Experience Counts Newsletter Page 1

To learn more about this concept of captive customers in detail, we suggest your read Competition Demystified by Greenwald and Kahn - published in 2005 by Portfolio. This paper is based on the book and on Brian Harrison Smith's decades of experience selling.

By Brian Harrison Smith.

Captive customers -- they automatically think of you as their supplier, and you may even take their business for granted -- generate long-term competitive advantage to you, compared to your rivals.

Once you have captured these customers your rivals not only have to supply a better product and or a better price, they have to "off-sell" you.

To craft plans and actions to build captive customers, you must implement the latest strategic account management practices. Here is why creating captive customers makes excellent long-term business sense, and some hints on how to do the capturing.

AVOID COMMODITY BUSINESSES
According to conventional marketing wisdom, commodity businesses are to be avoided. The first step in building any good business plan is to differentiate your product or service from the competition. But on its own, differentiation strategy to escape the woes of commodity businesses has one major flaw. It doesn't work. You need more than this.

Differentiation -- putting a fancy name on your steaks or chickens, for instance -- may keep your product from being a generic, but is does not eliminate the intense competition and low profitability of typical commodity businesses. A chicken is, pretty much, a chicken.

BUILD SOME BARRIERS
The problem in developing captive customers may not be the lack of differentiation, but the absence of barriers to entry in your most profitable strategic accounts. It is barriers to entry, not differentiation, that keeps the bad guys out and creates your ideal long-term strategic advantage.

The first task in basic strategic thinking is to understand what barriers are, how they arise, and how to build some.

The skills and competencies of the best-run companies are openly available to competitors, whether by hiring your top staff or sending people to the same business courses.

Benchmarked processes are all part of the operational effectiveness of any company. Your software vendors will sell their latest systems to your competitors, too.

Once barriers to entry exist, and you are inside the walls, your strategic planning must focus on initiatives that maintain and leverage these barriers.

There are only a few types of genuine competitive advantage that can build these barriers.

Of these, production, supply and demand advantages are the weaker barriers to entry. Economies of scale, combined with customer preferences, are the stronger.

• One way a market incumbent creates competitive advantage is by having a lower cost structure that cannot be duplicated by rivals. The incumbent can earn attractive returns under prevailing market conditions, but potential entrants cannot, due to their higher cost structures. Such advantages discourage educated competitors from entering an incumbent's market.
• But…
• Low cost structures can mean little money spent on research and development, and on new production facilities. Innovation suffers, and quality drops.
• Over time, in most industries, new processes, technical standards, or customer service requirements evolve and put the incumbent's competitive position at risk. While the incumbent is controlling costs, the competitors are building better solutions.
• With few exceptions, access to low-cost inputs -- raw materials or a poorly paid work force -- is only a source of significant competitive advantage when the market is local, either geographically or in product space. By the time the products or services are distributed widely, these low cost inputs are not much help as a barrier to entry.

• For an incumbent to enjoy competitive advantages on the demand side of the market, it must have access to customers that rivals do not.
• There are a limited number of reasons why customers become captive to one supplier. When the relationship is based on trust -- lawyers or accountants come to mind -- it's hard for unknown competitors to break down the walls. But strategic account management establishes profitable reasons for an incumbent's customers to be loyal.
• If your business works hard to show your customers that you, too, are knowledgeable about their industry, and that you can be trusted, it's harder for others to beat you just on price.

HABIT AND LOYALTY
Habit succeeds in holding customers captive when purchases are frequent and virtually automatic. Similarly, customers are loyal to a brand that has served them well, or that meets emotional or intellectual needs. You'll see this behavior in supermarkets -- which supermarket is "Your" supermarket, and in the products bought --are you a Campbell's Soup family, or a Habitant, or Heinz? -- rather than automobile dealers or computer suppliers.

Canon users wouldn't be caught dead with a Nikon, and visa versa. Habit is usually, or at least often, local in the sense that it relates to a single product not to a company's portfolio of offerings. Kraft cheese slices for the kids, perhaps, but other brands of fancier cheeses for the grownups. Always Chev trucks for the fleet, but Mercedes or BMW or Lexus, changing brands every three years, for the senior management.

COST OF SWITCHING
Customers are captive to current suppliers when it takes substantial time, money and/or effort to replace one supplier with a new one. In the computer arena, complicated software is the product most easily associated with high switching costs. The costs can become prohibitive when they involve not simply the substitution of computer code, but the retraining of the people in the firm who use the application, and the need for hardware with different components.

Whenever a supplier has to learn a great deal about the lives, needs, preferences and other details of a new customer there is a switching cost involved for that customer, who has to "teach" the new supplier, i.e. provide the information the new supplier needs in order to deliver what is required.

Switching cell phone suppliers can be cost effective, in a narrow, financial sense, but prohibitively expensive when the inability to carry over existing telephone numbers is taken into account.

SEARCH COSTS
If it costs too much to find a new supplier, customers are tied to their existing suppliers. The more specialized and customized the product or service, the higher the search cost for replacement.

Professional services, which involve an intense level of personal contact, fit into this category, as do complicated manufacturing and warehousing systems. If a company is not totally satisfied with a supplier now, it is often easier, and cheaper, to upgrade with a current vendor.

ECONOMIES OF SCALE
If there's a big difference in size between your organization and your rivals, there may be benefits of economies of scale that will serve you well.

Instinctively, we think that bigger is better, but that's not necessarily so.

As you develop your strategy to build barriers to entry, you might, if you are the small one, develop a strategy based on being quick and nimble and flexible. If you can turn on a dime, or if you can "empower" your client service staff to make on- the-spot decisions, you'll beat the giant who needs three levels of approval to arrange a late night delivery.

But if you are the big guy, you just need a different approach to strategy. Perhaps you can dedicate a production line to a captive client. Or the client may be large enough to justify an entire dedicated sales team -- inside sales, out side sales and sales engineer, whereas your smaller competitors can't free up three people for one customer, even if they could take the business away from you.

Greenwald and Kahn believe that because of the edge it gives incumbents in both winning new generations of customers and new generations of technology, the combination of economies of scale and customer captivity produces the most sustainable competitive advantages.

Three aspects of economies of scale have strategic implications for incumbents.