Choosing The Customer - HBR Article

Why Select The Customers You Want to Serve?

All companies claim that their strategies are customer driven

but many times they do not know / define who exactly is their “customer”

Customers are the people or businesses who buy what you sell and give you revenue. By that definition, end-consumers, wholesalers, re­tailers, purchasing departments …all become your customers. Sometimes a customer need not even give you revenue directly.

In the Pharma business, the most important customers are not the patients but the physicians who prescribe them. But Merck has chosen research scientists in labs and universities around the world as its primary customer. Accordingly, its business model re­lies on encouraging its own world-class researchers to act like university scientists by conducting basic research, publishing papers, and presenting results at conferences, all with the intent of discovering ground­breaking compounds that can then be com­mercialized by Merck’s marketing and sales group. The business is even configured like a research university— a simple functional structure in which a powerful, centralized R&D unit receives the bulk of organizational resources.

But most executives are reluctant to define their customers as narrowly as Merck has. By not singling out any group as the primary customer, ex­ecutives can sidestep difficult choices that might turn out badly – a temptation that’s particularly strong in new, rapidly evolving markets. What’s more, many business leaders believe that treating all value chain partners as customers improves internal coordina­tion and responsiveness.

But by not identifying a primary customer, companies run into problems. Consider Yahoo and Google.

Yahoo began as a broad-based internet portal supported by proprietary editorial content. To attract users, it hired journalists to write entertainment stories and created utilities such as Yahoo finance, Yahoo mov­ies, and Yahoo sports. Over time, Yahoo executives began to spread resources among many additional initiatives, including social networks, products, media, and advertising. As a result, they underinvested in search, and the website became messy and confusing.

Then Google entered the field. From the outset, Google focused on users who appreciated technology and its ability to unlock new opportunities and appli­cations. Like Merck, Google allocated the lion’s share of its resources (and prestige) to its technologists and engineers, who were given freedom to innovate. The aim throughout the business was to build the best technology in the world—whether in search, Android, or maps. With that sharply focused value proposi­tion and business model, Google quickly leapfrogged Yahoo in the competitive marketplace.

The bottom line is this: The strategic choice of primary customer—with special emphasis on “pri­mary”—defines the business.

This is certainly true at Amazon, which serves four very different types of customer: consumers, sellers, enterprises, and con­tent providers. You might think that it considers all four customer groups to be equally important. But the company’s choice of primary customer is re­flected clearly in its well-known mission “to be the world’s most consumer-centric company.” Amazon devotes maximum resources to pleasing consum­ers, even if that means sellers or content providers sometimes feel shortchanged (sellers whose store­fronts are hosted on the Amazon platform have been known to sue Amazon for more resources).

This un­wavering focus on consumers has created innova­tions such as prime free shipping, detailed product reviews (including negative ones), look-inside-this-book, and the listing of lower-priced products from off-site competitors. These practices have often been criticized as inherently unprofitable or injurious to Amazon’s other constituents. But the main results of the company’s choice are the ones that count most: unparalleled customer loyalty and stratospheric stock valuations.

Here we present a truly cus­tomer-driven framework that can help executives build winning business models for their companies . The framework lays out four steps (1) Identifying the best primary customer for your business (2) Creating processes to learn what that customer values (3) Allo­cating resources accordingly (4) Building an inter­active control process to monitor the assumptions that underlie your choice.

Step 1 : Identify Your Primary Customer

As the cases of Merck, Google, and Amazon illus­trate, your most important customers are not those that generate the most revenue but those that can unlock the most value in your business. For some businesses, the primary customer will be the end user or consumer of the product or service. For oth­ers, an intermediary (such as a reseller or a broker) will be the critical customer to which organizational resources should be devoted.

But how can executives be confident that they’re making the right choice? Identifying the best pri­mary customer for your firm involves assessing each group of customers along three dimensions: perspective, capabilities, and profit potential. Let’s look briefly at each.

Perspective refers to the culture of a business, often revealed in stories about important events or people in the company’s history. It is the lens through which executives consider op­portunities and strategic direction. Steve Jobs’s ob­session with perfection in product design creates a leans which will decide which opportunities Apple manag­ers will consider and which they will not. Walmart’s Sam Wal­ton was famously frugal in his own life. And Amazon founder Jeff Bezos is a zealot about delivering a su­perior experience to shoppers. “When [executives of other companies] are in the shower in the morning, they’re thinking about how they’re going to get ahead of one of their top competitors,” he told Fortune in 2012. “Here in the shower, we’re thinking about how we are going to invent something on behalf of a customer.” Clearly, the choice of primary customer must reflect a company’s perspective; otherwise the company will be unable to leverage the energy and creativity of its people in service to the customer.

 Capabilities  refers to the embedded resources of the firm. Some firms excel at technology (Apple, Google, Airbus), some at logistics (Walmart, Ama­zon, Dell). Others provide superior brand market­ing (Ralph Lauren, Nestlé, P&G) or have industry-specific capabilities (original content production at HBO and Netflix, mining at BPH Billiton). Such capabilities, which are built up over time and are of­ten difficult to copy, position a business to serve the needs of certain customers better than others. Dell in its early years built a formidable low-cost logistics operation to support its direct-to-consumer sales model. Today, the company is attempting to change its primary customer by refocusing on CIOs of large enterprises. This pivot has proved difficult for Dell because CIOs look for a set of capabilities—inte­grated hardware, software, and services solutions—very different from what end consumers need.

Profit potential refers to a customer’s ability to deliver profits. Techniques such as Michael Porter’s five forces analysis can provide insight into the rela­tive profitability of various customer types—and help weed out those that would be a poor choice for primary customer. Consider HBO. Cable opera­tors that purchase HBO’s content might seem to be the obvious choice. But cable operators have low switching costs—they can easily buy content from a variety of producers. Thus HBO would have little market power and would be unable to extract high margins from cable operators. But by targeting film­makers as the primary customer and devoting sig­nificant resources to their needs, HBO can create the unique products that viewers demand, allowing it to charge premium prices that cable operators can­not negotiate. Of course, profit potential isn’t always about customers who can pay premium prices; be­coming the preferred destination for cost-conscious customers can deliver substantial profits through volume, as Walmart has demonstrated.

LinkedIn is one successful company whose pri­mary customer clearly fits all three dimensions. For more on how it settled on individuals (rather than job recruiters or advertisers), see the exhibit “How LinkedIn Chose Its Primary Customer.”

Step 2 : Understand What Your Primary Customer Values

Once you’ve determined who your primary customer is, the next step is to identify which product and ser­vice attributes the customer values. Within the same market and industry, different primary customers ( different buyer personas) (different customer segments) may value different things: Some demand the low­est possible price, others want a dedicated service relationship, and still others are looking for the best technology or brand or other specific attribute. To complicate matters, customers often don’t know ex­actly what do they value.

Uncovering the full truth about their needs requires systematic research at multiple levels.

Let’s take the easy part first. Assume you have already chosen the best primary customer and have a good working idea of what the customer wants. There’s still plenty of room for improvement. You can refine your understanding by leveraging today’s easy and cheap access to data on customer buying habits, preferences, and search activities. Data analytics is an important tool in uncovering and rapidly respond­ing to changing customer needs. At Google, separate analytics teams for display, search, and maps spend untold hours in their labs with customers studying eye movement and other variables to gauge their reactions to subtle product modifications such as changes in color. Nestlé has a war room where ana­lysts monitor social media to track chatter that relates to or affects the acceptance of its products. The ana­lysts use the intelligence to inform product research and marketing decisions and to evaluate in real time how well their value propositions are meeting the needs of the primary customer. Such data can help you fine-tune a product or a website’s functionality to better meet your custom­er’s known needs.

They’re unlikely, though, to help you identify what your customers want but aren’t getting. For that, you need to actually ask them. Smart companies set up systematic dialogues with their primary customers. Managers at FedEx, for ex­ample, hold twice-yearly summits where they bring in a sampling of business customers (the firm’s pri­mary customer) to ask them where FedEx is doing a good job of meeting their needs and where com­petitors are doing better. At Germany’s Henkel, the world’s leader in adhesives, CEO Kasper Rorsted has created a “tops to tops” program in which all executives are required to meet regularly with their counterparts at major customers to ensure that their needs are understood and the company is respond­ing appropriately. Other companies, especially those with rapid product cycles, manage the dialogue through new-product testing. Google’s Gmail, for example, was released after five years of beta testing by more than 1,000 technology opinion leaders.

Finally, you should set up processes for identi­fying products or services that customers may not know they need. This can be challenging—and ex­pensive. Smart companies typically rely on ethno­graphic methods. At P&G, for instance, where con­sumers are the primary customer, executives ask their managers and market researchers to spend days at a time accompanying consumers on shopping trips and sitting at the family dinner table to more fully un­derstand the extent to which various products meet consumer needs. CEO A.G. Lafley recounts in his book The Game Changer how the experiences of P&G executives living with lower-middle-class families in Mexico City produced Downy Single Rinse, a fabric softener that is simpler to use for markets where wa­ter is in short supply.

Most companies assume that their products and services meet the needs of their customers. But sur­prisingly few actually test this assumption. So ask yourself, What are the processes we use to make sure that we truly understand what our customers value and that we can deliver value better than our com­petitors do?

Step 3 Allocate Resources to Win

As we saw with Merck and Amazon, your choice of primary customer and your understanding of what the customer values provide all the information you need to make the critically important decision of how to organize your company’s resources—in other words, what kind of business model to adopt. There are five basic configurations you can choose from.

1. Low price. If your primary customer is looking for the lowest possible price, centralized operating functions (such as merchandising and distribution) should receive the bulk of organizational resources, in order to create economies of scale and scope. Customer-facing units, such as stores or restaurants, should receive relatively few resources. This is the configuration used by Walmart.
2. Local value creation. If your customer values products and services that are customized to local tastes, preferences, and regulations, you should or­ganize like Nestlé. It pushes resources out to regions so that local managers can customize product offer­ings, while operating core functions are limited to corporate-level support activities.
3. Global standard of excellence. If your cus­tomers are looking for the best possible technol­ogy or brand no matter where they are located, you should organize resources around global business units that are defined by product lines. This configu­ration allows focus and leverage in R&D, brand mar­keting, and distribution. Microsoft, for example, has separate business units for Windows, servers, MSN, mobile, and Xbox. Each unit has full revenue and profit responsibility and its own R&D. (Note: Micro­soft has recently announced that it intends to change its structure to more of an expert knowledge organi­zation—described below—to emulate Google.)
4. Dedicated service relationship. If your cus­tomer is looking for an ongoing, deeply embedded service relationship, you should organize like IBM. Customer teams in industry-based “verticals” mar­shal and coordinate product and service delivery from centralized, product-based “horizontal” units.
5. Expert knowledge. Finally, if your primary customer is looking for expert technical knowledge, you should follow the example of Google and Merck, where R&D sits prominently on top of product or­ganizations that receive the lion’s share of the com­pany’s attention and resources, with other functions playing a supporting role. These R&D-led product units, which may be distributed in centers around the world, have no revenue responsibility: They are focused entirely on product development and on creating breakthrough technology. All sales revenue is routed through a centralized, stand-alone sales di­vision that is configured as a distinct function.

Of course, various permutations and combina­tions of these five basic configurations are possible. Many companies will want to leverage the advan­tages of several models at once. Some companies experiment with matrix structures that can simulta­neously emphasize, say, geography and function or business unit and region. This “split the difference” approach can be appealing if, for example, you are an engineering company like ABB and your primary cus­tomer is government purchasers that demand both the best technical features (global standard of excel­lence) and customized content (local value creation). But it should be noted that matrix organizations are notoriously difficult to manage; all too often, a matrix structure reflects an inherent confusion about who the primary customer is rather than an effective re­sponse to the customer’s needs and preferences.

As a general proposition, when a business finds that it has more than one primary customer, it should be split into separate units and adopt for each the configuration that best allows it to focus re­sources on the needs of its primary customer (“the rule of one”). At Nestlé, for example, although most of the business is structured using a local value con­figuration, the company’s strategy differs for two of its brands: Nespresso and Mövenpick. Customers want a consistent, premium experience from those brands regardless of location. Accordingly, those businesses are managed using a global standard of excellence configuration in which resources are cen­tralized and managed globally.

In reviewing a business model, the key ques­tion executives should ask is this: Do the choices we have made about the company’s structure reflect our choice of primary customer? If the answer is no, competitors whose business models are consistent with their chosen primary customer will almost cer­tainly be outplaying you.

Step 4 Make the Control Process Interactive

As good as your business model may be today, it can­not and will not survive forever. Customer tastes will change, new technologies will replace old, unfore­seen competitors will enter the market, and regula­tions and population demographics will evolve over time. That means you must constantly gather infor­mation on shifts in your competitive environment, especially those that might affect the criteria and behavior of your primary customer. You must be alert to emerg­ing threats and opportunities that will redefine what your customer values and that customer’s profit po­tential. If the changes are dramatic, you may need to fundamentally reorient your business model—and even, in the most radical situations, select a different primary customer.

The best way to get the information you need is to make sure that your company’s control systems are interactive. Everyone in the organization should be using the same performance measures as the basis for learning and debate. Monitoring changes in customer behavior and the competitive environ­ment, in particular, is not a function to be delegated to a special department. As a technology executive recently told me, “Companies that get it wrong are those that build departments with ‘innovation’ in their titles. We need to have everyone in the busi­ness innovating.”

Depending on your business strategy and indus­try, you can choose to use any of your current man­agement systems interactively—your profit planning system, your brand revenue system, your orders-on-book or new deal system. At HBO, for example, executives constantly track the company’s success rate in bidding for new shows from filmmakers and use that measure to prompt a discussion among managers throughout the business about changes in the competitive marketplace that could affect their strategy. Amazon’s category managers use their Monday morning meetings as a forum to study data about product assortment choices, revenue growth, customer orders, and inventory turnover. Reflecting the firm’s leadership principles (customer obses­sion; bias for action; earn trust of others; dive deep; and have backbone, disagree, and commit), these meetings are highly interactive as managers from a diverse array of functions work together to inter­pret the data and come up with action plans. Some of these actions may, over time, plant the seeds of a new strategy.

Systems that work well interactively—like those at HBO and Amazon—share three essential charac­teristics: They deliver information about uncertain­ties that could undermine the assumptions of a cur­rent strategy and require attention from the highest levels of management; they are widely used in the organization, receiving frequent and regular atten­tion from operating managers at all levels; and they involve face-to-face meetings that focus on emerg­ing data, assumptions, and action plans. There is no substitute for the energy and creativity that flow from open debate when participants leave their ti­tles at the door.

In using interactive control processes, manag­ers should continually ask three questions: What has changed? Why? and, most important, What are we going to do about it? If you identify changes in your customers’ profit potential, for instance, you might want to rethink your choice of your primary customer. Changes in tastes, regulations, technology, or competition may alter what it is that your primary customer values—resulting in a need to reallocate resources or redesign your business structure.

IF YOU HAVE significant first-mover advantage thanks to a new technology—or if competitors are evolving and struggling to find their way—you may be able to duck making a choice of primary customer, opting instead to stay fluid and focus on experimentation. But the entrepreneurial landscape is littered with the carcasses of companies that tried to be everything to everyone. Like Yahoo, they muddled along until they were overtaken by crisis, often bringing in a new leader in a last-ditch effort to impose discipline and focus on a failing business. It is, I believe, ultimately less risky to be proactive and make the key strategic bet of choosing a primary customer. Companies that hedge their bets usually find themselves looking at the taillights of their more decisive and committed competitors.

How LinkedIn Chose Its Primary Customer : Consider LinkedIn. In deciding where to focus, executives had to choose among three kinds of customers that all had the potential to generate substantial revenue: job recruiters, advertisers, and individual members. LinkedIn’s founding mission, to “connect the world’s professionals to make them more productive and successful,” speaks to job recruiters but is most strongly aligned with the needs of its individual members. Despite the fact that recruiters provide 54% of revenues and advertisers 26%, LinkedIn’s 250 million members offer the most profit potential: They are what makes the network so attractive to the other paying customers. LinkedIn excels at creating a superior experience for individual users. Its site is a less efficient platform for recruiters or third-party service providers.