Smart Customization

Profitable Growth Through Tailored Business Streams

The way a company responds to demands for customized products or services can make the difference between performance that leads a sector and performance that lags that of industry peers. A Booz Allen Hamilton study of product and service companies found that Smart Customizers companies that focused simultaneously on value creation strategies and delivery alignmentoutperformed industry peers two-to-one in revenue growth, and had profit margins 5% to 10% above competitors. Companies that failed to align the value of variety with the cost of complexity were five times as likely to grow at rates below their industry average.
The striking customer popularity and financial success of Southwest Airlines, Nucor Steel, and Commerce Bank have led many business executives and corporate strategists to proclaim that focus is the only viable approach to fending off competitors and achieving above-average shareholder returns. We disagree. At some point in a firms evolution, its focused market whether premised on geography, product, service, or segmentwill inevitably become saturated. The challenge for companies is not achieving a single point of focus. It is harmonizing multiple points of focus. In industry after industry, customers are demanding ever-higher levels of customizationproducts and services tailored to their needsand theyre confident that, in an economy characterized by greater and greater information transparency and sophisticated purchasing, they stand an excellent chance of getting it. The way a company responds to demands for customization can make the difference between performance that leads a sector and performance that lags that of industry peers. Indeed, companies that more effectively balance the value that customization brings to their customers with the complexity costs it can impose generate organic sales growth and profit margins significantly higher than their industry average, according to a Booz Allen Hamilton study of product and service companies in North America and Europe. The study, which benchmarked business units with sales from $1 billion to more than $20 billion at 50 companies, found striking differences between companies that adapted and aligned their customer strategies and fulfillment operations, and those that constructed more ad hoc responses to customer demands. Although no company studied had achieved complete alignment between its demand side and its supply side, the study revealed a two-to-one performance gap between Smart Customizers and Simple Customizers. (See Exhibit 1.)
Exhibit 1
Smart Customizers vs. Simple Customizers
Customer Insights and Value Creation
High Low

Smart Customizers
(42% of participants)

Supply-Side Customizers
(14% of participants)
I

Delivery Aligned with Cost Drivers and Account Value

High
I

Twice as likely to have growth rate above industry average More likely to have profit margins above industry average

Half as likely to have growth rate above industry average Profit margins above industry average

Average Customizers
(11% of participants)
I

Simple Customizers
(33% of participants)
I

Low
I

Growth rate in line with industry average Profit margins in line with industry average

Five times as likely to have growth below industry average More likely to have profit margins below industry average

Source: Booz Allen Hamilton analysis

The research encompassed such industries as consumer goods, chemicals, telecommunications, media, and financial services. The Booz Allen study, conducted over six months and involving such companies as Unilever, Campbell Soup, Rohm & Haas, BP Castrol, Sprint, Ericsson, Time Warner, Hearst Magazines, Fleet, and SunTrust banks, among many others, found that higherperforming companies consistently focus simultaneously on the same three best practices. Smart Customizers:

approaches to more routine customer demands. This ensures that a companys cost structure is not distorted by the high-customization needs of specific segments, and that differentiation is obtained without compromising scale. The problem is that most companies add variety to their product or service mix indiscriminately. Moreover, most companies dont target customer needs well enough to provide products and services that are order winnersofferings that set one company apart from another. Just as importantly, they dont have a deep enough understanding of cost drivers and cant distinguish between easy and difficult forms of customization, which limits their ability to maintain scale efficiencies. Consequently, customization programs frequently fuel an arms race with competitors that constricts growth and lowers profit margins. By providing customization for too many customers without asking the critical question, Is the additional variety worth the costs incurred?, companies undermine their own economies of scale. At the same time, unwarranted customization takes resources away from the highest-priority accounts and limits a companys ability to invest in more of the right opportunities. Simply put, the failure to fully balance the demand side of the equation with the supply side leads to customization initiatives that fail to deliver incremental growth in line with the programs costs. Smart Customization Index To help assess how Smart Customization translates into value for both customers and providers, we designed the Booz Allen Smart Customization Index. The index seeks to measure how fully companies are implementing Smart Customization, and to quantify its value in driving profitable growth. By synthesizing our initial benchmarking findings and Booz Allens client experience, we developed 36 best-practice criteria in customizations two component dimensions: 1) customer value creation; and 2) delivery alignment between cost drivers and account value. We then fine-tuned the weighting of the criteria, on the basis of their relative importance in predicting performance. The index provides a composite snapshot of how well a company is doing against the set of

Understand the sources of value that customization provides their customers Find the virtuous varietythe point at which customization adds value to both company and clientele alike Tailor their business streamsproduct development, demand generation, production and scheduling, supply chain, customer care, etc.and align them to the sources of demand, to provide customer value at least cost

Although Smart Customization seems like common sense, our study reveals that comparatively few companies are successfully balancing the value of customization with the cost of complexity. Our research showed that roughly two-thirds of companies with customization programs have failed to increase both their top-line and bottom-line performance. For the most part, we found that superior strategies were not matched by superior execution. This is not a challenge that can be addressed solely by investing in an expensive CRM information system, or by reorganizing a sales force. Smart Customization requires striking an overall balance between the value of product or service variety in the market and the cost of complexity in provision across multiple business functions. And not just for today: Companies also need ways to refresh the solution as they evolve new growth strategiesfrom the addition of new products and services to entry into new market segments. Differentiation With Scale By aligning their sales, marketing, and operations strategies with customer value, leading companies are able to provide some customers bespoke solutions that truly drive organic growth, and provide transactional

Exhibit 2
Growth and Protability Through Smart Customization Smart Customization Drives Higher Growth (99% Statistically Significant)
4 8 6 2 Profit Margin Index 4 2 0 -2 -4 -6 -4 20 30 40 50 60 70 80 Booz Allen Smart Customization Index Score -8 20 30 40 50 60 70 80 Booz Allen Smart Customization Index Score

Smart Customization Drives Higher Profit Margins (99% Statistically Significant)

Growth Index

-2

Notes: (1) Company growth index based on comparison of 3 year CAGR vs. industry peers to normalize across industries (15 industry peer groups used) (2) Company margin index based on comparison of operating margin vs. peers to normalize across industries Source: Booz Allen Hamilton analysis

best practices we identified. When we add together a companys scores on both value creation and delivery alignment, a company receives a score between 0 and 100. Those with total scores above 50, composed of above-average scores in each of the two dimensions, we labeled Smart Customizers. We then compared all the companies in our crossindustry, 50-company sample to their industry peers, a total universe of 600 companies in 15 sectors. Smart Customizerscompanies that focused simultaneously on both value creation strategies and delivery alignmentoutperformed industry peers by a two-to-one ratio in revenue growth, and had profit margins that were 5% to 10% above those of their competitors. Simple Customizerscompanies with index scores of 50 or lowerwere five times as likely to grow at rates below their industry average and had lower profit margins. (See Exhibit 2.) We found a very strong fit between a companys place in the Booz Allen Smart Customization Index and its revenue growth and profit margins compared with peers, with 99% statistical significance for both growth and margins. We believe the Smart Customization Index to be a superb diagnostic tool to assess any companys performance against a set of best practices that collectively power superior performance.

Simple vs. Smart The mobile telecommunications industry provides a clear illustration of the kind of complexity-burdened customization that has resulted in a profit-draining arms race among companies. Most carriers offer consumers and businesses a seemingly infinite number of calling plans. To keep up with their rivals, carriers continually add new programs, providing a proliferating array of sweeteners (free minutes, handset rebates, etc.) to win and retain customers. Business customers are pitched fleet management services for hardware distribution, usage tracking services, and wireline-network integration solutions that all too often are offered indiscriminately to highly profitable and marginally profitable customers. All customers are typically funneled through the same help and sales lines, where high-cost specialists, unversed in the multiple variations on calling plans, service packages and subscriber issues, cannot handle inquiries effectively. Instead of devising a tiered approach to customer service, where higher-end customers are provided specialized service to match the value they represent, carriers use the most expensive sales and marketing system for all customers. Faced with inadequate service and an array of hard-to-distinguish products, customers fail to develop loyalty to their wireless providers. Companies are forced to rely on new acquisitions to offset customer defections.

This senseless customization competition is eroding industry profitability. Operating margins for a composite of publicly traded wireless carriers in the U.S. fell from an average of 10% percent in 2000 to -13% in 2002. By contrast, Smart Customizers take a differentiated approach that is based on a customers unique needs and the value the customer returns to the business. Consider the dramatic transformation of one specialty metal alloy producer with which we worked. Previously, the company segmented its market by product application and by territory. It prioritized customers by their past spending only, with no distinction among customers based on purchasing behavior or profitability. But customer needs did differ significantly; different order winners appealed to different customer segments. Some competitors understood these differences, and cherry-picked the most valuable, high-volume accountsthose willing to pay a premium for justin-time delivery. Others focused on serving customers that valued low price over lead times, even if it meant switching suppliers regularly. Faced with these more focused competitors attacking its flanks, the company was losing share and sustaining losses. It tended to produce too much of some products to boost efficiencies, while going out of stock on some grades for weeks at a time. It incurred net losses in serving price traders at the low end of the market, as the costs of excess inventory swamped any savings from shaving a few cents per pound off each order. And because of long run times between set ups, the company experienced frequent stock-outs and long lead times, which prevented it from meeting the needs of just-in-time customers. To solve these problems, we helped the company develop a segmentation strategy that balanced the needs of different customer segments with an understanding of how different decisions drove complexity and cost in its business model. On the basis of this analysis, we helped the company customize its approach, to serve price traders and quality partners differently, with ramifications across sales, marketing, production scheduling, logistics, and customer care. We helped

the company restructure its sales force, developing a three-tiered system with dedicated customer teams for quality partners, and a mix of field, telesales, and distributors to serve price traders. We also redesigned its production and delivery processes according to a product wheel that changed alloys and specs every few days, not weeks, and restricted price traders access to higher-cost technical support. This transformation resulted in a doubling of the companys growth rate, a halving of inventory, and a reduction in lead times from an average of six weeks to as little as a few days for strategic customers willing to make a volume commitment. By focusing on the right order winners for each segment and aligning its organization and business streams to these market needs, the company was able to beat its focused competitors at their own game. By serving both segments of the market, it gained greater scale, even as its approach to tailoring its business streams drove striking quality improvements and cost advantages that its competitors could not easily replicate. Optimizing Complexity Companies dont set out to become Simple Customizers, naturally. Rather, the gap between Smart Customizers and most of the companies in our research that show little gain from customization seems to grow over time, as customer strategies evolve. (See Exhibit 3, page 5.) To fully capture the benefits of Smart Customization, companies must focus on three sources of improved performance: 1) Understand the sources of value from customization Companies often attempt to generate additional value through more differentiation and more complicated segmentation approaches. They add assortment, insert new specifications to products, create brand extensions and design value-added services. Over time, competitors also add more variety, segmenting the market more narrowly, to differentiate themselves and to stimulate additional demand. Typically, the focus is on capturing the next share point without fundamentally changing the production and delivery system. Costs remain under reasonable control, and profits increase.

Problems arise, though, when companies over-shoot the optimum level of complexity. Further customization efforts start to cut into margins. Soon, they reach a tipping point at which the additional complexity drives costs up faster than the incremental revenues from differentiation. This requires periodic efforts to rationalize the product portfolio, weed out unprofitable accounts, or ration services more aggressively. But many companies lack the customer profitability metrics they need to do this. Whats more, when youre engaged in a customization competition with industry rivals, its hard to keep an eye on growth and costs simultaneously. Most companies end up driving customization efforts with one foot on the gas and one foot on the brake; they get nowhere fast, and wear out their performance engine. Simply striking an appropriate balance between more and less variety can certainly boost growth, but it isnt enough to generate superior earnings or shareholder returns. 2) Find the virtuous variety To generate a step change in performance and positively shift the revenue curve from customization (Exhibit 3, arrow 2), companies must gain a deeper understanding of different segments needs, and distinguish the unique requirements of some segments from the needs common to all. This can be accomplished by separating order qualifiers from order winners.
Exhibit 3
The Smart Customization Performance Curve
Revenue Versus Cost Impact of Smart Customization

Order qualifiers are products and services that enable companies to stay in the battle with competitors. Theyre often not drivers of growth, though, because they are part of an arms race in which minimum product and service requirements continually escalate, regardless of whether they produce sustainable gains. In our metal alloys example, price, though critical, did not set competitors apart from one another; it merely qualified them for an order. By contrast, order winners are products and services that meet a customers most critical needs. At the metals company, lead times were an order winner for the most valuable customers. Order winners can vary across segments, whereas many threshold needs are shared across segments. By developing a clear understanding of what customers order winners are, a company can create customized offerings that capture market share and deepen strategic relationships, while preserving scale economies. 3) Tailor business streams to provide value at least cost Smart Customizers match their segmentation strategies with delivery mechanisms designed specifically to serve each segment profitably. In our parlance, they tailor the business streams to provide the highest value at the lowest cost.

Sources of Improved Performance

1 Understand Sources of Value from Customization

Customer Insights and Value Creation
I

Revenue From Customization ($)

2 New Max Profit 3 Cost Curve with the Complexity Cost Curve with the Complexity Contained

Differentiate from competitors through additional customization (e.g., assortment, services) Rationalize customization without clear cost benefit to maximize profits

1 Revenue Max Profit

Operating Cost

2 Focus on the Right Customization Not Just More

I I

Develop clear understanding of order winners across different segments Introduce customized offerings that capture share and deepen strategic relationships

Delivery Aligned with Cost Drivers and Account Value

3 Tailor Business Streams to Provide Value at

Least Cost
I

Low Customization

Optimal Product/ Service Breadth

Greater Product/ Service Breadth Enabled

High Customization

Better align delivery model with needs that differentiate performance for key segments Redesign key processes to meet needs while reducing overall cost-to-serve

Customized Value Proposition And Delivery

Source: Booz Allen Hamilton analysis

Exhibit 4
Tailored Business Streams

Define sources of value (dimensions of customer need) Identify and quantify opportunities to capture value Product innovation (speed and frequency) Differentiated service levels New channels Targeted campaigns and promotional efforts Differentiated pricing Unique packaging Bundling to expand value proposition Shift from "transactional" to "solution" sales approach for strategic customers Define sources of value (dimensions of customer need) Identify and quantify opportunities to capture value

Understanding Value (Demand)

Understanding Cost-to-Serve (Supply)

Understand drivers of cost-to-serve and complexity Identify performance improvement levers Understand mix of common versus unique and hard versus easy needs across and within customer segments Build alternative segmentations of delivery systems to satisfy participation requirements

Define Best Fit

Quantify trade-offs (speed versus quality versus cost) Select value propositions Pick delivery infrastructure to align with sources of value Align people, processes and organization Embed enabling systems and technology Define performance metrics and accountability Aligned leadership Agree on priorities Mobilize

Realign the Organization

Manage Change and Execute

Source: Booz Allen Hamilton analysis

Think of these Tailored Business Streams (TBS) as separate, mini-operating models. (See Exhibit 4.) Each stream may contain people, processes, and technologies to deliver parts of the product/service offering. Each stream caters to different expectations for cost, quality, speed, and innovation. Each has the appropriate management tools and processes in place to deliver at the lowest cost with the greatest return. But these streams flow together into a consciously integrated whole that isolates the highly complex and expensive parts of the business from the standardized portions. This ensures that the companys cost structure is not distorted by the high-customization needs of specific customer segments. It allows a company to create a high degree of differentiation without compromising scale. In addition, a company gains the ability to continually align its business streams with changes in customer value, providing solutions where merited and more transactional approaches where customer needs and economics require them. Tailoring business streams is one of the clearest methodologies for optimizing the complexity that is a natural by-product of an increasingly competitive, transparent, and interdependent economy. Businesses can flow the simplest and most predictable products/services through the most efficient and least expensive business stream. Harder, less predictable undertakings

flow through a more robust (and expensive) infrastructure. The streams can be kept distinct to prevent pollutioneasy operations dont require the expensive management and operational infrastructure that more complicated activities need. The streams also include guidelines to help companies tune them as market conditions and costs change over time. We have developed and implemented TBS approaches for companies in numerous industries, ranging from complex, engineered product industries, such as aerospace, to service-intensive industries like banking and telecommunications. Smart Customization through Tailored Business Streams has had a profound impact at these companies: At the service center for a leading U.S. bank, a TBS approach halved implementation time and increased customer satisfaction by 50%; at an aircraft producer, a shift to TBS cut billions of dollars from the cost structure; at a telecom services provider, TBS helped double the installation rate. Meeting rising customer demand is a daunting challenge for all businesses. Building Smart Customization requires analytical insight and an understanding of the sources of value and drivers of cost, experience in identifying trade-offs, the ability to design solutions, and the change management skills to follow through. We believe the destination justifies the journey.

Methodology
We explored approaches companies are taking in segmenting customers and customizing products, services, and processes to market needs, in order to evaluate how more customized approaches create value for customers and for suppliers. Our goals were to nd what linkages exist between specic behaviors and improved business performance; determine the length to which high-performing companies go in customizing their products and services, sales and marketing, operations, and customer service; and identify specic success factors and pitfalls of customization programs. We researched corporate operating units, with sales from $1 billion to $20 billion+, from 50 different companies, split evenly between North America and Europe. Product and service industries were represented; participants included companies in consumer goods, chemicals and gases (e.g., resins, lubricants, industrial gases), commercial banking, media, pharmaceuticals, telecom equipment, telecom carriers (both wireline and wireless), and utilities. Participants lled out a detailed written survey. Topics included segmentation, approach to customizing products and service levels, approach to aligning operations and the organization, analytical capabilities, IT systems support, performance measurements and incentives, and company data. We then conducted more than 150 in-depth management interviews across all 50 participants, including, for example, the CEO, head of sales, head of marketing, general manager, head of strategy, quality manager, and customer care manager. By synthesizing the interview ndings, general ndings from Booz Allen experience, and a statistical analysis of survey data to identify those behaviors that explained higher growth and protability, we identied a set of 36 best practices in customization and constructed a Smart Customization Index that weighted the criteria to reect their relative importance in driving higher growth. These weightings were based on multiple statistical approaches. Using peer groups to normalize for industry differences in growth and protability, we were able to demonstrate that a higher Smart Customization Index score is 99% statistically signicant in predicting both growth and prot margins above those of industry peers

What Booz Allen Brings

Booz Allen Hamilton has been at the forefront of management consulting for businesses and governments for more than 85 years. Booz Allen combines strategy with technology and insight with action, working with clients to deliver results today that endure tomorrow. With over 13,000 employees on six continents, the firm generates annual sales of $2.2 billion. Booz Allen provides services in strategy, organization, operations, systems, and technology to the worlds leading corporations, government and other public agencies, emerging growth companies, and institutions. Booz Allen has been recognized as a consultant and employer of choice. In a 2003 independent study by Contact Information CLEVELAND Leslie Moeller Vice President 216-696-1767 moeller_leslie@bah.com NEW YORK Matthew Egol Principal 212-551-6716 egol_matthew@bah.com SAN FRANCISCO Karla Martin Principal 415-263-3712 martin_karla@bah.com Kennedy Information, Booz Allen was rated the industry leader in performance and favorable client perceptions among general management consulting firms. Additionally, for the past two years, Working Mother has ranked the firm among the top 10 in its 100 Best Companies for Working Mothers list. To learn more about the firm, visit the Booz Allen Web site at www.boozallen.com. To learn more about the best ideas in business, visit www.strategybusiness.com, the Web site for strategy+business, a quarterly journal sponsored by Booz Allen.

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