Monthly Archives: June 2009

How Consumer Spending is Changing

consumer spendingUS consumers have responded to the global economic crisis by curtailing their expenditures, paying down debt, and saving more—all logical responses to a recession. Yet most consumers have acted by choice, not necessity. Spending, saving, and debt averages are not at abnormal levels today but rather returning to long-term trends. It was the behavior of US consumers during the past two decades, our research shows, that was the aberration. The return to traditional spending patterns will cause companies to adjust to a fundamentally altered playing field.

In a McKinsey survey conducted in March 2009, 90 percent of the US respondents said that their households had reduced spending as a result of the recession—33 percent of them “significantly” so. The survey, which included 600 households in three consumer segments comprising around 40 percent of all US homes,1 found that 45 percent of those who reduced spending did so by necessity, 55 percent by choice.

Courtesy of the McKinsey Quarterly.

Throw Out Your Old Marketing Playbook

marketing-fork-in-roadAround the world, marketing and sales executives are being asked to do more with less. It’s a demand many have heard in previous hard times, and most managers muddled through then. But the nature of the current downturn—and of the changes the marketing and sales environment has undergone since the 2001–02 recession—suggests that those who follow the survival techniques of past slowdowns risk betting on the wrong markets, customers, advertising vehicles, or sales approaches.

In previous downturns, many marketers doubled down on large, historically profitable customers, geographies, and market segments. Today, this approach may prove ineffective because the world’s economic woes are affecting customers and markets in unexpected and extremely specific ways. Marketers should therefore toss out those historical expectations and focus on the emerging pockets of customer profitability.

Cash-strapped marketers have also typically emphasized traditional media, such as television and newspaper ads, while cutting back on new advertising vehicles. But marketing has evolved rapidly over the past decade, with traditional media declining in importance as the Internet and social networking achieved meaningful scale. Marketing executives trying to rationalize media spending must factor this new balance into their austerity programs.

Another common approach for marketers trying both to cut costsand safeguard revenue has been to slash back-office sales overhead while continuing to invest in frontline salespeople. The evolution of the sales force in recent years means that marketers should take a much more nuanced approach. Companies used to regard the “feet on the street” model as their primary lever for increasing sales. Now they rely on a mixed model—customer-centric frontline product specialists and industry-specific sales managers who play a coordinating role—to provide better service and target new revenue opportunities. If executives ignore these new practices when they rationalize sales programs, hard-won customer relationships, revenue streams, and margin gains may be at risk.

Of course, not everything from the past is outmoded: marketers must still reexamine the value propositions of their brands, fine-tune products and pricing, and manage the cost of media agencies and other vendors carefully. But these steps aren’t enough. To weather the storm, it will be necessary to identify anew who and where the profitable customers are and to prioritize the most effective marketing and sales vehicles for reaching them.

When marketing and sales executives do so, it’s critical to bear something in mind: the broader forces at work in the global economy mean that the underlying economics of strategies could continue shifting with unprecedented speed and scale. Such extreme uncertainty demands constant attention, frequent reprioritization, and strategies that anticipate and respond to a changing landscape.

Where to invest sales and marketing resources

The impact of recessions always varies across economies; for one thing, unemployment levels rise at different rates in different regions. This time around, however, global economic conditions are affecting different geographies and demographic groups in even more diverse and complex ways. 

  • A global credit crunch and the attendant volatility in commodities are whipsawing economies around the world in different ways at different times, which means the relative attractions and risks of customers and countries are shifting rapidly.
  • The housing sector is contracting in markets around the world, but the level of mortgage default rates and the effect on consumer spending vary across and within regions. In the United States, for example, Arizona, California, Florida, Michigan, and Nevada have been hard hit, while other states less so.
  • Historically attractive demographic groups have experienced major reversals of fortune. The nest eggs and retirement prospects of the baby boomers, for example, have been dramatically reduced by rapid declines in equity and housing values. This development raises the possibility of significant shifts in spending. 

These disruptions suggest that the old tactic of focusing on historically profitable regions and customer groups will miss the mark. Instead, marketing and sales executives must reprioritize geographic markets and customer segments at every shift of economic fortune.

Reprioritizing geographies

Multinational companies will have to reassess their growth forecasts for the countries where they compete. Even assessments conducted as recently as 2008 should be reexamined, since the crisis has affected every country on Earth.

One global technology company, for example, recently began a major repositioning that shifted its marketing expenditures from developed countries to emerging ones offering higher projected growth rates and weaker competitive pressures. Recent economic events, though, have invalidated some of the territory-by-territory profit assumptions and significantly changed the time horizons of expected growth for others. The company recognized that its broad-based pre-crisis repositioning effort would generate disappointing results, so it is now working to identify markets with better prospects in this tough economic environment.

Companies can protect their revenues and profit margins by taking this granular approach a step further. Even within sectors or geographies that seem down across the board, the rates at which potential customers grow or decline vary substantially. While it is well known that the US manufacturing sector, for example, has weakened considerably over the past few years, manufacturing GDP has actually expanded in many counties across the country. In fact, from 2006 to 2007 the manufacturing revenues of companies in these counties rose by $97 billion, roughly two-thirds of China’s manufacturing growth over the same period. In Michigan, one of the hardest-hit states in the US Midwest, growth rates vary by double-digit percentages, and manufacturing revenues in the top counties rose by nearly $2 billion in 2007. Of course, no marketing strategy could now rely on these outdated figures. But a similar analysis today, probably at an even more detailed level, would in all likelihood help a company that sells manufacturing supplies to focus its scarce sales resources on growth counties instead of deploying resources across the board in a declining market.

Consumer marketers with access to micromarket data have even more opportunities to enhance profitability. One beverage company recently conducted surveys that identified staggering differences in the potential profitability of customers within individual markets and micromarkets. The price sensitivity of the respondents varied by as much as a factor of 13 across regional markets, a factor of 5 across cities within them, and a factor of 3 across zip codes within individual cities. Armed with this level of detail, a company can maximize its profitability by focusing on micromarkets less sensitive to prices while also offering discounts or preferential pricing elsewhere to drive sales volumes.

Reprioritizing consumer segments

Much as the profitability of different regions and micromarkets has shifted, fluctuating unemployment rates, equity prices, and housing and fuel costs have changed the profitability of consumer groups that cut across geographies. In many cases, changes in consumer behavior will force companies to reallocate marketing resources from historically attractive segments. Some groups that until recently had been major contributors to spending growth will become less profitable. Affluent young professionals, many of whom work in the financial-services sector, probably won’t continue to fuel historic levels of growth in luxury goods, for example.

In other cases, the shock of the economic crisis could accelerate longer-term shifts in the spending and attractiveness of segments, such as the baby boom generation in the United States, as well as its counterparts in Japan and Western Europe. The high spending rates of the boomers made them a sought-after and profitable customer segment for many companies. The “wealth effect” of real-estate appreciation, along with the gains (or hopes of future gains) of the equities in the boomers’ retirement accounts, enabled much of this spending. Indeed, many boomers were borrowing against these assets to pay for their lifestyles. As a result, US boomers have saved less for retirement than previous generations did.

Today, the one-two punch of depressed housing values and big losses in equities means that many boomers face uncertain retirement prospects and can’t continue to spend as they once did. In fact, they will have to reprioritize their spending across categories en masse. In 2006, when we asked boomers how they would cut their overall expenditures by 20 percent, the respondents singled out clothing, personal care, home furnishings, and travel for cuts but said they were less likely to reduce spending on necessities like food, housing, and health. For companies in the sectors, such as home furnishings, that will probably bear the brunt of these spending shifts, the task ahead is to target demographic segments with better growth prospects.

Reprioritizing business-to-business opportunities

Business-to-business (B2B) companies must go a step further. A fresh look at segments isn’t enough; instead, such companies must reexamine their opportunities and risks on a customer-by-customer basis. Of course, they must start by assessing the basics: whether a customer has enough cash or liquidity and the likelihood that such funds will survive. Then they should think about how the crisis will affect all aspects of their profitability.

Many suppliers, for example, have long-standing agreements to offer volume-based rebates to their customers who are distributors. But the weak economy may cut the volumes of some distributors drastically, so that they no longer qualify. Similarly, some customers may find their economics undermined by volatility in the price of their key inputs, such as fuel and other commodities, and will therefore no longer be able to buy at the volumes and prices suppliers expect. Suppliers must stay alert to these possibilities and respond accordingly.

For a leading manufacturer of industrial controls, such shifts have drastically affected margins, transforming what a year ago was one of its most profitable accounts into one of the least profitable today. In the past, this account rated preferential attention and service, flexible terms, and high levels of tech support. Now, it calls for aggressive corrective action—reining in costs to serve, renegotiating rebates, encouraging more efficient order quantities—of a kind that would have been unthinkable not long ago.

How to invest marketing and sales resources

In addition to putting resources into the geographies and customers with the greatest profit potential, executives must emphasize the media and sales efforts most likely to deliver such profit. In previous downturns, that meant investing in proven advertising vehicles while cutting back on newer ones with shorter track records, as well as focusing resources on sales reps while trimming central back-office functions.

Over the past several years, however, the challenges of marketing proliferation have created a more complex mix of marketing vehicles and sales models.4 Historical responses or across-the-board cuts may be exactly the wrong thing in this recession (see sidebar, “Budgeting on autopilot”). A more nuanced approach is required.

Reprioritizing advertising vehicles

New communications vehicles such as the Internet, social networking, and mobile devices are gaining scale and delivering effective results. Meanwhile, classic media such as television have become, at a minimum, much more costly. Most marketing plans therefore try to meet their objectives cost-effectively by using a mix of traditional and new vehicles, with the latter typically accounting for 10 to 15 percent of spending.

A reprioritization of this kind requires a better understanding of the effectiveness of different forms of advertising than many marketers have today. These marketers, who assume the reach and cost of a vehicle serve as a proxy for its effectiveness, ignore the vehicle’s quality—that is, its ability to influence customers. Quality is easiest to measure in direct businesses, which can precisely determine the return on investments in outbound catalogs or e-mails. But there are ways to estimate the quality even of harder-to-measure vehicles—such as television, product placements, and sponsorships—and to prioritize them accordingly.

Companies can maximize the accuracy of their quality assessments by combining a variety of information sources, such as quantitative customer surveys, postevent focus groups (for sponsorships or other on-the-ground marketing efforts), and workshops where marketing managers and outside experts from advertising and media agencies piece together a collective point of view. Several major consumer companies that recently conducted such workshops found the consensus reached in them extremely consistent with more in-depth, quantitative studies.

No matter how a company arrives at its quality assessment, the real power comes from combining that analysis with data on the reach and cost of an advertising vehicle. This combination of reach, cost, and quality helps marketers compare the impact of different vehicles on an “apples to apples” basis—the key to effective prioritization. As the experience of one representative company demonstrates, it is not uncommon to find a hundredfold difference between the impact of two different vehicles. There is no consistent pattern indicating whether traditional or new vehicles have higher scores for reach, cost, or quality, so marketers must make their own objective comparisons to eliminate ineffective vehicles without hesitation and to support high-impact ones with confidence.

  • To read the full article on The McKinsey Quarterly, click here »

Why Many Business Plans Fail To Deliver

man with a planAn economic downturn is a great time to start a business.

It sounds paradoxical, but think about it. Costs are lower, and more talent is available, thanks to layoffs. Prospective clients are more likely to try a new supplier who can help them cut costs or increase their competitiveness. Established players, too, are focused on cutting costs instead of increasing market share.

All of this helps clear the way for the next venture with the better mousetrap—but only if the entrepreneur can write a clear and convincing business plan.

Anything less is heading straight for the bin. Because, let’s face it, the intended recipients of such business plans—investors and lenders, family and friends, anyone with capital to invest in the project—are all much more wary of risk now in these turbulent times.

Truth be told, most business plans fail to make much impression on potential investors. Most aren’t even read in full. Their shortcomings tend to be obvious even in a two-page executive summary, largely because they are written before enough real work has been done to create a solid foundation.

I set out to understand why most business plans don’t deliver. Drawing on the hundreds of plans and pitches that I’ve seen over many years of working with entrepreneurs and early-stage ventures, I searched for common patterns in plans that gained no traction. The result? Five oh-so-common varieties of plans that go quickly into the trash without further consideration.

JOURNAL PODCAST

John Mullins speaks with the Journal’s Jennifer Merritt on how entrepreneurs can divorce their passion for a big idea from the business sense required to build a strong business plan and put their idea to work.

 

To help budding entrepreneurs avoid these traps, I also identified the three key elements that go into a successful business plan: a logical statement of a problem and its solution; a battery of cold, hard evidence; and candor about the risks, gaps and other assumptions that might be proved wrong.

In what follows, I will expose the deal-killers found in the five most commonly rejected types of business plans, and share tips for creating plans that should get you invited back for a second meeting and, if all goes well, raise some capital and attract some initial customers.

Here I Am, Never Mind the Problem

In this kind of plan, the writer is smitten with the elegance of his or her technology. The plan begins not with the identification of a customer problem to resolve, but with a detailed explanation of how the technology works, why it is cutting-edge or state-of-the-art, and how it is better, faster and cheaper than current solutions.

Such a plan is typically readable only by those already in-the-know in its particular technical realm. Even worse, seasoned investors know that the better technology does not always win. Remember Betamax?

A Me-First plan sends a clear signal that the writer’s priorities are misplaced. What matters more than great technology or a great idea is the problem or pain that the new solution or technology resolves.

There is a better way. A good business plan starts with a clearly defined problem—something that’s really troubling or compelling—supported by evidence from marketing research, testimonials, letters of intent, or whatever, that the pain is real.

If you can convince your readers that this problem is real, they’ll be hooked, at least for a while, as they read on to see whether you’ve found a solution that can resolve the pain. If the pain isn’t real, stop writing. There’s no need for a solution.

Next, identify exactly which customer group has that pain, even if the initial target market is a small one. Investors know that, if a sustainable beachhead can be established in an initial target market, success in a niche market can serve as a platform for taking the solution to other market segments as the business grows.

Consider Nike Inc., the leading maker of athletic footwear. Founders Phil Knight and Bill Bowerman, a distance runner and a track coach, respectively, addressed the quite literal pain of distance runners’ sprained ankles, shin splints and other injuries caused by the miles and miles of training on rough country paths in running shoes that just weren’t up to the task.

The new waffle soles of latex rubber that Nike came up with addressed runners’ pains head-on. The first shoes targeted elite distance runners, hardly a large market. But once distance runners started winning Olympic medals wearing Nike shoes, other runners—and sports—followed.

A Coke For Every Kid in China

Telltale Terms

Many business plans fail to deliver because they cloud the opportunity in a fog ofterms that make investors wince.  Here are some words and phrases to avoid.

Huge (as in “Our market is huge!”) Translation: The writer hasn’t bothered to get reliable data on market size, or has failed to think carefully about the initial target market, which almost always should be quite narrow. Nike’s initial target market of elite distance runners was minuscule, but it provided a solid foundation for growth.

Conservative (as in “We conservatively forecast that…”) Investors know that the initial sales numbers—never mind the profits—rarely pan out. So, let the numbers speak for themselves, based on the evidence you’ve gathered.

Revolutionary (as in “Our revolutionary technology…”) Translation:“We are so enamored with our idea that we have not thought clearly about how to distinguish it from other approaches and are not interested in what the customer thinks of it. Customers simply aren’t visionary enough to fullyappreciate our technology….”

Assumptions (as in “Assumptions for the figures in our financial statements”) If you are “assuming” most of your numbers, you’d better stop now. A far better notion is “Evidence that underlies each of the figures,” set forth in a table in front of the financial section so the figures can be readily used to stress test the plan in advance as well as to update the plan as further evidence becomes available.

We believe (as in “We believe that…”) Translation: “We haven’t bothered to obtain a shred of real evidence, because we’ve been too busy writing this business plan to actually gather any evidence, but it is our desperate hope that…” If you don’t have any evidence, stop writing and go get it!

No competition (as in “We have no competition.”) If there’s a single phrase that can send a business plan directly into the trash, this is it. Of course you have competition!  They just haven’t heard of you yet. To prospective investors, perhaps surprisingly, competition may be a good sign, as it suggests that there’s a problem that someone besides you thinks is worth solving.

 

This gambit rests its case on a plethora of secondary data to show how large and fast-growing a market is. The plan then makes a heroic leap and assumes that the new venture will grab X percent of that market—it could be 1%, 10%, 30% or whatever. “Surely,” the plan argues, “with the large number of customers in our market, we’ll easily get enough. We only need a small fraction to have a very nice business.”

Plans like this reveal that the writer isn’t sure what the initial target market is. It’s much easier to win a large share of a carefully targeted but narrow market—think Nike again—than it is to win a small share of a very large market.

Further, penetrating a new market requires customers who are aware of the new product, and distribution systems that allow them to buy it. Coke-for-Every-Kid plans gloss over these details. They ignore the difficult work—not to mention the expense—of crafting a strategy to gain market awareness, persuade customers, and set up distribution.

This kind of plan also often signals that the writer is reluctant to get out from behind his or her Internet connection and actually talk to prospective customers. Talking to customers is harder work, but brings all kinds of benefits and insights, not only to the business plan, but also to the business itself. Such conversations can reveal what customers really want—and help tailor the offering to meet those needs.

You can probably find secondary data that support such things as the size of your market and trends that suggest your market will or won’t grow. All such evidence should be cited, with its source, to show that the data are reliable and credible, and that you are, too. But that’s just the start. You’ll need primary data, too, from interviews you carry out or a survey you conduct, to demonstrate the likelihood that customers will buy what you have to offer.

Conduct some experiments, even a market test. The more hypotheses you can test before writing your business plan, the more convincing you’ll be. One caveat, though: If you wait for all of the evidence before you get started—analysis paralysis—the opportunity may well be lost, as someone else may beat you to market.

Every assertion in your plan should be backed up by evidence. If it’s not, take it out, or stop writing while you gather the evidence you need.

Just Look At Our (Paper) Profits

Of our five fundamentally flawed business plans, this one is perhaps the most difficult to spot.

The archetype is the failed Internet business Pets.com, which offered pet supplies via the Internet. Simply put, the economics of delivering large, heavy bags of dog food one at a time could not compete with the economics of putting pallet-loads of the same bags of dog food on supermarket or discount-store shelves and letting the customers do the delivery.

Such business plans often contain detailed spreadsheets showing why the numbers would work. That’s why these kinds of plans are difficult to spot—the numbers look like they work. As one entrepreneur told me, “With a couple of beers and an Excel spreadsheet, you can make a lot of money in no time,” or so it will seem. While consumers certainly liked the idea of having Fido’s dog food delivered, they were not prepared to pay a price that would enable the economics to work.

Savvy investors not only tear apart the spreadsheets but ask fundamental questions. Does the revenue model depend on making a large number of small transactions (think Amazon.com) or a small number of large ones (automobile manufacturing)? Do its profit margins depend on high gross margins to cover high product-development costs (think Microsoft), or lower margins to cover slimmer operating costs (Costco)? Is a large investment in development or other fixed assets required (a manufacturing facility, for example)? Is the working capital cycle favorable or unfavorable (do you expect to be paid in advance), or will you have to carry inventory and receivables that can tie up scarce cash (manufacturing and distribution businesses)? Some combinations of these factors are clearly attractive. Others are obviously flawed from the start.

Our Team Walks on Water

Investors won’t be snowed by top-tier diplomas or past employment with a leading company. Investors care first about the main challenges of the industry in question, and whether the proposed team has hands-on experience tackling those challenges.

Every industry has critical success factors—typically two or three—that, when addressed effectively, are likely to bring success even if less-important challenges aren’t handled well. Location, for instance, is a critical success factor in much of retailing.

A business plan that identifies its critical success factors and shows how the team’s expertise and experience are suited to addressing them is much more likely to attract capital—or at least a second look.

Here’s where candor helps, as well.

Surprisingly, plans that point out the lack of a key skill or capability in the management team can fare quite well, by acknowledging the missing link and encouraging the prospective investor to fill that slot with a qualified person whom he or she favors.

Plans that succeed in attracting capital often include one or more members of a team who have failed in a prior venture. When that failure is accompanied by lessons learned, it’s often viewed, as one investor told me, as “an education on someone else’s nickel.”

Everything is Wonderful

The most common type of business plan, and the one that goes most quickly into the trash, is the one in which the writer can’t find anything but good things to say about the opportunity and plans to pursue it.

Investors know that in the real world most opportunities, even good ones, have weaknesses. Typically, it’s not yet clear in an early-stage business whether the customers will buy, or buy at the price that’s been proposed. Most industries are not filled with infinite possibilities, either, especially given the overcapacity in today’s global economy.

Experienced entrepreneurs know better than to assert that everything is wonderful about their opportunity. They know there are potential pitfalls in their market or industry. The facts are that most opportunities are highly uncertain. Most new ventures will fail. Of the few that do succeed—winning capital, customers and positive cash flow—it’s usually not because of the original plan, “Plan A,” about which the business plan is written, but because of an as-yet-unknown “Plan B.”

Candor, again, is key. There probably will be some questions implicit in your business plan that have not been answered. Will your solution actually work? Will customers buy it? How much will they pay? How will competitors react to your entry? Does your entrepreneurial team have what it takes—the experience and expertise—to deliver on the critical success factors that apply in your industry?

Rather than attempt to paper over the rough spots and uncertainty, identify them yourself and deal with them candidly in your plan. A solid dose of candor will go a long way, compared with describing risks and then stating why they won’t occur.