Should Innovation Continue During Inflationary Market Conditions?

Innovation may be the most powerful deflationary force in the world. Artificial intelligence, for example, is dramatically reducing training time and costs. Inflation should justify more, not less, incentives for R&D. That's because only emerging technology allows businesses to satisfy the market's demand for goods and services. The efficient scalability delivered by innovation outpacing present and future demand may be the only force keeping prices from increasing. Moreover, innovation in the form of automation reduces the demand for labor, the largest fraction of any organization's cost structure, and makes retained workers more efficient.

Innovation happens on a continuum. It can be incremental (a cool new feature on a smartphone camera) or completely disruptive (self-driving cars). Smart companies operate at both ends of the continuum. When employees have an innovative mindset, they are full partners in the exploration of innovative ideas and customer inputs. One strategy is to use existing products to enter new markets where there may be fewer inflationary issues.

Inflation and market volatility give the makers of products and services perceived as indispensable more pricing power. For example, ASML, a Netherlands-based semiconductor equipment manufacturer, has a monopoly on Extreme Ultraviolet (EUV) lithography, a necessary technology for the fabrication of the advanced microchips that power everything from iPhones and cars to jet fighters and blenders.

ASML sells to the three largest semiconductor companies in the world. In technical terms, it's a triopsony, an economic condition in which there are only three large buyers for a specific product or service. Limited competition means the three buyers dictate market demand and hence enjoy outsize bargaining power over prices. It's usually not an ideal situation for the selling company.

But because semiconductor manufacturers are under intense pressure from their own customers to increase supply, the market leaders such as Intel, Broadcom, and Qualcomm are desperate for higher production capacity. In such circumstances, ASML is in the driver's seat on pricing. ASML now demands premium prices not just for its current production but for guaranteed consignment of future production.

Innovate for Growth, Price for Profits

To break the cycle, innovate for growth and price for profits. To improve your pricing leverage, some element of your offerings must be differentiated. Otherwise, they are commodities, and the lowest price gets the business. The challenge for many firms is that their core offerings are commodities—or close to it. That's fine. There are customers that have basic needs. For the rest of your markets, differentiating from the competition is vital. In addition to high-value products, greater differentiation can derive from services.

The global steel industry is a great setting to see how this plays out. Steel, a technology developed around 1000 BC, is as pure a commodity as one can find. Large global competitors are buying up smaller basic steel plants around the world with the aim of dominating price-based competition. Yet niche opportunities for premium prices abound. Argentina's Tenaris SA provides high-value seamless steel pipes used in offshore drilling operations around the world—an application enjoying soaring demand as the petroleum industry moves farther offshore.

The growth of this market makes it attractive for the global giants, who can offer low prices to customers. In contrast Tenaris bundles high-value-added services with its premium steel pipes—a strategy that has been effective at keeping these global giants out of the market. Tenaris bundles advanced technical support, engineering, and just-in-time deliveries that help its customers improve their exploration and production operations. Their understanding of the way their customers operate—economically, technologically, and environmentally—differentiates them from the price-oriented steel conglomerates.

The net result: Tenaris and other niche players are able to command and protect prices of $2,000 per ton, over three times the prices the global commodity players battle over. Their understanding of customer operations and priorities enables them to gain far higher profitability margins and keep the titans at bay.

Sources of Innovation

There is no magic about where to find innovation. Customers know what is needed next. A good value-based approach to customer relationships identifies wide ranges of ideas for feature, product, and service innovations which customers value. The trick is to make sure they are willing to pay for the innovation as part of the discovery process. Then you have an idea of both the value of the innovation to them and the viability of the innovation for your business. There are four types of innovations to consider:

1. Incremental Innovation involves feature/service improvements of existing products into existing markets.
2. Disruptive Innovation is the development of modern technologies for your existing markets.
3. Architectural Innovation takes existing technology to new markets to expand a business globally.
4. Radical Innovation is the development of innovative technologies for new markets.

We fervently hope that the days are over of sending a team of technologists to the laboratory with the hopes that they'll yell “eureka” and produce your next silver bullet of growth.

Polaroid was a technological leader in instant photography using specialty chemicals. They were quite successful and knew full well that digital photography was the wave of the future. So they applied their chemical process to instant movies. Polaroid's Polavision was introduced at the same time as the first video cassette recorders (VCRs) were coming out. Introduced at a higher price with a lower quality, Polavision quickly hit the scrap heap of inwardly-focused innovation. We had a conversation with the chief engineer at Kodak where he scoffed at the failure of one of their competitors. He was blindsided several years later when Kyocera introduced the first camera phone.

Incremental innovation provides many opportunities for the innovative evolution of a business and your customer experience. Conduct interviews with non-customers to get ideas as well. Innovation for non-customers provides an excellent opportunity to expand your competitive footprint using value rather than price.

The Basics of a Good Offering Structure

To create high-impact offerings, set out some basic objectives. The basic objectives include:

• Matching offerings with the high-value needs of target customer segments.
• Offering low-value flanking products that appeal to price-sensitive customers and reduce the effects of price negotiations on high-value offerings.
• Meeting or beating competitive performance on core customer needs.
• Building strong fences between high- and low-value offerings to prevent customers from negotiating for high-value offerings at low prices.
• Training salespeople on how to have clear discussions with customers with choices that define price-value trade-offs during negotiations (Rule Eight).
• Arming sales with Give-Gets, well-defined product/service levers to alter offering value and price by adding or removing specific features.

An essential benefit of well-defined offering levels is that it enables your sales teams to better control price negotiations. Having both high- and low-value offerings puts sales in the driver's seat during price negotiations. If they are pressured to lower the price, they can offer the customer the low-value product. For some, the low-value offering will better meet their needs and budget, so they'll buy it. On the other hand, most poker-playing customers will react with indignation. They do this because the salesperson has called their bluff and exposed their true intention: getting the high-value offering for a low price.

The reality of managing this poker game is that it is a little bit more complicated than just having one high-value and one low-value offering. After all, you have multiple segments with different use cases to serve. And each customer within those segments may have varying needs. Setting up sales to control the poker game and better manage pricing requires creating more options for price-value trade-offs. To do this, it is helpful to think of constructing offerings with three levels: core offerings, expected offerings, and value-added options. Let's consider each in turn.

Value-Added Options: The Critical Role of Services and Solutions

Even though the logic of high- to low-value product offerings is compelling, it is not enough. Most firms are facing commoditization of their core products. Finding it harder to stay ahead of the competition, the smart ones have invested heavily in creating value-added options: services, consulting operations, and capabilities for outsourcing entire business processes.

Those firms that succeed create a cadre of loyal customers, competitive barriers, and confidence in their prices because they are creating superior value for their customers. Some of the service innovators have been at it a long time. Traditional product companies like GE and Air Products began developing their successful models many years ago.

Developing Services and Solutions to Create Pricing Leverage

Let's start by categorizing services. The first category is enabling services such as maintenance and support, postdelivery training, or predelivery design support. These types of services are often expected to be available, and that expectation is often misinterpreted as an unwillingness to pay for them. The rationalization to give them away is almost always the same: “We have to include those services to ensure that the product performs.” But customers will pay for them, and, accordingly, they should be an explicit part of the offering and price menus.

When sellers feel these services must be included, ask two basic questions. First, “At what level should our services perform?” Second, “What is the monetary impact for customers if there are different levels of performance?” The answers to these questions do two things. They force a definition of the boundaries between the expected and value-added levels for services, and they enable identification of customers and which are seeking high or low value. The second category of services are high-value adds and are often components of solutions to specific customer business problems.

Combining enabling services and value-add services can lead to the creation of powerful solutions for customers. Consider General Electric and its design of the GE90 aircraft engine. The GE90 was a modern design competing against older offerings from Pratt & Whitney and Rolls-Royce. Using new materials and engineering advances, the GE90 was a technological marvel. But at the beginning of the GE90’s development, it was also a commercial failure.

What happened? It turns out that GE hadn't done its homework in the area of customer value. While its engines were technically superior, GE, to its surprise, lost deal after deal to Pratt & Whitney and Rolls-Royce. The reason, as GE eventually discovered, was simple. Customers were reluctant to take the risk of change. They chose a product they knew over a product they didn't because with experience came predictable total costs of ownership.

GE responded by creating an entire solution around the GE90 that simultaneously addressed customers' financial concerns (their value needs) while demonstrating the competitive advantages of the engine's feature set. The new solution called “Power by the Hour” tapped into the old practice of leasing capital equipment so that customers could pay for a fully maintained and operational engine.

Logical, Disciplined Offering Structure

When we talk with product teams about the importance of low-value flanking products and value-adding services, they express two very real concerns. The first is fear that if they introduce a low-value option that it will cannibalize demand for their higher-value offerings. And second, they will not be able to control access to services. If either of these happens, it could wreak havoc with their P&L. The key to addressing both concerns is to create a series of fences to protect the organization from such threats.

One of the main reasons for having a logical, disciplined offering structure is to prevent customers from obtaining high-value offerings for unjustified low prices. The basic elements of the offering structure must enable the creation of fences to work. A fence is just what it sounds like: a means to protect the integrity of offerings by forcing a trade-off between price and value. An effective strategy for market dominance is to develop a dual offering that covers both the high- and low-end customer needs. Flanking offerings both grow the revenue and protect the global footprint of the firm.

Creating good fences is another one of those overlooked areas where product teams can build value for their organizations. The key is to pick criteria that will withstand all-out assaults by poker-playing customers and will be supported by senior leaders. Common examples of strong fences include distinct differences in product features, sales channels, service and support levels, logistics, and brand. Providers of information products use timeliness of access, depth of information, ability to perform analysis, catalog data, and format. The good news is that the rules for creating actionable fences are simple.

1. Fences must be based on clear, objective criteria.
2. The criteria must make sense to both customers and the sales professionals.

This transparency allows you to pass the ultimate test and explain to one customer how and why another customer qualified for a lower price. Confidence in pricing allows sales professionals to justify differentiation in pricing without any of the pain and suffering when challenged as to why another customer is getting a lower price.