Value creation is not quite as straight forward for engineering manufacturers as you might think it is.
Whilst we all know that a manufacturer designs, makes and sells products, being a successful manufacturer is not just about who can make stuff the best and the cheapest.
Winning the manufacturing game is really about how to create value for your customers in ways that your competitors can’t.
Understanding customer value creation is a fundamental requirement of any successful business and, just to make it more difficult for us, different customers want different things.
Some can only afford the cheapest whereas others want the best quality.
Some want your products delivered to them – others want to collect from you.
Some want it packaged – others don’t.
There is a long list of things we could discuss here, but fundamentally, there are only two sustainable ways you can create value for your customers, according to Michael Porter in his book “Competitive Advantage: Creating and Sustaining Superior Performance.”
Generic Competitive Strategies
The first method is to be the least cost producer (Figure 1):
If you can produce a product (or service) that is of the exact same quality (or better) than your nearest competitor and you can produce it at a lower cost, then your business will remain profitable the longest during a period of falling prices, and long after your competitors have gone out of business.
The second method is to offer your customer something they want which they can’t get elsewhere.
Your unique offering differentiates you from everyone else and your customer will be willing to pay extra for your product (or service) as long as you are offering something they value.
This could include product attributes such as improved quality, durability, size, fit, compatibility with other products, etc.
It could also include service attributes such as performance guarantees, customisation, commercial terms, after sales services, and so on.
The more unique these attributes or combination of attributes and the more strongly they are desired by the customer, the greater the strength of your differential competitive advantage.
There is a third method and this can be a trap, especially for SME manufacturers.
If you operate in a niche sub-sector of the market, i.e. your market is so small that the bigger, stronger competitors are not interested in competing with you for it, then your niche might start to attract more competition as the overall market grows and/or new technologies become available to change the economics of serving your market.
If this happens you can find your business stuck in the middle (see Figure 1) and rapidly needing to adopt one of the first two strategies to survive.
In other words, there are only really two fundamental methods for long-term value creation.
How Competitive Advantage Drives Value Creation
Using Porter’s value creation model, it is easy to see how commoditisation and differentiation interact with prices.
If the product available from all suppliers is more or less the same, then the lack of differentiation between offerings leaves the customer choosing on the basis of price alone.
This ultimately drives prices downwards to the point where only a few low-cost producers can still make a marginal profit.
Generally the lower-cost producers are the larger ones that win the game by buying up their smaller struggling rivals, acquiring their assets and continuing to build scale whilst their smaller rivals with fewer differential advantages fall by the wayside and go out of business.
Market consolidation is therefore the consequence.
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In most cases though, despite the efforts of the bigger companies and their monumental merger and acquisition costs, very few businesses succeed in becoming the least cost producer in their industry.
When this happens, it typically occurs in mature markets where the products and services sold have become commodities.
Any market will naturally move towards commoditisation as it matures and as rival firms copy each other’s differential advantages.
So for most manufacturers (and SME manufacturers in particular), successful competition and business longevity rely on continuously finding new ways to differentiate your product/service solutions and creating barriers to imitation (or at least building those barriers as high as possible).
The Quest For Differentiation
As manufacturing industries mature, the quest for differentiation typically moves through a number of key phases or waves.
The initial wave is dominated by product innovation (Figure 2).
When a company brings a new product to market, its rivals follow by introducing imitations or similar products that do something a little bit different or work in a slightly different way.
During this wave, the game is all about who makes the best product.
Early competition is thus driven primarily by product differentiation based on alternative product technologies, product designs and configurations.
This form of competition continues until a dominant product emerges and forces standardisation within the market.
Whilst products can still have minor differences to justify different price points for different customer segments, these are relatively minor tweaks to the overall standard.
As product offerings standardise, a new wave begins where manufacturers start to compete on the basis of who can produce the standard product at the lowest cost.
Technological innovation therefore shifts from product innovation to process innovation (Figure 3).
We’ve seen this in recent years as manufacturing companies have invested a lot of time and money into initiatives such as lean, six sigma, Sales and Operations Planning (S&OP), Enterprise Resource Planning (ERP) and so on.
Early adopters of these process technologies enjoyed a differential advantage for a period of time until their closest competitors were able to implement the same to catch up.
As before then, it becomes tougher to deliver sustainable competitive advantage based solely on the combination of product differentiation and lean, low-cost operations.
Unless you happen to possess a patented product or process technology that your rivals cannot imitate, any technology leadership you might have will be short-lived and you’ll need to keep playing catch-up with technologies your rivals implement first.
Hence, as the industry continues to mature, process technologies standardise too and price becomes the dominant factor once again.
New product technologies and manufacturing process techniques are coming along all the time.
Some may prove to be disruptive and have a major impact on the industry, and some less so.
However, adoption of these product and process technologies is becoming more of a qualifier, just to stay in the game, rather than a true differentiator.
For many manufacturing sectors, this is the current state of play and competition on this basis alone is proving futile.
So it begs the question, how else might you differentiate your customer offerings and how can you do this in a way that avoids the commodity trap?
In recent years, a number of manufacturers have been forced to compete in a new way.
Faced with product commoditisation, process technology standardisation, customer budget cuts, falling market volumes and low-cost competition on a global scale, manufacturers in sectors such as aerospace, defence, automotive, industrial and medical devices have been getting closer to their customers using service innovation (Figure 4).
As they did so, manufacturers discovered that their customers possess untapped needs and money to spend, not on their core products, but on related products and services associated with the support and upkeep of their core products.
Faced with gradual erosion of their traditional manufacturing business, these manufacturers responded by embracing the opportunity to develop new service capabilities and meet the needs of their customers more holistically.
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Whilst offering and selling services is nothing new, what makes this story so interesting is the way in which these manufacturers have continued to design, make and sell products as well as adapting their organisations, systems, processes and business models to integrate service aspects into their core offerings.
In rethinking their manufacturing, these leading manufacturers have boosted their revenues, widened their profit margins and extended their order books as well as protecting their business against low-cost competition.
In short, they have changed the game to their advantage!
Learn more about customer value creation and how you can transform your business to avoid the product commoditisation trap by reading our white paper: Rethinking Manufacturing – How To Protect And Grow Your Manufacturing Business By Giving Your Best Products Away.
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