MAXIMIZE THE “SURPLUS” IN YOUR CHAIN
Once you understand what drives consumer value and what drives cost, you can design and deliver products and services that strike the optimal balance between the two, thus maximizing “consumer surplus” (the difference between consumer value and total costs).
Yahoo! has succeeded where so many portals have failed because it has organized itself around many of the sources of consumer value on the Internet. It established first- mover advantage, which was critically important. Moreover, it developed features consumers
truly valued such as a compre- hensive, intuitive, and user- friendly guide to Web navigation, aggregated content, communica- tions services, and personaliza- tion, all of which have helped it create a strong online brand. That brand has given it license to enter new markets (e.g., chat, e-commerce) and allows it to maintain a huge user base that attracts advertising dollars. As a result,Yahoo! has met or exceeded consensus estimates every quarter since going public.
Dell developed a whole new approach to maximizing the consumer surplus in its value chain with its direct sales model, lean supply processes, use of the
Case Study: Power-by-the-Hour Contracts
The recent rise of Power-by-the-Hour contracts for aircraft engine maintenance is a good example of creating additional “consumer surplus.” The primary lever here is cost. The cost for spare parts has always been much lower for engine manufacturers than outside suppliers, since the original manufacturers have access to the original tooling and, for engines in production, can add incremental units to series production. Nevertheless, outside suppliers were eating into engine manufacturers’ market share for spare parts, as the manufacturers raised prices so high on these components that even cost-disadvantaged outsiders could compete profitably.
Engine manufacturers evaluated their value chain and identified an ingenious way to maximize consumer surplus. Rather than lower spare parts prices to recap- ture market share, they offered major airline customers Power-by-the-Hour con- tracts, in which they would maintain engines for a fixed price per flight hour. This allowed engine manufacturers to recapture share and profitability, and reduce costs further by replacing rather than repairing parts. In addition, manufacturers leveraged maintenance best practices over a larger pool of engines, reducing costs still further. And customer value was also enhanced, since airlines could now predict and budget for maintenance payments with greater accuracy. Since Power-by-the-Hour contracts do not reduce the market price for spares, they do not damage the manufacturers’ margins on their remaining parts business. It is not surprising then that Power-by-the-Hour arrangements are becoming increas- ingly popular.
Internet, and unwavering focus on driving P&L to each process in its business model. Dell builds PCs to order in a matter of days, often collecting payment from its customers before making pay- ment to its suppliers. This model is not easily copied, although certainly many are trying.
“PICK YOUR SPOTS” AND CAPTURE THE VALUE
While the entire value chain makes money, there are steps along the way that create value and others that do not. Moreover, there are steps that directly influ- ence the total value created by the entire chain. Companies need to recognize what parts of the value chain they can and should control to maximize their own value capture.
In organizing to capture that surplus, don’t ask the ques- tion, “How can I optimize my current supply chain?” As Peter Drucker once said, “There is lit- tle point in trying to do more cheaply what should not be done at all.”
Instead, focus on what the ideal value chain would look like. Taking this broader, more strategic perspective will help you develop an understanding of the key levers within your indus- try and build a strategic vision of how these levers may evolve. Once you know that, you can organize around just those areas that promise the greatest ongoing returns.