Why value creation is becoming more important than before

Why value creation is becoming more important than before and if cost control remains necessary, it cannot be sufficient alone.

As we saw in a previous post, the long-term sustainability is based on the combination of the ability to control costs and to create value.

We saw that value of a service or product is made of functional value (for example it feeds me), emotional value (for example it tastes, smells and looks good) and brand value (I trust the brand or the shop that it will deliver state of the art food that will not disappoint me, is good for my health and shows I have good taste). In short, value maximization and cost reduction are the two main daily activities of any executive in the business.

In the 20th century, cost reduction was the main driver for success and remains so for many companies. The world was indeed stable and innovations rare or predictable. They were therefore relatively easy to imitate. As a result, maximizing efficiency was the key element of success and growth.

Companies had plenty of time to adapt to competitive evolutions. What we consider today as emerging or emerged markets had not yet started to emerge and only benefited from innovations years after the customers of mature countries had already shifted to new technologies, products and services. Things happened in cadence.

The word “globalization” did not have the importance it has now –in fact, even though the word appeared in the first dictionary in 1951, it really became popular and broadly used at the end of the 20th century- and governments restricted free trade and protected their industries through regulations, limitation of information, cartels, tariff barriers and monopolies. As a result, many companies had limited expertise as they were not really challenged or had a restricted access to best practices. Therefore, improving operational performance and keeping a cost advantage over competition was very important in order to make profit and grow in markets with a limited scale.

For example in the auto industry, by maximizing its manufacturing efficiency, Toyota was able to achieve superior quality at minimum cost when Mercedes could only achieve a comparable level of quality through expensive control process and the use of expensive materials. Superior quality and cost reduction were the byproducts of its efficiency as “right the first time” implied both cost reduction and quality enhancement. It is what Japanese call “monozukuri”.

As a result, as illustrated in the book “The machine that changed the world” based on a study led by the MIT, Toyota refined the Fordism to a superior level and became a benchmark in manufacturing. Toyota became the #1 in the industry by basically offering products without defects at a relatively low price, which none of its western competitor could do at that time. Typically, Toyota vehicles were known for their “value for money” characteristics hence a good if not unbreakable product at reasonable price that will neither let you down.

Since then, all competitors have copied the “Toyota Way” and most car manufacturers are making products that don’t break down any more and have a relatively competitive cost. If Toyota still keeps the lead in this area, it cannot suffice to make it a significant competitive advantage as such. As a result, Toyota must find new sources of competitive advantages in areas more difficult to imitate. This will become even more critical in a world where the ownership itself will be more and more challenged by other forms of mobility. Making good or even better cars will not be enough to draw customers’ attention.

Toyota must increase its value perception if not by pure quality or cost advantage but through innovation, design or brand improvement. It is what Toyota started in the recent years and if the results are still to be confirmed, the recent progress are already reflected in the latest brand value ranking of Interbrand for example. We will come back to some examples in a future post.

In the 21st century, innovations are introduced much faster than before and this move is accelerating.

First, as we all know, the pace of introduction of new products and services themselves is much faster than before. Second, they are launched in all markets almost simultaneously even if their introduction is adapted to local specificities and market conditions.

If value creation is getting more important, why is it that many companies and financial markets overemphasize cost reduction?

The first reason is that cost is easier to measure than value, which is not even monitored in many cases.

The second is that, in many parts of the world, most executives are mostly metrics driven. For example in countries like France, Germany and Japan, the royal career path is in engineering related fields. To quote Mark Twain, “If your only tool is a hammer then every problem looks like a nail”, and not all executives master value creation. Indeed, it requires on top of scientific knowledge, a different skillset with real understanding of customer behavior, marketing techniques, openness to new and diverse domains and all kind of other soft expertise that are rarely taught at school and even less experienced in factories or in boardrooms.

The third reason is that in many corporations and culture, it is believed that executives are here to decide everything and it is much easier to make a decision based on figures than on far customers’ feelings.

In fact, many successful brands don’t own part of their operations anymore. Apple or Nike doesn’t have a factory, Amazon a bookstore, Rakuten inventory, Google a physical media or Uber a car…. People go for those brands as they offer a unique experience that they can really identify as such. All those names have been the champions of value creation. Of course they have to control their cost but most of their success is based on how to create value at minimum cost. The interface of an Apple product, the story around the latest pair of shoes carrying the name of a famous basketball player for Nike, the ease of ordering a product or an eBook on Amazon, the experience of the virtual mall at Rakuten or the bottle of mineral water in the rear seat pocket of an Uber car are good examples of functional or emotional value with limited relation with costs. Eventually the consistency of all the actions will grow the brand value – customers are ready to choose those brands even at higher price because they know that Apple is easy to use, Nike is cool, Amazon is practical and Uber offers a private driver’s experience at the price close to that of a taxi)

But those brands specialize their competencies in what they think is related to their brand and unique offer, using third party companies for what they think is not their core skills.

In some cases cost management can be part of those skills if it is associated with customers’ understanding. For example, when Renault, by limiting investment, designing to cost or streamlining its distribution and marketing expenses, launched the first Logan and more recently the Kwid for Indian market, a real low cost car, it invented a new market that did not exist. First in emerging markets, it opened car ownership to a new huge customer base and later expanded it to second car buyers in mature countries. By understanding customers’ real needs and putting the money where it made sense for customers, it invented a new segment.

The example of the probable coming success of the Renault Kwid in India shows that if cost reduction is necessary to succeed, it needs to be associated with a good understanding of customers to create a new product that represents a real value gap to what was until then the mobility alternative. The failure of the Tata Nano, an even much cheaper car that did not meet customers’ expectation in terms of functions and emotion (status and pride of ownership as represented by design) shows that understanding customers’ needs is of upmost importance compared to cutting costs blindly.

Some media highlighted another example recently. According to IHS, the cost of an Apple watch is hardly more than 80 $ which represent a quarter of the customer price as it starts from 350 US$. The manufacturing cost itself represents 2.5$. For the assembly company, which for Apple is traditionally the Chinese Foxconn, the 2.5$ represent 100% of their performance and their objective of cost improvement is probably in the area of the cent. But Foxconn, like other components suppliers provides its services to so many other brands that it is not in this area it will make any difference.

In the area of pure technology and their large scale manufacturing expertise, Japanese firms such as Sony or Panasonic are excelling in bringing new technical concepts to industrial reality. Japanese firms still lead in many technical areas.

In contrast, the Korean Samsung decided more than a decade ago to focus on marketing and value creation. It accepted to be 2 to 3 years behind its Japanese competitors in manufacturing as a result of this strategy. It decided that product attractiveness and brand reputation were the key area to focus on. It appointed a CMO coming from the champion of marketing Procter and Gamble.

As a result, for most customers Samsung replaced the once leading Japanese brands in consumers’ heart. According to Interbrand, Samsung is now the 7th brand of the world –in brand value- all sectors included and first non-American company with a brand value estimated at 45 billion US$. In the same ranking, both Sony and Panasonic do not appear in the top 50 and are at 52nd and 64th position with a brand value of respectively 8 and 6 billion US$. Even if Panasonic improves its manufacturing cost structure by 2 or 3 % a year, a 6% cost advantage in manufacturing versus Samsung will never be as decisive as a good design, a good marketing campaign or simply a better understanding of global consumers’ unmet needs.

Not surprisingly, most Japanese electronic companies are gradually becoming B-to-B suppliers providing state of the art parts for major brands outside of Japan. It is the case of Panasonic, Hitachi, Sharp but more surprisingly Sony that used to be the first consumer electronics brand not earlier than 15 years ago. This is the area where their technical and manufacturing skills are performing the best. It is of course a place there is some merit to be but it misses opportunities. Indeed, there is room for Japanese firms in electronic as in many other areas, if they improve their marketing skills –in the broader sense that includes customers’ unmet needs understanding and innovation to meet that needs- to come back stronger in the future.

In order to create value faster and globally, customers’ understanding, diversity of ideas creation, fast decision and finally risk taking make the difference. In that sense, the traditional management systems that were taught so far are not working any more. A new type of management is required. And this new type of management is compatible with Japanese management values and culture based on harmony.

We will see in another post that it also has its rules, its own language and processes.

But it requires mostly the combination of creativity, common understanding of the direction to follow and agility.

And all regions and functions have a say in the definition of this strategy. They have a role to play beyond their technical or regional responsibility in the sense that each unit can lead some activity for the global community.

In short it requires a commonly defined frame and the freedom to decide the implementation.

And this is where the third road of management plays its role.

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