Product Innovation Using Twitter and Tweetups - Part 1

Over the years we have gathered several thousand examples of product innovations. We have found patterns in the needs of customers and in the approaches that companies follow to develop product innovations to meet those needs. At the highest level, a customer has three basic needs, which create three major customer segments. First, there are physical needs related to the physical situation of the customer or of the location where the product is purchased or used. Second, there are emotional needs, which reflect the customer’s personal needs for comfort, status and the avoidance of anxiety. Finally, there are intellectual needs which segment customers based on their current knowledge and understanding of the company, its products and how the products are used.

To meet the needs of these customer segments, companies follow three primary approaches to product innovation. First, they may provide the customer with information, which helps the customer to recognize and recall the name of the company and its products, to explain the product’s relative benefits or to obtain directions on how the product should operate within a broader customer cost system. Second, the company may reduce the resources the customer requires for the use of the product. These resources include money, time, effort and health. Third, a company may improve the experience the customer has with the product. These experienced-based innovations add new appeal to the senses, associate the company or the product with an image to increase the customer’s pleasure in using the product, increase the customer’s sense of security with the product or entertain the customer while he waits for or uses the product.

Kraft has demonstrated some of these patterns in its recent DiGiorno flatbed pizza introduction. In one of its most innovative approaches to this introduction, the company is seeking out influential users of Twitter. Twitter is the social online media company that allows users to communicate quickly using very short, 140 character messages. For influential users of Twitter, Kraft is offering to host Tweetups. Tweetups are in-person get-togethers prearranged on Twitter. The company is recruiting these Twitter users, called Tweeters, in Chicago, New York and Los Angeles. The company is offering to provide DiGiorno flatbed pizzas to these Tweetup events in the hope that attendees will like the product and spread the word.

In the second part of this blog, we will tie these product innovations back to the customer need segments and types of product innovations we have outlined above.

Big Cost Differences in an Industry - Part 2

McKinsey and Company has undertaken a detailed examination of Productivity in the pharmaceutical industry. This extensive study offers us an opportunity to see common patterns in cost management and productivity improvement. We described these patterns in Part 1 of this blog. These common patterns of Productivity improvement include four major concepts.

1. Reduce the rate of cost for the Input

2. Reduce the Inputs not producing Output

3. Reduce unique Intermediate Cost Drivers(ICDs) in products and processes

4. Spread fixed cost ICDs over new Output

McKinsey undertook a detailed analysis of 1900 pharmaceutical production lines at 150 plants located all around the world. The Firm measured the Productivity levels among the plants and companies in their study and found dramatic differences in Productivity among these 150 plants. (See the Perspective, “What Makes Returns High?” on StrategyStreet.com.) The top quartile of the companies involved in this study had manufacturing utilization rates that were more than twice those of the bottom quartile companies. McKinsey estimated that, if the average drug-maker would match the total labor productivity of the top players in the industry, it would realize an improvement of 5 to 6 percentage points in operating earnings, quite an improvement

Here are some of the cost management reasons for the superior performance of the best performing companies and how these cost management efforts fall into the four categories of cost reduction above:

* Measure of I/ICD and Concept #2: McKinsey found that the top performers used non-production labor extraordinarily efficiently. For example, the quality control employees for the top performers reviewed an average of 110 batches a year, while those in the bottom quartile did less than 5. This finding is a good example of both an Input, the quality control employee, and an Intermediate Cost Driver, a quality control batch. A company using this measure would reduce Inputs not producing Output through reporting to the employees of this measure of their efficiency. (Concept 2)

* Concepts #2 and #3: The high performers use standardized ways of measuring and controlling equipment, reducing line stoppages and waste. This is an example of two of the patterns. (Concept 2) This approach reduces Inputs not producing Output by eliminating unplanned downtime. It also reduces the unique ICDs in processes by standardizing processes. (Concept 3)

* Concepts #2 and #3: The top performers were more likely to use lean management tools to plan and schedule activities, so they released a higher percentage of their products to market without reworking. This approach reduced Inputs not producing Output by improving the accuracy of production forecasts. (Concept 2) It also reduced unique ICDs in the process by reducing the rework activities through a reduction in errors. (Concept 3)

* Concept #2: The top quartile players reached final delivery in half as much time as the average manufacturer, and more than five times faster than those in the bottom quartile. The top performers reduced Inputs not producing Output by speeding the process.

* Concept #3: The best performers eliminated unnecessary complexity from their production planning activities by using fixed, repeatable, short duration production schedules in order to avoid forced changes in production plans. These companies reduced unique ICDs in their processes by reducing the movements of Inputs.

* Concept #4: McKinsey found that small plants were substantially less productive than larger plants. However, the very largest plants were not the most productive. This illustrates the spreading of fixed cost ICDs over additional product Output. It also warns us of the limit of that concept when there are multiple products emerging from the plant.

Every drug maker that McKinsey studied had launched a lean, or Six Sigma, project in the recent past. Yet relatively few of these companies were effective in reducing their comparative costs.

For further explanation of these cost reduction patterns, and for over 600 cost reduction concepts, illustrated by 2400 examples of these concepts in action, please visit www.strategystreet.com/improve/costs. These concepts will help you improve your company’s productivity.

Big Cost Differences in an Industry - Part 1

The objective of every cost management system is to improve the Productivity of the Input (I) resources used to produce the final Output (O) product. These resources include the Inputs of People, Purchases and Capital. The Output is the unit of product sold. A simple measure of Productivity is Inputs divided by Outputs (P=I/O).

There are several stages in producing a unit of Output, so relatively few employees (one of the key Inputs) actually produce a unit of Output. Instead, most employees produce something else as an intermediate end product on the way to the final product. We call these intermediate end products Intermediate Cost Drivers. So, to increase Productivity, you would like to improve the ratio of Inputs needed to produce Intermediate Cost Drivers (I/ICD).

You would also like to reduce the activities, or Intermediate Cost Drivers, you require to produce a unit of final product Output. In ratio form, this means you want to reduce the ratio of Intermediate Cost Drivers in the Output (ICDs/O).

The measure of Productivity then expands into two factors:

Productivity = Inputs/Output = Inputs/Intermediate Cost Drivers x Intermediate Cost Driver

Or

P = I/ICD x ICD/O = I/O

We have studied several thousand cost reduction efforts from the last 25 years. We believe that you can categorize all cost reduction efforts into one of four major concepts:

1. Reduce the rate of cost for the Input

2. Reduce the Inputs not producing Output

3. Reduce unique Intermediate Cost Drivers(ICDs) in products and processes

4. Spread fixed cost ICDs over new Output

The current issue of The McKinsey Quarterly describes an interesting study that McKinsey has undertaken in the pharmaceutical industry. The study’s conclusions offer us the opportunity to categorize their findings into one of these four cost reduction concepts.

In Part 2, we will describe some of McKinsey’s findings and then tie the findings to the four major productivity improvement concepts above.

The End of This Story is Predictable

For a while last year, it looked like the legacy airlines were well on their way to profitability. Business and international demands were strong and the companies had pricing power. The legacy airlines attributed much of this pricing power to their strategy of removing capacity from the marketplace. Let’s look at how that capacity removal is working out over time across the entire industry.

Recently, the Wall Street Journal’s “The Middle Seat” column conducted an analysis of some Morgan Stanley research data. The analysis evaluated changes in capacity in the industry over the recent months. They found that the legacy carriers, such as American and United, were seeing competitors grow faster than they did on overlapping routes. The faster growing competitors included jetBlue Airways and Southwest, the usual suspects. Southwest grew aggressively in Denver, while Frontier Airlines shrank capacity there. JetBlue grew in the Caribbean region as American Airlines pulled capacity from those routes. So as the legacy carriers, the industry’s Standard Leaders, reduce their capacity, the industry’s low-cost carriers, in this case Price Leaders, expand to take their places.

Why would the low-cost carriers be able to expand in a market where the industry’s legacy carriers are losing money? The answer lies in costs.

Recently, Scott McCartney, the author of “The Middle Seat” column in the Wall Street Journal’s travel section, cited another analysis from the consulting firm Oliver Wyman. Some of these conclusions were striking and scary for the legacy airlines:

* In 2003, low-cost carriers carried 26% of domestic passengers. By 2007, they carried 31%. These Price Leader airlines have been able to grow in both up and down markets.

* In the third quarter of 2008, the legacy carriers’ average revenue per seat mile was 12.46 cents, while their costs per seat mile were 14.86 cents. The airlines were losing money on each seat mile.

* The low-cost airlines fared better during the same period. Their revenue per seat mile was 10.92 cents, while their costs were just 10.87 cents. Note that the average unit cost of the legacy airlines during that period was 35% higher than the average unit cost of the low-cost carriers.

* The absolute spread between the legacy and low-cost airlines is increasing. In 2003, the low-cost airlines had a cost advantage over the legacy airlines of 2.7 cents per seat mile. By 2008, the gap was 3.8 cents. In both cases, though, the percentage gap has remained about the same.

The reason for the growth of the low-cost carriers compared to the high-cost carriers is, in part, due to their different growth rates. (See the Symptom and Implication, “Some competitors are using growth to reduce their costs” on StrategyStreet.com.) The low-cost carriers are expanding. They are able to hire employees at the bottom of the tiered wage scales. On the other hand, legacy airlines are shrinking, so they have a harder time reducing unit costs. Many of their employees are already at the top of their wage scales.

These analyses should serve as important warnings for the legacy carriers. They are no different than U.S. Steel or Bethlehem Steel, Chrysler or General Motors. If these Standard Leader companies can not achieve cost levels equivalent to those of the low-cost carriers, they will inevitably cease to exist in their current form.

Some of the legacy carriers have labor contracts coming up for renegotiation. People costs make up about 60% of the costs of legacy airlines. I hope that the representatives of these employees are reading the same studies that we are. Restrictive work rules, rather than hourly rates of cost, are the usual culprits when low cost competitors are competing with unionized Standard Leaders. These work rules spread jobs around and ease the burden of work on the unionized employee. They also open an umbrella over non-unionized or less-unionized employees in competing companies. This begs the question: What good are these work rules if the employee does not have a secure job…or any job at all?

Just when they thought it was safe...

The telephone industry has had its ups and downs over the last twenty years, but the wireless business has helped it survive nicely.

Telephone customers are changing how they buy phone service. For the last several years, customers have been migrating away from land line phones to cell phones. Many of the under-35 set rely exclusively on cell phones for their phone service.

The largest telephone companies, including AT&T and Verizon, solved the problem of the lost land line business by buying cell phone carriers and expanding the cell phone business. This move kept their profits intact. These companies make most of their cell phone profits with voice communications. A secondary source of profits for them is data communications. Today the combination of land line and cell phone services produces an attractive business for both AT&T and Verizon.

They have had their challenges, though. One of these challenges has come from the internet calling unit of eBay, Skype. For the last several years, Skype has offered very low-cost telephone service using Voice/Over Internet Protocol (VOIP) to allow its subscribers to use the internet for their phone calls. The company claims to have over 400MM users worldwide. This low-end product has certainly had an effect on the land line businesses of AT&T and Verizon.

Now Skype is coming to the cell phone business. Skype has developed a service that allows its users on mobile phones to make calls and send instant messages on mobile phones, with Apple phones and BlackBerrys. This new service has the potential to allow customers to use data plans, rather than more expensive voice plans, to make calls using Skype.

This is an example of a low-end competitor posing a challenge to the leading products of the industry leaders. If industry leaders, whom we call Standard Leaders, do not stop or slow the growth of low-end Price Leaders and Next Leaders, these companies can eventually become Standard Leaders in their own right. (not likely in a Hostile market. See the Perspective “Commodities and Hostile Markets” on StrategyStreet.com.) Consider the following examples:

~ Dell began its career in the personal computer industry as a Price Leader.

~ Enterprise Rent-a-Car grew to become the largest automobile rental company, starting from a low-end base.

~ Today’s LG appliances compete against the GEs and Whirlpools of the world. They began as Price Leader Lucky Goldstar products.

~ Dean Foods grew to become the largest dairy producer in the United States beginning from its roots as a private label supplier.

~ Gallo entered the mid and high-priced segments of the table wine industry, from its beginning, with such low-end products as Thunderbird wine.

~ Southwest Airlines has become a leader in the airline industry from its roots as a discount air carrier.

~ VF leads the denim industry, where it once was a cut-rate competitor of Levis.

~ Nucor is the second largest steel manufacturer in the United States. It began its life as a seller of one of the industry’s cheapest products, rebar.

~ Toyota and Honda both entered and grew in the American automobile market, starting with the small car segment. Is Hyundai next?

~ Wal Mart has become the largest department store and grocer in the U.S., surpassing Sears, Macys and Kroger.

~ Charles Schwab has become a powerhouse in the brokerage industry, starting from its original base as a discount broker.

Price Leader Expansion Under Standard Leader Umbrella

Over the last year, private label sales of food and other grocery products in the U.S. have grown at over 10% per annum. These private label products are examples of Price Leaders, companies and products who offer performance less than that of the larger, industry-leading, Standard Leaders for a price substantially less than Standard Leaders.

Standard Leaders are the companies and the products that are most common in an industry. Standard Leader products make up the majority of the industry’s sales. A Camry and an Accord would be Standard Leader products. The Yaris and the Fit are Price Leader products.

Private label products rely in the brand name of the retailer to establish Reliability, while offering the consumer Function benefits that are roughly equivalent to the Standard Leader product. Sometimes industry Standard Leaders will produce private label products which are unrelated to their major branded products. More often, though, private label products are produced by private label company specialists, such as Ralcorp and Cott. The majority of these private label food producers are mid-sized private companies. Most are unknown by the average consumer. They include companies such as Schwann’s, Land O’Lakes, Specialty Foods, Sterm Foods and Pan-O-Gold.

In the food business, private label products can put significant pressure on the industry’s Standard Leaders. That is happening today. While private label products have grown 10% in the last year, many of the branded food companies are growing well below that or are shrinking in their sales. ConAgra Foods saw a sales increase due to price increases, but sales volume actually fell. Kraft Foods, General Mills and H.J. Heinz also saw declines in sales volumes.

The reason for the disparities in growth rates between private label products and branded foods is pricing. Last year the branded food companies had a unique opportunity to raise prices dramatically, on the order of 10%, due to the rising commodity prices at the time. However, these commodity prices have come down and the branded food companies have continued to maintain, or even raise prices. With the fall-off in the economy, and these price umbrellas set by the branded food companies, private labels have jumped in popularity. This is a form of the Leader’s Trap. We just placed many examples of the Leader’s Trap on our StrategyStreet web site (see http://www.strategystreet.com/tools/glossary_of_terms /leaders trap and also the Symptom and Implication, “Leaders Stress Quality to Offset Competitors’ Lower Prices” on StrategyStreet.com).

The problem that private labels are creating for the branded food companies is one of improving Functions and Reliability. The increased volume that the branded food companies are allowing private label products enables these Price Leader companies to improve their products, reducing or erasing the Functional and quality differences their products have compared to the branded products. The private label products then become permanently stronger.

This is a serious challenge. J.D. Power & Associates recently reported that consumer perceptions of private label grocery brands have shifted to the positive. Many consumers no longer consider them to be low quality with bland packaging. These consumers look at private label brands as unique and having quality that equals that of traditional brands. The traditional branded companies are setting up powerful competitors who will always maintain a price advantage over them.

These private label store brands are unlikely to lose all the market share they have gained over the past year, once the industry Standard Leaders reduce their prices, as they inevitably will.

Pricing Against a High-End Product

In StrategyStreet terminology, a Standard Leader is a company who sells the majority of its products at the most common industry price point. The most common product we call the Standard Leader product. At the high end of the market are those companies who offer products with extra features and services for prices starting about 10% higher than the Standard Leader product. We call those companies, and their products, Performance Leaders. In the personal computer industry, Apple is a Performance Leader; Dell and Hewlett Packard are Standard Leaders.

Apple introduced its Mac-Book Air laptop early in 2008. This was an ultra-thin machine that appealed to customers who wanted light weight and high style in their personal computer.

Somewhat later in the year, Hewlett Packard introduced its high end Voodoo Envy laptop. This is an example of a Standard Leader company introducing a Performance Leader product in competition with a Performance Leader company. (See the Symptom and Implication, “Customers are taking on more suppliers because shortages have appeared” on StrategyStreet.com.) This happens in most industries. Recently, Dell has announced its Adamo high-end personal computer. Dell claims the Adamo is the thinnest and the most stylish in the market. These three Performance Leader computers sell strictly on style. Their technical specs are not much different from other laptops, or from one another.

There is something interesting, though, in the way the computer industry Standard Leaders have priced their products against the Apple computer. The Apple Mac-Book Air sells for about $1800; Hewlett Packard’s Voodoo Envy sells for $1900; and Dell’s Adamo sells for $2000. The Standard Leader products carry prices above the price of the Mac-Book Air, the leading Performance Leader product.

This is an unusual approach to pricing. The Standard Leaders would like to take market share from Apple but they have given up one of their most powerful advantages, their low costs due to Economies of Scale and, potentially, lower prices. (See the Symptom and Implication, “The larger companies are squeezing out the smaller” on StrategyStreet.com.) A more robust approach is for the Standard Leader to use its superior economies of scale and distribution power to introduce a product somewhat below the price of the Performance Leader product. This enables the Standard Leader to introduce a product that will take share from the Performance Leader, slowing its growth and reducing its margins. Consider these examples of that pricing strategy.

* Toyota introduced the Lexus brand against Mercedes Benz at a price point of $39,000 compared to an average $50,000 Mercedes Benz price.

* MSN priced its broadband product at $39.95 to compete against AOL’s broadband at $44.95.

* The Palm PDAs competed against PDAs using Microsoft’s Pocket PC operating system at prices 20% or more below the pocket PC-driven machines from Compaq and Hewlett Packard. Then, smartphones undercut PDAs.

* Schwab’s 2% cash back credit cards carried no annual fees in competition with fee-bearing airline miles credit cards.

* McDonalds and Dunkin Donuts introduced high-end coffee drinks at prices nearly 50% below those of an equivalent drink at Starbucks.

* Kraft’s DiGiorno high-end frozen pizza came out at a price of $5.59 to compete against home delivery pizza at around $7.00.

My guess is that neither the Hewlett Packard nor the Dell high-end computer will have any impact at all on Apple and its Mac-Book Air.

The Exceptional Growth of a Price Leader Product

In our terminology, a Price Leader product is a low-end competitor in the market place. It competes against both other Price Leader products and against Standard Leader products, which are the industry leading products.

There are two types of Price Leader products. They differ from one another in the benefits they offer the user and the buyer of the product. The user and the buyer may be the same person but the activities of each create different needs. The first type of Price Leader, a Stripper product, offers both the user and the buyer of the product fewer benefits than does the Standard Leader product. The second type of Price Leader product, the Predator product, offers the user the same benefits as the Standard Leader product but offers the buyer fewer benefits. Stripper products, as a group, usually have less than 15% of the total market’s unit sales. Predator products would also usually have a minority market share, though they may be on their way to becoming very powerful Standard Leader products as their buyer benefits increase.

Recently, the Deloitte’s Center for Health Solutions reported that 750M Americans traveled abroad for medical care in 2007. The same group predicts that, by 2010, nearly 6MM Americans will travel outside the U.S. seeking medical treatment. This is called “medical tourism.” It is a Predator product. Its Function benefits for the user are the same as those of the Standard Leader product, health care in the United States. The U.S. Standard Leader product is holding a high price umbrella over this new Price Point. This Predator’s buyer benefits, however, are considerably less than those of the Standard Leader product. The customer must travel in order to obtain the service, so its Convenience is lower. Also, because the services are provided in a foreign land, there are fewer Reliability benefits with the product than with the Standard Leader product.

The advantage that all Price Leader products have is their low price. In this example we can see that the low price is powerful indeed to produce such a growth rate in medical tourism.

Over time, the buyer disadvantages of medical tourism will decline due to the fact that many people will have tried it. These people will convince their peers that it is a safe and worthwhile product, reducing Reliability disadvantages.

Eventually, this Price Leader healthcare product will put pressure on both the pricing and the current business model for the Standard Leader’s equivalent services.

For more information, visit strategystreet.com.