"Cost reduction, like a growth strategy, must be customer value-oriented."
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By Vikas Mittal, Shrihari Sridhar, Roger Best
Forced by the economic shock of the continuation of the global pandemic, B2B CEOs are busy developing a large number of response plans. The most eyebrow-burning decisions are often: whether to cut costs and how to cut them.
As in past recessions, some CEOs have embarked on sweeping pay cuts and widespread furloughs, while others have taken a more piecemeal approach — renegotiating supplier contracts; cutting out underperforming products, regions and departments; and moving to lower-cost sales channels. Our research suggests that neither approach may be quite right.
A more effective cost-cutting strategy should be customer-centric from the start and consistently implemented.
Customer centricity is often overlooked when it comes to cutting costs, as it is often seen as a strategy to increase revenue. This is not true: B2B companies will lose a lot of money if they ignore what their customers value when cutting costs.
In an analysis of 626 B2B-listed companies and their 4,105 customers, we found that companies with high cost reductions but low levels of customer value (measured in customer satisfaction) had the worst gross margins, while companies with high cost reductions and customer value had the highest profit margins. In other words, instead of taking into account the cost reduction of customer value, the profit margin is reduced.
To achieve customer-centric cost reduction, B2B companies can take three approaches: reducing value-added loss to provide more attractive customer value, improving customer acquisition and retention effectiveness, and focusing on strategic projects that best align with customer value.
01 Reduce value-added loss
When the value driver pursued by the company does not meet customer preferences, it will produce value-added waste. The innovation race to add more and more complex product features (and cost more) while ignoring what customers need and want is a major cause of value-added loss. Such investments consume only resources, but do not enhance pricing power, so they reduce profit margins.
For a few value drivers that particularly contribute to improving total customer value, if they can be identified and more consciously committed to improving these drivers, while eliminating the disconnect with these drivers, the value-added loss can be completely eradicated.
After we studied five B2B companies (a manufacturing equipment distributor, a modular office leasing company, an engineering, procurement and construction company, an aerospace equipment manufacturer, and a hotel service provider), we found that at least 80% of each company's customer value comes from 2 to 3 drivers. This is a consistent model that we have proven with hundreds of B2B companies.
By focusing on the product and service features that best fit these customer value preference drivers, and removing those that don't fit, companies can reduce fixed costs and variable costs without impacting sales.
For the hotel service providers we studied, when they matched their service priorities with customer value drivers, they found that employees were looking for sales and bidding, communication, and sustainability, while customers valued quality products, better ongoing service and support, and safety.
With this in mind, the company reallocated resources to these drivers of customer value, thereby improving the company's overall customer value index, as well as revenue and profit levels.
Customer-centric cost-cutting implications: In any product or service, spending should be fully focused on the primary driver of total customer value, and spending beyond that needs to be cut.
02 Manage customers more effectively
Focusing on the most important customer value drivers can make existing customers more confident that you understand their needs, thereby earning their loyalty and helping your company win accurate new customers at low cost.
This could be a significant cost savings: A recent study of 128 large public companies concluded that a 1% increase in customer satisfaction would reduce future costs of sales by 0.53 percent, meaning that the average company in the study would save about $130 million on average. Savings come from commissions, marketing and advertising costs, shipping costs, and reductions in bad debts.
Customer loyalty and word-of-mouth referrals are especially valuable for B2B businesses. In fact, our analysis found that more than 82% of customers are willing to do business with a company because of past experience or good reputation. Satisfied customers will be loyal, which will reduce the cost of sales.
In addition, they send potential customers with similar needs to their doors – a low-cost source of new business.
Similarly, companies can maximize these effects by focusing on the primary drivers of customer value. In the modular office rental companies we studied, when their attention was focused on product and service quality, communication, and ongoing service and support (the three drivers of customer value), there was a noticeable increase in back business with existing customers.
The company also focuses on these drivers in its marketing and sales efforts. For example, it collects anecdotes about customers and these drivers, posts them specifically on the company's website, and invests in an online customer portal that is easy to access for mobile devices.
Over time, this focus has helped companies gain market share from customers who value these drivers, and customer acquisition costs have fallen. Equally important, the company's market share with price-sensitive customers has declined, which is also a sign that the company has attracted accurate customers with the value it promises.
The engineering, procurement and construction firm we studied increased its winning rate in existing client bids by more than 42 percent with two newfound drivers that represent 60% of its clients' value – project management and ongoing service and support.
It also boosted the new customer winning rate from 46 percent to more than 65 percent. The result: Since 2018, the company has achieved its revenue targets for each quarter, while hiring people in sales and business development has decreased by 30 percent and total bids have decreased by 18 percent year-over-year.
03 Strategic Project Selection and Cancellation
At any given time, B2B companies are implementing a large number of strategic projects. For example, install customer relationship management software, develop new products, and explore digital channels. At first glance, every project is designed to increase customer value and boost sales. However, these projects are often not tied to proven customer value.
When we studied the manufacturing equipment distributor ranked 65 company-level projects based on the potential increase in customer value, we found that 10 of them brought a 71% improvement, and 5 of them brought a 61% improvement.
As a result, the executive team decided to focus their money, attention, and energy on these 5 projects, temporarily shelving 14 projects and abandoning 46 projects altogether. Not only did this reduce costs and wasteful expenses, but the focus on value drivers also increased sales.
Eliminating insignificant projects saved the company more than $15 million in costs, expanding profits and increasing customer value while providing employees with a clearer, more focused strategy.
In today's unprecedented business environment, many CEOs are pursuing cost-cutting initiatives. But in doing so, they should recognize that cost reduction, like a growth strategy, must be customer value-oriented.
Wisely cutting costs by focusing on the drivers of customer value will not only allow companies to weather the current downturn in demand, but also lay the foundation for a long-term, customer-centric strategy. Such a strategy would allow everyone – from executives to the front line – to focus on doing more with less.
About the Author: Vikas Mittal, J. Thompson, Marketing Scholar, Jones Graduate School of Business, Rice University Hugh Liedtke Chair Professor.
Shree-Hari Al-Sridal is the Joe Foster Chair Professor of Business Leadership and Professor of Marketing at The Mays Business School, Texas A&M University.
Roger Best is an emeritus professor of marketing at the Lundquist College of Business, University of Oregon and co-founder of the University and sports product management program. They co-authored the book Market-Based Management (seventh edition).
Original article "Cost Reduction should be customer-centric"
Published in the October 2021 issue of Business Review
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