Strong challenge

Cost to customer of 16 conriections

64c*

Price (1CX16)

Customer inducement 460:*

EVC=42it

Price (1.5CX16) Labor Tool purchase and set-up Labor

Achilles' individual couplers (reference product) Ineffective response

Hector's multi coupler (new product)

Cost to customer of 16 connections

Achilles' competitive advantage

26c

Customer inducement 4c

1
J

1
Profit
2(D

..,.42C* Price 220: (1.375a: X16)

Price (1.5X16)

EVC 20

Achilles' cost

Tool purchase and set-up Labor

Hector's multiCDupler (reference product)

Achilles' multicoupler (new product)

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months, the payback period for shifting from Hector's multicoupler system to Achilles' was more than two years because ofthe required investment in high-cost tools and workforce retraining, and the very low customer inducement. Achilles could not drop the price in order to increase customer inducement without seriously cutting into its already slim profit margin. Moreover, it appeared that the added feature of testing the connection had not given Achilles' system the hoped-for competitive edge: customers perceived both brands of multicoupler tools at parity. Even more significantly, however, the key purchasing decision makers had changed with the introduction of multicouplers. Price-minded engineers had once been the key purchasers. Now foremen, who cared more about service performance, had a greater voice in the buying decision. Hector had realized this and modified its selling message accordingly. Achilles' salesmen, however, were still concentrating on the headquarters staff and pushing life-cycle costs, in which their product had a slight advantage. In the wake of EVC analysis, Achilles' basic strategy was reformulated. The new objective: to convert users of individual couplers to its own multicoupler system through an inducement of 20 cents and thus preempt Hector. The salesforce was doubled and sales efforts were redirected to reach the foreman. Development efforts were shifted from coupler research to reducing the initial cost ofthe tool, so that the competitive advantage could be expanded. The results were dramatic. Sales productivity actually tripled, the R&D budget could be reduced by 50 percent, and overall financial performance improved from a minus 20 percent to a plus 30 percent return on investment. Developing value-based strategies Over time, perhaps, Achilles Fasteners might have been able to fight off the challenge from Hector in much the same way without the benefit of EVC analysis. But it would not, in all probability, have gained the necessary insights early enough to do so before it had suffered a serious loss of competitive position. The analysis helped Achilles to concentrate on opportunities in market segments where it could offer a high customer inducement rather than expending resources on a foredoomed effort to win aw^y customers from Hector on its own ground. The virtue of EVC analysis is that it provides a uniquely fast, focused and reliable way to identify successful value-based product-market strategies.

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To develop and apply an EVC-based strategy requires, at the outset, determining the product's EVC(s) against the relevant reference product(s). Variations in EVC from customer to customer arising from the different ways they use the product become the hasis for segmenting the market and looking for ways to expand the company's competitive advantage in each segment. The product can then be priced to provide adequate profit and a strategy developed to maintain the advantage as competitors inevitably try to play "catch-up" to the customer. Let us take each of these steps in turn. Segmenting the market Significant differences in EVC arise from the ways in which customers use and derive value from their respective reference products. These differences result from differences in post-purchase costs and/or incremental value, which in turn usually result from distinctive characteristics ofthe customer and/or the application. For example, the EVC of a minicomputer will differ against each of its possible reference products, including other minicomputers, microcomputers, mainframe computers, or manual performance of the task. It will differ by application as well. Will the device be used for production-line control, distributed processing, energy savings, word processing? In each application its value will be different. Finally, even if the reference product and the application are the same, the EVC may vary with the characteristics ofthe customer. For the small customer who has just decided to automate his accounts receivable work, the reference "product" is the cost of labor and manual procedures, and the supplier may have to study the customer's operations in detail to accumulate the information needed to justify the equipment. In a division of a large multinational, on the other hand, the reference product may be a timesharing service or a competing minicomputer small-business system, and the evaluation would have to include a comparison of equipment as well as a study of operating procedures. Beyond this, the two customers may well value the minicomputer differently because their requirements with respect to intensity of usage or operating reliability differ. The value of functional features and other product-package attributes often differs in unexpected ways between different customer groups. Quantifying the variations in incremental value, and hence in EVC, from one market segment to another may require

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extensive field interviews. The focus of the search at this point will be not so much on differences in up-front costs as on characteristics of the customer or the application that account for the differences in post-purchase costs or incremental value. The critical variables which account for these differences are usually situation-specific, but a few have repeatedly turned out to be significant: ^ Intensity of product usage. Post-purchase costs sometimes differ sharply between heavy and light users. For example, a front-end loader will probably have greater value to a customer who uses it eight hours a day in a mining operation than to one who uses it four hours a day on a construction site. H Geographical scope of usage. A local contractor using earthmoving equipment may be less concerned about reliability and downtime than a multinational company with extensive operations in the Third World. \\ Growth in the customer's business. Fast-growing customers may be especially receptive to a new product that can cut their operating costs, while slow-growing customers may be quite content with their present equipment and be unwilling to invest in new technology. Sorting out customers by growth rates may also highlight market segments that are particularly receptive to new technology. Persuading the low-growth customer to replace an installed equipment base might require a product with superior performance specifications. ^ Nature of the application. Seemingly identical products may differ in EVC depending on how they are used by the customer. For example, a manufacturer of off-highway vehicles found that its product's start-up costs and overall life-cycle costs put it at a disadvantage against a powerful competitor. But while the competitor's vehicles cost less to operate at cruising speed with a light or moderate load, this company's vehicles did have a cost advantage in high-tonnage, slow-speed applications. Management redirected its sales strategy at customers who used the vehicle for short hauls - e.g., in open-pit mining operations. Expanding competitive advantage Having identified the variables underlying significant EVC variations between customers and segmented the market accordingly, the company will next assess the opportunities to expand its product's competitive advantage (defined as the difference between

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Calculating EVC The economic value to the customer (EVC) of a given product x, as defined in this article, is calculated by subtracting its start-up costs (SC) and its post-purchase costs (PPC) from the life-cycle costs (LC) of a reference product j , then adding the amount of incremental value (IV) it offers relative to the reference product. As a formula:

Thus, substituting the figures from the example shown in Exhibit I:

The italicized terms may be defined as follows: Reference product. In principle, any product that is either accomplishing the same function or meeting the same need as the product whose EVC is to be calculated. In practice, the reference product will normally be the (competing) product that the customer is currently using. Life-cycle cost. The sum of a product's purchase price, start-up costs and post-purchase costs (see below). Purchase price. The total amount paid by the customer to the supplier. Over and above the product price this may include freight, insurance, engineering, installation charges, and initial technical training provided by the supplier and charged to the customer. The capital portion of the price may be eligible for the investment tax credit, reducing the net price.

EVC and manufacturer's cost) in each segment. This may be done by redesigning the product to reduce the life-cycle cost or to alter the ratio of the customer's front-end costs to his post-purchase costs. Additionally or alternatively, competitive advantages may he expanded by improving the product's functional performance or by increasing its incremental value through changes of a nonfunctional nature. Let us take these three possibilities in turn: 1. Reduce the life-cycle cost or alter the cost mix. Customers are often willing to pay a considerably higher initial price for a product with significantly lower post-purchase costs. Manufacturers of carbide tools, for example, have been able to command a premium because

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Start-up costs. Initial costs not included in the purchase price - i.e., costs absorbed by the customer or paid to a different supplier. In addition to any of the items mentioned above that are not provided and charged to the customer by the product manufacturer, these include the cost of modifications to the customer's existing system, such as the costs of space, power and air-conditioning required to accommodate the product; lost production (downtime) while the system is being modified or the product is being installed; and initial technical training provided by the customer. Some portion of these costs may normally be eligible for the investment tax credit. Post-purchase costs. Ongoing costs borne by the customer once the product is in use. These costs (which are often not fully evaluated at the time of purchase) may include maintenance and repair, continued technical training and provision of reserve or back-up capacity; financerelated costs, such as depreciation tax shield, interest charges on capital and federal taxes attributable to changes in the asset base and/or increased revenues; and operating costs, including labor, raw materials, power consumption, scrap rates, inventory costs and space requirements associated with the product's use. Post-purchase costs are generally calculated over the product's useful life and then discounted back to arrive at their present value. If the products to be compared have different useful lives, these should be adjusted to provide a consistent basis for the comparison. Incremental value. The amount by which the product's potential dollar value to the customer exceeds that available from the reference product. Incremental value may derive from physical features of the product or from other attributes ofthe total "package," such as delivery reliability, service responsiveness and even brand name.

the substantially longer life of their tools effectively reduces the downtime of a customer's production line and permits more stampings per tool. In the wake ofthe phenomenal increase in fuel costs in the mid-1970s, many suppliers have designed and successfully marketed energy-efficient products with higher initial but lower operating costs. Through product design, a supplier could absorb part of his customer's value-added into his own product, thus providing higher EVC. For example, operating costs can be cut by reducing raw material costs, reducing the total labor content, or reducing the ratio of skilled to unskilled labor. Of course, such changes may in turn affect power consumption, scrap rates, inventory costs and space requirements.

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Often an important way to expand competitive advantage through differentiated product design centers on the tradeoff between the product's purchase price and its post-purchase costs. Even at the expense of higher post-purchase costs, some customers are likely to favor the product with low front-end costs (purchase price plus start-up costs) if their capital funds are constrained, if they are uncertain of the product's value, or if demand for their end product is highly uncertain. A manager caught in a capital budgeting crunch, or one whose performance will be rated primarily on his use of assets, may likewise choose to pay higher post-purchase costs out of yearly revenues rather than increase his investment base. Customers of both types - those who are sensitive to life-cycle costs as well as those who are primarily looking for a lower purchase price-may be found in the same industry. When buying distribution transformers, for example, large investor-owned private utilities focus on the operating losses of the transformers and generally base their buying decision on the life-cycle cost of the product and a formal evaluation of vendors' delivery reliability, sales effort, product reliability, and so on. On the other hand, some larger utilities and most municipalities and rural electric cooperatives focus primarily on the purchase price of the transformers without considering the operating-cost differences, which could amount to twice the purchase price over the product's lifetime. Transformer manufacturers have responded with a higher-priced, lower-operating-cost product for the large privately owned utilities and a product with the converse characteristics for their other customers. 2. Expand incremental value by functional redesign. Functional features, physically built into the product, may contribute to its incremental value - that is, make the new product more desirable to the customer than the reference product - in various ways: t They may increase the user's production capacity or throughput. For example, a new type of telephone multiplexer supplied by a manufacturer may permit transmission of many more messages, increasing the telephone company's revenues. II They may enable the user to improve the quality or reliability of his end product, thus permitting him to charge his customers a higher price. For example, components incorporated in nuclear or space exploration systems generally command a premium. Similarly, highly reliable components have a special value to electric utilities and steel mills, because of the high cost of maintaining reserve capacity to protect against equipment failures.

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f They may enhance end-product flexibility. For example, a golf-ball typewriter offers the user the convenience of readily changeable type styles. Other products may be designed to accommodate future technologies with minimum modification - e.g., a boiler that can burn either gas, oil or coal, reducing the customer's risk that his investment will be made obsolete. ^ They may add functions or permit added applications. For example, a word-processing computer replacing a memory typewriter can also be used for payroll or accounts-receivable applications. Or a farm tractor might be designed to double as a snowplow. One powerful use of the EVC approach is in low-growth industries or replacement markets where, as product sales reach maturity or begin to decline, the product life cycle may be rejuvenated through product line extensions. The EVC analysis familiarizes a supplier with the cost structure of his customers and thus allows him to concentrate his product development in areas that will have the highest value to the customer. 3. Expand incremental value by eapitalizing on associated intangibles. Physical redesign of a product, of course, is not the only way to expand competitive advantage. Other attributes ofthe product "package," such as delivery arrangements, technical help, or special financing terms, may serve the same purpose. For example, a maker of heavy roadbuilding equipment might choose to gain a competitive advantage among smaller road-building contractors by providing strong local service and financing arrangements which they would value more than superior features. Beyond this, customers may be willing to pay considerably more for one or two otherwise equivalent competing products hecause of associated intangible or psychological values, such as prestige, brand name, product aesthetics, or satisfaction of personal or social needs. Such intangibles are normally much more important in consumer products: watches, automobiles, cosmetics and sports equipment all exhibit larger EVC differences between market segments than do industrial products such as drill presses or photocopiers. But skilled industrial marketers can often identify and exploit such opportunities as well. For example, an industrial buyer may be prepared to pay more for a brand-name product with no advantage in performance or reliability, simply to ensure that he won't be blamed

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for false economy if the product should fail to perform in an important application. The reputation for service and reliability associated with the brand names of GE or IBM, for example, often gives these companies a real competitive edge. Pricing to share the benefits With the market appropriately segmented and the product designed and positioned to maximize its competitive advantage in each target segment, the supplier must now set the price. In apportioning the competitive advantage between himself and the customer, he cannot simply aim to maximize his profit; he must give the customer sufficient inducement to switch. In theory, the customer stands to benefit from any price that is below the product's EVC. In practice, it will take more than a marginal inducement to make him switch. Customer resistance, or inertia, can arise from various sources: uncertainty about the product's benefits; reluctance to change suppliers; concern over the length of the payback necessary to justify its purchase; or reluctance to assume the risks of being the pioneer user. In any case, customer inertia may well differ from one segment to the next, and the threshold inducement will vary accordingly. Indeed, many EVC-based strategies are founded on astute customer-market segmentation. Successful segment pricing requires a thorough segment-by-segment analysis of EVC and an understanding of how the threshold customer inducement differs from segment to segment. Rather than trying to serve the whole market at once, many manufacturers choose to pinpoint the customers for whom their product can provide a high EVC and a large inducement. Often manufacturers will sequence the introduction of a product in various segments so as to maximize their financial benefit. For example, a manufacturer planning to introduce a new high-speed material transfer line may, to begin with, target his marketing effort on customers with three-shift factories where his equipment will have the highest utilization and EVC and can command the highest price. Next, he may develop models appropriate for two-shift shops, where EVC - and hence the appropriate selling price - may be lower. Such careful segmentation, of course, permits the manufacturer to limit the number of customers offered the necessary introductory bargain price. Because the concept of EVC takes life-cycle cost into account, it is helpful in pricing products that tie the customer to the supplier's

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technology, obliging him to continue buying parts and supplies from the same source. A supplier may follow the example of Hector Electric by pricing the basic product low to achieve penetration and post-purchase items at a premium to assure overall profitability. If he sells to original equipment manufacturers (OEMs), he may develop and price his product to penetrate the OEM market, but derive the bulk of his profits from post-purchase sales to the end users. Manufacturers of aviation lighting equipment, for example, penetrate the OEM market (aircraft manufacturers) through price and quality competition. They make most of their profits, however, from selling replacement units to the airlines that purchase the planes and are thus tied into a particular manufacturer's technology. A supplier of industrial components may not, of course, be able to expand his volume by increasing the customer inducement if his customers cannot expand their sales of the end product to consumers. In that case, a marketing strategy built on quality rather than price would be indicated. In calculating EVC and using it for pricing, then, it is always important to identify the customer and the intended source of profits. But since the customer may be unable or unwilling to evaluate the product's value and life-cycle costs, a coherent communication strategy is vitally important. Communicating EVC to customers Once the manufacturer has segmented the market and developed and priced his product, he must reach the customer and convince him of the product's value. When the product is priced at a premium but offers lower life-cycle cost, EVC analysis can be useful in developing a sales strategy to focus the sales message and shift the customer's attention from purchase price to the life-cycle advantage. For example, the manufacturers of minicomputers used for energy conversion and monitoring of large buildings emphasize in their selling message that their products, despite high initial cost, make possible substantial reductions in fuel and operating costs and hence a quick payback. Similarly, lighting manufacturers have developed computer time-sharing programs to demonstrate to their utility customers that, despite higher initial costs, mercury vapor lighting saves energy over sodium lamps. Sales engineers then quantify the savings likely to be realized from tbe lower power-

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generating capacity required as a result of eflicient mercury lighting. In large customer organizations there may he several purchasing decision makers at different levels, each using different criteria to evaluate the product. In such cases, sales efforts must be carefully targeted to reach each category of decision maker, and sales messages must focus on their respective buying criteria. It takes a well-trained salesforce, in close and continuous touch with key customers, to use EVC effectively. Besides educating the customer, the salesman must understand how he derives value from the product and channel this knowledge back to R&D. Yet the value customers perceive in a given product depends so heavily on the way they evaluate it (and the reference products) against the performance requirements and economics of their application that management ought to be keenly concerned about how well and thoroughly these evaluations are made. As a rule, makers of smaller industrial products don't keep in very close touch with the customer's evaluation process. Yet most managers of value-based businesses regard close customer relations as their first priority especially if the product reaches the customers through independent distributors. Sustaining competitive advantage The differentiated product of today naturally tends to become the commodity product of tomorrow. Sooner or later competitors catch up in their design efforts, bring out "me-too" products and start cutting prices to "buy" market share. If a supplier has slowed the pace of his product development and his customers have built tbe necessary purchasing and evaluation capability, he may find himself in real trouble. To succeed in a value-based business, it is necessary to find ways of increasing customer inducement over time. With a pricing strategy that provides enough volume to accumulate experience and reduce costs yet still generates acceptable profits, a manufacturer can reinvest in product development so as to keep expanding EVC. Successful companies in the advanced electronic component market bave fully understood this requirement. Intel, for example, has constantly expanded its EVC, staying well ahead of both its competitors and its customers by progressively incorporating more software functions into its microprocessors.

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In low-growth industries or in replacement markets, an equipment manufacturer may be able to rejuvenate a mature product line by extending it or introducing new products that render the customer's installed equipment base obsolete. For example, telephone switching equipment based on new technology, which can provide important incremental value, is being used to displace equipment based on the older technology. Unless a business is content to revert to a cost-based strategy, then, it must gear itself to maintaining a steady flow of progressively higher-value products. But this can be very difficult. Major technological innovations can't always he programmed; and in the intervals between them, customers are still looking for increases in value. Accordingly, to bridge the gaps between product programs, companies often seek to increase customer inducement by improving intangible values: better financing terms to help the customer through a cash crunch, for example, or more extensive service to maintain the installed base or to provide better coverage in remote areas. Managing the transition Companies embarking on the transition from cost- to value-based strategies should be prepared to overcome a certain amount of footdragging by the functional units of the organization. Often a company finds it easier to convince customers to switch than to persuade its own people to change their habits. Managers who by training and instinct have always focused on product costs often find the shift to a value-oriented strategy hard to stomach. One company had trouble training its salesmen to help customers understand the value of the product in their particular applications. The salesmen were thoroughly conditioned to sell on price alone. Some managers find it psychologically difficult to maintain a value-based perspective month in and month out, simply because of the altered nature of the information they must have in order to manage. One company stumbled over the shift because its cost accounting and measurement system reported unit-cost trends without reference to value delivered. Even when value data are available, managers may be reluctant to use them. Cost data are (or at least have the appearance of being) precise, "hard" and concrete. Moreover, they normally appear at regular intervals. Value data, on the other hand, are typically "soft" - that is, not precisely quantified, highly dependent on

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customers' internal procedures, and often only partial, since the internal engineering studies used to evaluate new equipment are not always completed. Accordingly, the business manager has to renounce total reliance on financial reports and, to some degree, learn to live with ambiguity. Once the transition is accomplished, moreover, the manager of a value-based business must work to maintain a wide enough margin between value and cost. The wider the margin between the EVC and the manufacturer's costs, the greater the chance of a sustainable competitive advantage. Hence, cost is a priority for the business manager - not always the lowest costs, but low enough to maintain the margin to provide both adequate customer inducement and adequate profits to finance the necessary investments in R&D, facilities and training. Companies that have successfully made the transition are usually surprised, when looking back, to note how many changes in functions, procedures and reports were necessary to accomplish the shift. A typical reaction: "We thought it was just a change of marketing signals. It's turned out to be more like a new way of life." Concluding note The EVC concept has emerged as a useful and frequently powerful aid in the quest for strategic advantage. Its practical application, as we have seen, is straightforward, but its management implications run deeper. As a customer-oriented approach to viewing the market or designing a product line, the EVC concept is most effective when it is understood and supported throughout the company, from R&D to the salesforce. An organization-wide commitment to EVC will foster the creative market segmentation that yields real strategic advantages; it can strengthen the company's image as a provider of superior products; and it may well help to put the company in a commanding competitive position.

John Forbis is a Principal and Nitin Mehta an Associate, both in the Cleveland office. This article is reprinted by special permission from the June issue of Business Horizons. Copyright 1981 by the Foundation for the School of Business located at Indiana Universitv.
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