Exciting new technologies enter our lives at an ever-quickening pace, shaping the future for decades to come, but the bulk of a firm’s current revenue and earnings come from well-established technology platforms. For companies to compete in today’s economy, they must focus delivery of their product and service offering on the benefit attributes that customers value most, and accomplish this in a lean and cost-efficient manner.

So if we accept that statement, the question for senior leaders becomes “what stands in the way of accomplishing this task?” We must ask ourselves “Is the product line and customer complexity that developed with the business now impeding efforts to move forward in important areas?”

Following a typical industry life-cycle, product lines experienced rapid growth, followed by slowing growth, consolidation and in some instances decline. During the days of rapid growth, organizations focus on new customer acquisition while simultaneously testing the limits of the new technology. Frequent design “tweaks” are common and often aimed to satisfy specific customers’ needs and create minute points of competitive differentiation. New customers become greedy with their requests for a highly customized product. The combination of an unbridled “sales-driven” approach with high levels of customization and a developing technology suite, creates a recipe for product proliferation. The financial impact of an overly complex product line that sub-optimizes manufacturing productivity is often masked in the “rapid growth” phase of the cycle by higher selling prices and margins.

Growth and margins attract new entrants, each positioning to claim a piece of “rapid growth” for their shareholders. As the new technology takes hold, growth naturally flattens out. To the extent over-investment in capacity occurs, competing firms vie for market share to absorb fixed cost. Margin compression inevitably leads to consolidation through mergers and acquisitions. Sound familiar to anyone?

A firm competing in the “difficult middle” of the cycle may typically find a product portfolio comprised of complex over customized products from two or more legacy companies that were combined to create the current business entity. The portfolio often includes less advanced technology developed and supported for a specific customer, but not necessarily as robust or cost efficient as later designs.

Addressing Product Portfolio Complexity

Tackling the task of product line rationalization can prove daunting given the complexity of most businesses – thousands of customers and thousands of products. A structured approach such as the DMAIC [1] process from six-sigma can prove highly effective in focusing this effort. Following this framework, a critical feature of the define phase is “voice of customer.” In other words, the project needs to be framed in a way that delivers the clients’ priority benefit attributes (e.g., lead time, applied cost, product consistency, ease of application, etc.) Portfolio rationalization occurs not for convenience of the organization, but rather as a means to an end for the client.

As with many things in life, a quick study of the product portfolio typically reveals the all-too-familiar 80:20 rule – 80 percent of revenue or profit comes from 20 percent of the products. Illustration 1 shows a hypothetical company’s cumulative gross margin by number of products manufactured.

So, confronted with the situation present in Illustration 1, do we simply “chop off the tail” by discontinuing roughly 600 products that drive only a few percentage points contribution to the firm’s total gross margin? Send the letters, new business rules, and call it a day? As appealing as this may appear let’s consider the likely outcomes. First, on the positive side, manufacturing efficiency would no doubt increase – larger batch sizes, fewer materials to procure, reduction in technical complexity, as well as less space and working capital committed to inventory. Additionally, many of the lower contributing products are undoubtedly “dogs” placing disproportionately high demands on all forms of service and after-sale support.

Now I must introduce a little reality: the customer portfolio and product portfolio most certainly do not perfectly overlap. A four-quadrant view as presented in Illustration 2 can prove useful in understanding the customer-product relationship.

Some quick explanation of the table is in order. The 1000 products produced by the firm have been arranged by two dimensions – Strategic Customer (Yes/No) and Strategic Product (Yes/No). Thus far, we have spoken only of sorting products produced by total contribution to firm gross margin. Although this represents a good directional indicator, I would argue for a more comprehensive view of individual product and customer value. Some suggested additional criteria are outlined in the Table 1. The correct criteria will vary, but a firm’s customers and products should be sorted in a way that gives full consideration to both current and potential business results.

Table 1 – Additional Factors

Customers

Products

Strategic market

Ease of manufacture

Growth potential

Differentiated technology

Competitive rivalry

Product reliability

Relationship strength

Performance versus alternatives

Financial health

Favorable cost position

Degree of collaboration

Intellectual property protection

Appreciates Technology

Multi Customer Appeal

Returning to Illustration 2, I want to call your attention to a very important feature of the data – in some measure, strategic customers buy non-strategic products. Likewise, non-strategic clients purchase strategic products. Let us consider this point quadrant by quadrant.

Strategic Customers and Strategic Products:

This group of 125 clients embodies the criteria identified as consistent with advancing the firm’s business strategy. The 250 strategic products they purchase represent the best of the best, delivering the highest levels of customer value and competitive differentiation. These products define the state of the art for the business and the core nucleus of the product portfolio. None of these products should be discontinued at this time. In our hypothetical example, these 250 products may represent 50-75% of both total revenue and margins. If you find this percentage puzzlingly low, consider that the strategic product set may include new products early in their life cycle and low in current annual sales volume.

Strategic Customers and Non-Strategic Products:

Most frequently, these products are older technology or very highly customized products.

In the context of a long term customer relationship, it is not uncommon for important customers to purchase outdated technology because salespeople have not been proactive in introducing newer replacements to existing products. It often takes the advances of a competing firm to make the client aware of better alternatives.

This discovery can destabilize the customer relationship leading to competitive entry and share loss. The action with the 250 products in our example is to continue supporting these products in the short term, but set an aggressive timeline to present clients more robust technology where available. I would expect that this group of products could represent 10-30% of both sales and gross profit. It is highly likely that some difficult, highly customized products will need to be maintained long term to support important clients.

Non-Strategic Customers and Strategic Products:

In the example above, 875 non-strategic customers consume 100 strategic products. To the extent the firm can control “cost to serve” (SG&A) proportional to the incremental revenue and margins these transactions yield, this represents good business. Marketing leaders should recognize this business as purely opportunistic, perhaps with the added benefit of driving some higher volume and better fixed cost absorption for select strategic products. Alternative channel strategies – independent representatives or e-channel – can prove helpful in controlling non-product costs while driving additional sales growth.

Non-Strategic Customers and Non-Strategic Products:

For the most part, these products should be discontinued and where practical, customers offered alternatives from the strategic product set. Many of these products are highly customized and therefore without a replacement from the established strategic products. Nonetheless, in some instances the customer and coatings firm will realize a win-win situation as discontinuing the non-strategic product causes the client to migrate to more robust technology. Before initiating wholesale discontinuation of these 600 products, we must be mindful of the overlap between strategic and nonstrategic customers; in our example this is 110 products.

Importance of Overlaps: To take this point one step further let’s look at the implications of the following overlaps:

Strategic products: There are a total of 260 strategic products. Strategic customers purchase 250 of these products, and non-strategic customers buy 100. Therefore, 90 products are purchased by both groups and only 10 strategic products are purchased exclusively by the non-strategic client group. Does it seem logical that the 90 products purchased by both groups may have the greatest appeal across a broad range of client applications? Could it be that these are the most robust and differentiated technology and represent a priority opportunity for the selling team? Likewise, might opportunities exist for the 10 products sold to non-strategic customers within the strategic client group? Could these 10 products possibly be “diamonds in the rough?”

Non-strategic products: Of the 740 non-strategic products, 110 are purchased by both client groups. More specifically, 250 non-strategic products are purchased by strategic customers and 600 by non-strategic customers. Therefore, discontinuing the 740 products would cause strategic customers to seek new sources for 250 products, destabilizing some customer relationships and potential introducing new competitors to the firm’s most valued clients. The coatings firm must evaluate on a case by case basis the cost and risk of discontinuing the 140 non-strategic products purchased exclusively by strategic customers.

Conclusion

Discontinuing products can be a frightening exercise. However, focusing the sales team on the best products should support competitive differentiation and growth. Additionally, the operational efficiency created from a streamlined product line will support a stronger and more responsive business with lower costs and lead-times.

References

  1. Define, Measure, Analyze, Implement, Control.