Business Marketing:
Understand What
Customers Valueby James C. Anderson and James A. Narus

Harvard Business Review

Reprint 98601

HarvardBusinessReview
NOVEMBER – DECEMBER 1998
Reprint Number
Michael e. porter

CLUSTERS AND THE NEW ECONOMICS OF COMPETITION

98609

daniel golem an

WHAT MAKES A LEADER?

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carl shapiro
and hal r . varia n

VERSIONING: THE SMART WAY
TO SELL INFORMATION

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stewart d. friedm an,
perry christensen,
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WORK AND LIFE: THE END OF
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bob zider

HOW VENTURE CAPITAL WORKS

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henry mintzberg

COVERT LEADERSHIP: NOTES ON
MANAGING PROFESSIONALS

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andy bl ackburn,m at t halprin,

HBR CASE STUDY

THE CASE OF THE PROFITLESS PC

98603

and ruth veloria

ja mes c. anderson
and james a. narus

idea s at work

bill grossfirst person

BUSINESS MARKETING: UNDERSTAND
WHAT CUSTOMERS VALUE
THE NEW MATH OF OWNERSHIPPETER F. DRUCKER

98607

hbr cl a ssic

THE DISCIPLINE OF INNOVATION
peter l . bernstein

98601

98604

bo oks in review

ARE NETWORKS DRIVING THE NEW ECONOMY?

98602

I D E A S AT W O R K

Gauging – and communicating –what your products and services
are worth to customers has
never been more important.
“Everything is worth what its purchaser will pay for it.”Publilius Syrus, first century b.c.

Business
Marketing:
Understand
What
CustomersValue
by James C. Anderson andJames A. Narus

ow do you define value? can you measure it?
What are your products and services actually worth tocustomers? Remarkably few suppliers in business markets
are able to answer those questions. And yet the ability to
pinpoint the value of a product or service for one’s customer
has never been more important. Customers – especiallythose whose costs are driven by what they purchase – increasingly look to purchasing as a way to increase profits andtherefore pressure suppliers to reduce prices. To persuadecustomers to focus on total costs rather than simply on acquisition price, a supplier must have an accurate understanding of what its customers value, and would value.
Put yourself, for a moment, in the role of a commercial
grower. Two suppliers are trying to sell you mulch film: thinplastic sheets that are placed on the ground to hold in moisture, prevent weed growth, and allow melons and vegetables
to be planted closer together. The first supplier comes to you
with this proposition: “Trust us – our mulch film will lower
your costs. We’ll provide superior value for your money.” Thesecond supplier says, “We can lower the cost of your mulch
film by $16.83 per acre,” and offers to show you exactly how.
Which proposition would you find more convincing?

H

James C. Anderson is the William L. Ford Distinguished
Professor of Marketing and Wholesale Distribution anda professor of behavioral science in management at Northwestern University’s J.L. Kellogg Graduate School of Management in Evanston, Illinois. He is also the AT&T ISBM
Research Fellow at the Institute for the Study of Business
Markets, located at Pennsylvania State University. James
A. Narus is an associate professor of management at theBabcock Graduate School of Management at Wake Forest
University in Charlotte, North Carolina. Their book, Business Market Management: Understanding, Creating, andDelivering Value, has just been published by Prentice Hall.

Copyright © 1998 by the President and Fellows of Harvard College. All rights reserved.

5

I D E A S AT W O R K

u n d e r s t a n d w h at c u s t o m e r s va l u eMany customers, like the commercial grower, understand theirown requirements but do not necessarily know what fulfilling thoserequirements is worth to them. To
suppliers, this lack of understandingis an opportunity to demonstratepersuasively the value of what they
provide and to help customers makesmarter purchasing decisions.
A small but growing number ofsuppliers in business markets draw
on their knowledge of what customers value, and would value, togain marketplace advantages overtheir less knowledgeable competitors. These suppliers have developed
what we call customer value models,
which are data-driven representationsof the worth, in monetary terms, ofwhat the supplier is doing or could
do for its customers.
Customer value models are basedon assessments of the costs and benefits of a given market offering in aparticular customer application. Depending on circumstances, such asavailability of data and a customer’s
cooperation, a supplier might build
a value model for an individual customer or for a market segment, drawing on data gathered from several
customers in that segment.
Customer value models are noteasy to develop. But the experiencesof suppliers that have built and usedthem successfully suggest several
guidelines that we believe will be
useful to any company attempting
to define and measure value for its
customers.

A Common Definition of Value
To measure value in practice, it is
crucial to have a shared understanding of exactly what value is in business markets. Before we go into any
detail about building value models,
we need to provide a brief explanation of what we mean by value. Valuein business markets is the worth inmonetary terms of the technical, economic, service, and social benefits acustomer company receives in exchange for the price it pays for a market offering. We will elaborate onsome aspects of this definition.
First, we express value in monetary
terms, such as dollars per unit, guilders
per liter, or kroner per hour. Econo6

mists may care about “utils,” but wehave never met a manager who did!
Second, by benefits, we mean net
benefits, in which any costs a customer incurs in obtaining the desired benefits, except for purchaseprice, are included. Third, value iswhat a customer gets in exchange forthe price it pays. We see a market offering as having two elemental characteristics: its value and its price.
Thus raising or lowering the price ofa market offering does not change thevalue that such an offering provides
to a customer. Rather, it changes thecustomer’s incentive to purchasethat market offering. Finally, considerations of value take place withinsome context. Even when no comparable market offerings exist, there isalways a competitive alternative. In
business markets, one competitive
alternative may be that the customer
decides to make the product itself
rather than purchase it.
We can capture the essence of thisdefinition of value in the following
equation:(Values 2 Prices) > (Valuea 2 Pricea)
Values and Prices are the value andprice of the supplier’s market offering, and Valuea and Pricea are thevalue and price of the next best alternative. The difference between value
and price equals the customer’s in-Using Customer Focus Groups
to Assess Value
Although field value assessment – gathering data firsthandwhenever possible – is the mostcommon way to build customer
value models, not all situations
lend themselves to it. Indeed,in some cases, the only way toobtain information for a value
model is to rely on customer perceptions. The results of such assessments may not be as precise
as those calculated from fieldvalue assessments; nonetheless,they can be quite effective. Consider a telecommunications
company that used focus groups
to gain a better understandingof the worth of an advanced intelligent network service called
single-number reach.
Single-number reach is designed for people who wantcallers to reach them easily,
even if they are not at a single
location or phone number during the course of a day. Provided
from a central office switch, theservice allows a caller to seek
the buyer of the service via a sequence of programmed telephone numbers. To determine
the target market segment, thecompany conducted four focus
groups with itinerant Generation X professionals, some ofwhom had six telephone numbers on their business cards.
At the beginning of each focus
group, the moderator demonstrated the service using a specially arranged prototype andthen asked focus-group participants to write down their first
impressions of the service andhow much they would be willing to pay for it per month. The
participants then engaged in a
discussion of the service, how
they would most likely use it,and so on. At the conclusion of
the approximately hour-long
discussion, the moderator asked
the participants to write down
their interest in the service using a ten-point scale and again,
how much they would be willing to pay for it per month.
Although the company wasinterested in the actual monetary amounts given at the beginning and at the end, it was moreinterested in any pattern of differences between the amounts.
An ominous pattern would be

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November–December 1998

u n d e r s t a n d w h at c u s t o m e r s va l u ecentive to purchase. Simply put, theequation conveys that the customer’s
incentive to purchase a supplier’s
offering must exceed its incentive topursue the next best alternative.

Building Customer Value Models
Field value assessments (also knownby other names, such as value-in-use
or cost-in-use studies) are the mostcommonly used – and, we believe, themost accurate – method for building
customer value models. Field value
assessments call for suppliers togather data about their customers
firsthand whenever possible. Clearly,
however, conducting such direct
research isn’t always an option. In

steep declines from the initialamounts to the ending amounts,
indicating that the participants
were initially intrigued with theservice but, upon further consideration, concluded that it
would not offer them muchvalue. No significant change between the initial amounts andending amounts would be apreferable pattern, provided thespecified amounts were sufficiently large. The final pattern,considerable increases from theinitial amounts to the ending
amounts, would indicate thatwhen the participants thought
about the service, they recognized a greater potential value.
That pattern would suggest the
crucial role of business marketing communications in conveying the value of using the service to prospective customers.
The company used the resultsof the research to provide estimates of the service’s worth tolocal telephone-service providers
and to show those providers anapproach for segmenting themarket, targeting customers,
and positioning the offering.

harvard business review

cases where field value assessments
are not feasible, it is possible to gain
a worthwhile understanding ofvalue through such methods as direct and indirect survey questions,conjoint analysis, and focus groups,
all of which rely primarily on customers’ perceptions of the functionality, performance, and worth of a
supplier’s offering. (See the insert“Using Customer Focus Groups toAssess Value.”) Below, we describe aprocess for building a value modelusing field value assessments.
Get started. Without a doubt, themost difficult customer value modelthat a supplier will build is its firstone. Indeed, gaining a comprehensive understanding of the value ofa market offering in a particular customer setting may appear monumentally difficult. But it can be done.
The first step is putting together theright kind of value research team.
The team should include people
with product, field engineering, andmarketing experience, and two or
three forward-thinking salespeople.
Having salespeople involved at thestart is particularly important. They
know the customer and how theoffering is used; they also know
which customers might be willingto cooperate in value research. Salespeople who are part of a value assessment initiative from the outset arealso more likely to understand andappreciate it. They will, therefore,
support the approach and can thenpersuasively relate their experiences
to others in the sales force.
Selecting the right market segment
to target is the next step. Because
the supplier will need to conduct
value assessments with at least two
and perhaps up to a dozen customers
to build an initial value model, it’sa good idea to start with a segmentin which the supplier has particularly close, collaborative relationships with customers, extraordinary
knowledge of how customers use
the offering in question, or relatively
simple offerings.
Before approaching a customer,
the team should think through what
it will need from the customer andwhat the customer will gain, and be
prepared to offer an incentive. For
example, the supplier might offer toNovember–December 1998

I D E A S AT W O R K

provide the resources to gather thedata at no charge to the customer
and guarantee to share all findings.
For most companies, the promise ofshared research findings among participating customers in an aggregatedor disguised manner is an irresistible
incentive because it allows them tobenchmark. W.W. Grainger, a major
distributor of maintenance, repair,and operating supplies in North
America, offered both incentives forthe 15 companies that participatedin its initial model-building effort.
Generate a comprehensive list ofvalue elements. Value elements areanything that affect the costs andbenefits of the offering in the customer’s business. These elements
may be technical, economic, service,or social in nature and will vary intheir tangibility. How well a pigment
disperses in a coating, for example,
would be a technical element; providing a consolidated monthly invoicerather than a separate invoice foreach purchase would be an economic element; design assistance would
fall under the service heading; andease of doing business with the supplier would be social. As it is generating the list, the team should consider
the entire life cycle of the offeringin question, from how the customer
acquires and uses it to how the customer disposes of it when it is nolonger needed. The list should capture all the potential effects that doing business with a supplier might
have on the customer’s business.
It’s important to be as inclusive as
possible. Leaving out elements, particularly those that might make thesupplier’s market offering look unfavorable next to the incumbent or
next-best-alternative offering, will
undermine the project’s credibility.
By identifying as many elements
as possible, the team will be able
to gauge more accurately the differences in functionality and performance its offering provides relative
to the next best alternative. Broadly
stated categories, such as the cost of
an hour of downtime in a customer’splant, may be easier to identify. But
they tend to leave out cost elements,
producing less valid estimates ofworth. A bottle breaking in a filling7

I D E A S AT W O R K

u n d e r s t a n d w h at c u s t o m e r s va l u eline causes downtime, certainly, but
it also generates costs in scrap, discards, disposal, maintenance labor,cleaning and sanitizing chemicals,
and so on, many of which tend to
be buried in various plant-overhead
accounts.
Often, the value research teamwill have to make trade-offs between
relying on a customer’s perception of

the next step is obtaining initial estimates for each element and findingout what each one is worth in monetary terms. Sometimes, suppliers
find it useful to gather data by placing a team member in a key functional area of the customer’s organization for a week or two in order togain a better understanding of whatis actually being done and where
things can go wrong during the day. For example,
a supplier might have ateam member work in
the customer’s receiving
department. To allay any
concerns on the part ofthe employee, customer
management should tellthem that the person isthere to help out and to learn.
Frequently, the customer doesn’tknow that it has the data or information the supplier is looking for. The
customer may think the information
does not exist. In fact, the kind ofdata that needs to be pulled together
in the analysis may reside on six orseven databases or systems in different functional areas.
Sometimes, the only way to findthe data is for team members to ask
around until they come across theindividual who knows where the information is.
Focus groups made up of representatives from each functional area
in a company can also be an effective
mechanism for uncovering data. The
Proaction Group, a Chicago-based
consulting and strategy implementation company, recently conductedfour internal focus groups at a customer company for exactly that purpose. To prepare themselves and theprospective focus-group participants,
Proaction consultants met individually with each prospective participant before the session, learning
what the issues might be and gathering some initial data. During the session, participants were asked whatkinds of information they thought
should be used in a value model andthen where in the organization tolook for that information. The consultants discovered sources of data
in places that neither they nor thecustomer’s management had previously identified.

Frequently, the customer
doesn’t know that it has thedata or information the
supplier is looking for.
what all the relevant elements are
and actually observing firsthand theways in which the supplier’s offering
affects the customer. The customer’s
management may not have an accurate understanding of all the value
elements associated with a particular offering. Believing that this was
frequently the case, Alcoa Aerospacedeveloped a program in which thecompany trained its salespeople infield-value-assessment methods andthen gave them an assignment inwhich they had to comprehensively
chart all the steps a customer took in
acquiring, converting, and disposingof an Alcoa offering. Interestingly,
the program gave salespeople a reason to approach customers: to ask
them to cooperate in letting themdo their assignments. The promiseof enhanced knowledge of their own
businesses provided an incentive forthose customers.
Alcoa’s initiative paid off. At theend of a two-month period, the salespeople got together and presented
their findings to one another. The
presentations allowed participants tolearn from others’ experiences andto exchange ideas about various customers’ situations and the potential
for future sales. The customers benefited because they learned about costand benefit elements they had previously been unaware of – elements
they could now factor into their own
assessments of suppliers’ proposals.
Gather data. With a comprehensive list of value elements in hand,
8

The value research team also
needs to be creative in finding othersources of information. Independent industry consultants or knowledgeable personnel within the supplier company can be good sourcesof initial estimates. San Diego-based
Qualcomm, a supplier of satellitebased mobile communications systems for truck fleets, for example,
drew on the American Trucking
Association’s research studies toprovide ranges for some of the elements in the value model it developed for its OmniTRACS mobile
communications system.When asupplier provides a service that mitigates the customer’s risk, it can be
useful to tap actuarial consultants toestimate what the cost of the potential difficulty would be.
The ease with which the team canestablish monetary estimates for its
value elements will vary. The valueof social elements such as greater
peace of mind, for example, is generally very difficult to express in monetary terms. In fact, most suppliers
do not even attempt to assign monetary amounts to social elements. Instead, they put those elements aside
and discuss them with the customer
in a qualitative way after presenting
quantitative results. Qualcomm does
not assign monetary amounts to
many less-tangible elements but
still includes them in its analysis as“value placeholders.” In this way,
Qualcomm conveys to its customers
that those elements are worth something and leaves open the possibility
that a specific monetary amountmight be ascertained in the future.
In any field value assessment, suppliers will find that some assumptions must be made in order to complete an analysis. These assumptions
might be about the functionality
or performance a market offering
actually provides in the customer’s
specific setting, particularly for elements that are extraordinarily difficult or costly to measure. Or theymight be about the monetary worthof perceived or measured differencesin functionality or performance that
an offering provides in the customer’ssetting. It is critical for the supplier
to be explicit about any assumptions
it makes. If the customer doesn’t

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November–December 1998

u n d e r s t a n d w h at c u s t o m e r s va l u eknow how or why the team assigned
a certain value to an element – or is
not encouraged to offer its own rationale if it disagrees with the supplier’s estimates and then to join the
supplier in researching a mutuallyacceptable solution – the supplier’s
credibility will be compromised.
Validate the model and understand variance in the estimates. After building the initial value model,
the supplier should validate it byconducting additional assessmentswith other customers or potential
customers in the market segment.
Conducting further assessments enables the supplier to refine its value
estimates and to understand better
how the value of its market offering
varies across customers’ applications, capabilities, and usage.
What’s more, as the supplier conducts additional value assessments,
it will develop a greater understanding of where it needs to use firsthanddata and where it can rely on customers’ perceptions. (In soliciting
perceptions, the supplier should remember that people are generally
better at making comparative judgments [more or less than] than absolute judgments [it’s worth X]. In
other words, the supplier should provide the initial estimate and ask theinformants whether that element ismore or less valuable to them thanthe estimate.)
In conducting additional assessments, the supplier will also learn
how the value its offerings provide
varies across kinds of customers. The
supplier can then build a databasethat contains value estimates – andthe individual customer characteristics, which we call descriptors, thatmight affect those estimates – from allparticipating companies. Looking at
all of the data together, the supplier
can then determine which descriptors have more impact than otherson the value customers receive fromthe offering in question. As a result,the supplier can choose to pursue
those customers and prospective
customers for which its offering will
provide superior value.
Create value-based sales tools.
Suppliers can not only use value
models to inform and guide theirown decision making but also toharvard business review

create persuasive sales tools. One
common sales tool is a value casehistory. Value case histories are written accounts that document the costsavings or added value that a customer receives from its use of a
supplier’s market offering. Sonoco
Products Company’s protective
packaging division, for example,
tracks the savings its customers gainfrom implementing an offering it
calls total packaging solutions.
Rather than selling customers themore commonly marketed corrugated-cardboard packaging materials,
Sonoco offers packaging systems
that, it maintains, are stronger,
lighter, and smaller. The major elements in Sonoco’s value model thus
include savings from reduced product damage, packaging costs, shipping costs, and storage costs. When acustomer has used these “solutions”
for a year, Sonoco constructs a casestudy about the cost savings and reports the findings to the customer.
Sonoco maintains a file of these casestudies, which its salespeople draw
on when making proposals to otherprospects. The studies persuasively
convey the cost savings that theprospects themselves would likely
realize.
Value assessment can also becomea service that suppliers offer as partof a consultative selling approach.
For example, a supplier can developa spreadsheet software applicationthat salespeople can use on-sitewith a laptop computer to evaluate
the potential value of the offering to aparticular customer. (For an illustration of how such a tool can be used,
see the insert “How BT Products
Uses Value Models as Sales Tools.”)

Putting an Understanding ofValue to Use
Suppliers can use their understanding of value to strengthen performance and create competitive advantage in several ways. For example, a
supplier can use its knowledge totailor supplementary services, programs, and systems in its current
market offerings and to guide thedevelopment of new offerings. Integrating everything it has learned
about value into its marketing efforts, it can also gain new customers.

November–December 1998

I D E A S AT W O R K

Finally, it can better sustain customer relationships by documenting
its delivery of superior value overtime and by discovering new ways
to update and reinvigorate thoserelationships.
Managing Market Offerings. In thearticle “Capturing the Value of Supplementary Services” (HBR January–
February 1995), we argued that suppliers can capitalize on the inevitablevariation in customers’ requirements
within market segments and increase their profitability by providing flexible market offerings. Doingso entails constructing what wecall naked solutions with options.
Naked solutions consist of justthose product and service elementsthat all customers within a market
segment value. We said that suppliers should strive to sell naked solutions at the lowest possible pricethat will yield a profit. Then suppliers should “wrap” those solutions
with options-specific product andservice elements that some, but notall, customers value.
A company’s ability to manage
flexible market offerings successfully
rests on its understanding of thevalue each component of an offering
creates as well as its associated cost.
An understanding of how customers
value those components – and what
they cost the supplier to deliver – enables suppliers to identify and eliminate what we call value drains. These
are services that cost the supplier
more to provide than they are worth
to the customers receiving them andthat have no strategic significance.
Consider this: A producer ofchemicals used in extracting oilfrom wells routinely performed afield analytic monitoring service forits customers to determine when,and in what amounts, they should
apply its products. A salesperson visiting one of the company’s small,less sophisticated customers noticed
the reports stacked in a corner of the
production shed. When asked about
their usefulness, the customer
replied that he was not using the information at all and instead just had
the producer’s truck driver pump a
few gallons of the chemicals into
each well whenever the truck cameby. Learning this, the supplier offered9I D E A S AT W O R K

u n d e r s t a n d w h at c u s t o m e r s va l u e

How BT Products Uses Value Models as Sales Tools
BT Products, a subsidiary of BT
Industries Group, which is basedin Sweden, is a worldwide producerof warehouse trucks for inventory
handling. In 1993, the company
created BT Compass, a logisticsplanning software system, to help
its customers improve their profitability by lowering the total costof the inventory-handling process.
The BT Compass system provides
the following:n a full analysis of the customer’s
operational requirements,n a fast comparison of different
pallet handling and orderpicking solutions,n optimum warehouse layout,n accurate calculations ofhandling capacities,n complete analysis of projected
life-cycle costs.
The BT Compass system has beendeveloped to work in seven languages, and all inputs and outputs
can be translated into any languagewith a single keystroke. It displays
different layout options by using
high-quality color graphics, and allplans can be printed quickly usinga printer or plotter.
BT Products uses the Compass
system when a customer is contemplating a change in materials
handling or is adding a new facil-

to discontinue the service and, in
exchange, give the customer a 7%
per-gallon price reduction. The customer readily agreed, and the profitability of that account jumped fromminus 6% to 32%!
Rather than finding value drains bychance, as in the example, suppliers
can set out to detect them by using
field value assessment in conjunction
with activity-based-costing analysis.
Identifying and eliminating value
drains results in better allocation of
resources and improved profitability.
Virtually always, the results morethan pay for the cost of doing the10ity. The system helps the customer figure out, for example, theoptimal aisle width that will accommodate the dimensions of acounterbalance lift truck, and it
calculates the layout and equipment requirements to meet peakhour needs.
BT Products measures the actual
performance of its competitors’
equipment, often buying the equipment to test it. Thus it knows thecritical performance measures that
customers use to judge lift trucks.
BT Products also gathers information about the customers’ individual systems. Customers sometimes
provide functional specifications
and ask the lift truck supplier totell them the number and types oftrucks required. If the performance
is not met, the selected supplierhas to provide additional trucks at
no cost to the customer.
The data the customer mustenter into Compass requires somecompetence on their part. To help
the customer gather the required
data, BT Products has developed aone-page worksheet that pulls together the necessary input data.
(See the worksheet “The Information BT Products Gathers to Build
Customer Value Models.”) Somecustomers know the required data

field-value-assessment research.
Guiding the Development of New
or Improved Products and Services.
Most market research that is conducted to provide an understandingof a customer’s requirements andpreferences does not address thequestion: “If we do X, what is it
worth to that customer?” Knowingthat an improvement in some functionality is important does not tella supplier if the customer is willingto pay for it. Value models providethat information.
In cases where the supplier’s newoffering will introduce technology

very well; others do not. BT Products’ most senior salespeople workwith the customers in doing theanalysis. They even provide handson data collection as needed at thecustomer’s facility.
One of the advantages of using
Compass is that it combines warehouse planning with an analysis of
the kind and number of trucks
needed to optimize warehouse performance. Recently, Birkenstock,
the German shoe manufacturer,
decided to build a new warehousein Asbach, Germany. An in-house
consultant responsible for the procurement process for this newwarehouse had proposed a layoutthat required three lift trucks tohandle the pallet movements. By
using Compass, BT Products wasable to demonstrate how an alternative layout in conjunction with
its high-performance trucks required only two trucks – one lesstruck and one less operator. According to BT Products’ managers, without Compass, they would not havebeen able to find this new solution
and provide the detailed performance results for their trucks. In
addition, they believed that theywould not have been able to convince Birkenstock managementthat their solution was correct.

into the market, for example, avalue model can demonstrate toprospective customers how the technology can provide greater value forthem. That’s an especially criticalpoint when the new technology
makes the market offering itself
higher priced than the alternative
choices, which may use more established and familiar technologies.
At the same time, a model allows
the supplier to see how the value of
its new technology varies acrossapplications, customer capabilities,
and usage situations.
When a supplier is developing aharvard business review

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u n d e r s t a n d w h at c u s t o m e r s va l u e

I D E A S AT W O R K

The Information BT Products Gathers
to Build Customer Value Models
This chart represents the BT Compass value-assessment
worksheet. It shows the parameters that affect the costs andbenefits of the supplier ’s offering. Clearly, many of theelements listed won’t be relevant in other industries, butthey are central to assessing value for this company.

BT Compass data collection
Customer:Comments:

Date:

MachineryType of truck/crane

Alternative 1

Wire guidance

Alternative 2

Alternative 3Radio shuttle

Select conveyer

Load dimension
Number of different
unit widths
Unit no.
Width
Depth
1.
2.
3.
4.

No./bay

HeightCustomize
Building BuildingheightlengthSprinkler

Aisle width if
not standard

Numberof aisles

Rear transfer aisle for order picking
Low order picking truck
Capacity:
Pallet handling
Pallet movement/day
Number of shifts/day
Working time/shift
Double cycles in %Max. utilization in %No. of cycles/transfer
No. of cycles/channel change
Admin. time/cycle in sec
P and D located outside store, in %Dist. in meters to that position
No. of 90 degree curves
Battery capacity in Ah
Relocations in % (cranes)
No. of relocations/cycle (cranes)
Commercial overview
Depreciation time in years
Building
Racking
TrucksCranesConveyors
OthersInterest in %Number of different unit
heights for selected unit width
No. of units
Weight in kg.

Pallet perchannelUprightwidth

Vertical
pitchType of high level picking truck
Type of low level picking truck
Order Picking
No. of orders/day
No. of orderlines/order
No. of items/orderline
No. of orders/picking roundNo. of shifts/day
Working time/shift in hours
Prep. time/pick. round in sec.
Prep. time/orderline in sec.
Picking time/item in sec.
Replenishment
Pos. time/orderline 1st level
Pos. time/orderline 2nd level% of picking 2nd level
Picking from 2nd level
Effective working time in %Picking height in mm
No. of picking aisles
Battery capacity in Ah
Operational cost
Heating/m3 and year
Personnel incl. social/year

new offering in response to customers’ requests or demands, it canuse value assessments to determine
what improvements are worthwhile
and which ones have the highest
priority. For example, the supplier
could ask managers in different functional areas of customer companies
to evaluate potential improvements.
One chemical pigment supplierasked managers in its customer’s
production and R&D areas to perform
a conjoint analysis for potentialchanges in its offering. Specifically,
the supplier wanted to know how
the customer would value some nearharvard business review

handling
Pallet movemen
t/day
Number of shifts/dayWorking time/shift
Double cycles
in %Max. utilization in %
No. of cycles/t
ransferNo. of cycles/channel change
Admin. time/cy
cle in sec
P and D locate
d outside store, in %
Dist. in meters
to that positionNo. of 90 degr
ee curves
Battery capaci
ty in Ah
Relocations in% (cranes)

term-achievable changes in technicalattributes, such as gloss or dispersibility. At the same time, thesupplier asked the customer’s general managers and purchasing managers to consider the potential valueof changes in the products’ commercial attributes, such as the supplier’s
delivery service and payment terms.
Although the findings largely conformed to the supplier’s management
expectations, there was at least one
important discovery: the relatively
high value the customers placed on
improved dispersibility. Subsequent
field investigation confirmed that

November–December 1998

Palletthe supplier’s customers were indeed having many troubles with“flocking,” the clumping that cansometimes occur as a dry pigment isdispersed into a liquid solution.
Gaining Customers. Knowledgeof how their market offerings specifically deliver value to customers
enables suppliers to craft persuasive
value propositions. Consider thecase of Greif Brothers Corporation,
which produces fiber drums, plastic
drums, and intermediate bulk containers for food products and chemicals manufacturers. Rather thancompeting on a price-per-container11

I D E A S AT W O R K

u n d e r s t a n d w h at c u s t o m e r s va l u e

Understanding Value: How W.W. Grainger and
Its Customers Benefit
W.W. Grainger distributes maintenance, repair, andoperating (MRO) supplies and related information to
the commercial, industrial, contractor, and institutional markets in North America. Grainger’s mission
is to provide the lowest total-cost distribution for
173,000 MRO supply items, such as claw hammers,
replacement motors, safety eyewear, and lubricants.
In the early 1990s, Grainger’s managers realized thatto reach their ambitious goals for growth, the company
would have to help its customers better understandthe total cost of MRO supplies acquisition and management. At the same time, a growing number ofGrainger’s large customers were becoming concerned
about the money they were spending – beyond theactual purchase prices – for MRO supplies. Recognizing
an opportunity, Grainger’s managers formed Grainger
Consulting Services (GCS) to help customers understand the total cost of MRO supplies management.
GCS began by performing a benchmark study free ofcharge for 15 of Grainger’s large customers. At eachcompany, GCS detailed the steps involved in acquiring
an MRO item and outlined the estimated costs associated with each step. Since the original studies, GCS
has gained extensive experience and knowledge inbuilding customer value models, which it calls total
cost models. And as its reputation has grown, it has
increasingly offered its consulting services on a for-fee
basis to clients.
GCS’s experience with Pharma Labs (a disguisedname) provides a good illustration of how it builds anduses customer value models.
Pharma Labs is a rapidly growing pharmaceuticals
manufacturer. At one of its largest plants – a facility
with 380 employees – purchasing managers werequestioning whether to outsource their MRO procurement and inventory management processes. During
a routine sales call, the Grainger account manager
learned of the managers’ concerns and arranged a halfday meeting with the vice president of operations, thepurchasing manager, and the maintenance manager atthat facility.
During the meeting, two GCS managers toured thefacility to gain an overview of its MRO-supplies-management processes. Also during this meeting, GCS
consultants showed Pharma managers how GCS defines cost savings and outlined the sometimes hidden
costs of MRO supplies management. The consultants

12

told the Pharma managers, for instance, that somecompanies do not account for MRO supplies inventory
and associated carrying costs.
Following the meeting, GCS proposed that it perform what it calls a baseline assessment, which documents the total costs of MRO supplies management
and then, following that assessment, offer Pharma
managers some strategic recommendations about
how they could improve their operations. GCS told
Pharma Labs that the assessment and the strategy development would take 6 to 12 weeks to complete andwould cost $45,000. Pharma Labs management agreed
to the proposal, hiring GCS in January 1997.
To begin, GCS put together a case team, which consisted of a consulting manager, a consultant, and abusiness analyst. Pharma Labs formed a steering committee and a project team. The steering committee
comprised the relevant department heads, such as
maintenance, purchasing, manufacturing, inventory
management, management information systems, andfinance, and was responsible for project oversightand strategy development. The project team was asmaller cross-functional group with representatives
from each of the departments on the steering committee and was responsible for working with the GCS
case team.
Generally, GCS looks for the elements of its customer value models in four primary areas: processes(from how the need for items is identified to payment
of invoices), products (product price, usage factors,
brand standardization and application), inventory(on-hand value and carrying costs), and suppliers (performance, consolidation and value-adding services
provided). In each area, GCS defines value and costsaving elements (such as freight and courier charges
and the cost of overtime), specifies the measures forthe elements (such as procurement cost per purchaseorder, number of suppliers, and inventory accuracy),collects the data and analyzes them, and specifies
measures for monitoring performance. At PharmaLabs, the measures for monitoring performance included supply expenditures, number of suppliers, andtransaction volume.
In a baseline assessment, GCS uses process mapping
and activity-based costing to build customer value
models, drawing on proprietary databases that thecompany has built from its findings in past engage-

harvard business review

November–December 1998

u n d e r s t a n d w h at c u s t o m e r s va l u ements. At Pharma Labs, GCS applied an activitybased-costing approach to identify procurement costs
across all typical functional areas – purchasing, maintenance, receiving, and accounts payable. These identified costs were generally in line with costs tracked
in the GCS databases.
In any analysis, GCS attempts to use the customer’s
electronic data whenever possible. The team usuallyattempts to get one year’s worth of data. Early on, thecase team makes a site visit to examine the customer’s
data and to assess how accurate and complete theyare. In the case of Pharma Labs, GCS analyzed two
years’ worth of purchasing and accounts payable data,
as well as six months of procurement card data. The
data provided GCS and Pharma with insights about
the potential for consolidating the number of products
Pharma purchased regularly from various suppliers.
It also suggested how Pharma might consolidate its
purchases in return for lower prices and greater valueadding services from its remaining suppliers.
At Pharma Labs, as in most GCS engagements, thecase team also had to do an invoice analysis – actuallyinspecting past invoices to gather usable data – to validate the electronic data and to provide additional lineitem product detail when available. The level of detailthat the customer has is usually not adequate. The
customer’s system may contain only aggregated purchase-order information, showing only how much was
paid in total. Complicating the task further, invoices
themselves often have incomplete item descriptions
that make it difficult to determine exactly what waspurchased.
The GCS team also found from its inventory analysis that Pharma Labs had no records of the amountof inventory on hand or its usage. Inventory levels
were extremely high – the team later found that Pharma had more than $1 million worth of slow-moving
inventory – but no actual record of this inventory
was maintained in a system to track and manage
the items.
The GCS case team supplemented its analyses byinterviewing the Pharma project team members. In
these interviews, GCS shared its preliminary findings,
tried to uncover anything that they might have overlooked, and learned what the Pharma managers themselves perceived to be potential areas of improvement.
The interviews were, in fact, fruitful, alerting GCS andharvard business review

November–December 1998

I D E A S AT W O R K

Pharma managers to at least one significant finding in
the procurement area. It turned out that Pharma lab
technicians played an unusually large role in the
procurement process, handling some routine purchasing, maintaining detailed, handwritten logs of alltransactions, receiving the items into inventory, andmanaging that inventory. The GCS value model
showed that Pharma Labs was spending 30% of its
procurement costs – or the equivalent of nearly threefull-time positions – on lab technicians who could be
redeployed from this purchasing function to morevalue-adding activities in their intended function.
Pharma Labs eventually signed a supply agreementwith another company, which, in return, put one of its
people on site to manage this procurement process.
After GCS completes a baseline assessment, it thentries to specify improvements that the customer canmake in 6 to 12 months. It also works with the customer to formulate changes in the MRO-suppliesmanagement strategy.
At Pharma, GCS identified at least $327,000 in total
cost savings on the $6.1 million Pharma was spending yearly on MRO supplies, including the costs ofacquiring and managing them. These projected costsavings came about through consolidation of suppliers and product-spending reductions ($165,000), inventory reduction ($72,000), and process improvements ($90,000). For example, GCS recommended
that Pharma Labs dramatically consolidate its MRO
supplies purchases. Pharma Labs agreed and initiateda national account agreement with Grainger in June
1997. In return, Grainger provided Pharma Labs withan on-site Grainger representative to manage thepurchase and inventory processes at the company.
This allowed a Pharma Labs maintenance technician
who had been spending 100% of his time purchasing
MRO supplies to return to performing value-adding
maintenance activities.
What were the ultimate results of Grainger’s workwith Pharma Labs? In December 1997, GCS and Pharma Labs jointly conducted an audit of achieved costsavings, which were found to be $387,000 during thefirst six months. What’s more, for the whole of 1997,
W.W. Grainger sales to Pharma Labs increased sevenfold, from $50,000 to $350,000. Clearly, a better understanding of value created substantial benefits foreach company.

13

I D E A S AT W O R K

u n d e r s t a n d w h at c u s t o m e r s va l u ebasis, Greif markets complete packaging systems. That is, Greif stays
involved with its customers throughout the life cycle of the containers –monitoring how the customer uses
the container, following the container’s path to the end user and retrieving it when it is empty, and disposingof it or reconditioning it. Greif’s value
proposition – total-cost-based packaging – promises that its systems cantion Agency. While these analyses do
not account for all the reasons thatenvironmental stewardship would
be worth something to a customer,
such as the value added to the customer’s reputation, they nonethelessmake environmental stewardshipworth something to the customer inmonetary terms.
Using the value model to construct
several viable total-cost-based packaging solutions,
Greif’s strategic
account manager and a team of
Greif experts
from logistics,
handling systems, and computer services
then give a comprehensive presentation to theprospective customer’s senior managers. During the presentation, they
discuss the merits and prices of eachsolution.
Sustaining Customer Relationships. At the core of all successful
working relationships are two essential characteristics: trust andcommitment. To demonstrate theirtrustworthiness and commitment
to customers, progressive suppliers
periodically provide evidence to customers of their accomplishments.
Sales managers at Greif, for example, give customers quarterly reviews that document actual costsavings. Applied Industrial Technologies (AIT), a major distributorof specialty replacement bearings,
power transmission components,and fluid power products in the
United States and Canada, provides
another good example.
AIT primarily serves maintenance,
repair, and operating (MRO) supplies
markets within the primary metals,
mining, pulp and paper, utilities,
chemical processing, textiles, foodprocessing, and agricultural industries. It operates more than 337
branch locations across the UnitedStates. In 1990, the company began
to market a value proposition promising to help its customers improve
productivity rather than simply
selling them parts at a low price.
Through value assessment, the company began to work with its cus-

Knowing that an improvement
in some functionality is importantdoes not tell a supplier if acustomer is willing to pay for it.
significantly reduce a customer’s
total packaging costs.
How does Greif develop its propositions? First, a Greif strategic account manager, together with arepresentative from the customer,builds a value model to understandtotal costs. (Greif developed its current model based on informationfrom 20 major customers.) Key elements include the costs associatedwith tracking and retrieving thedrums, cleaning and maintaining
them, testing and recertifying recycled drums, and all the associatedpaperwork.
Greif has found that customers –both existing and potential – canreadily assign monetary values tosome elements but that other elements are more difficult to pin down.
For those elements that are harder
to quantify, Greif takes its analysis toa deeper level. Consider the benefit
of environmental stewardship. To
get a handle on the value of thatelement, Greif determines what percentage of its customers’ customers’
locations (that is, the end users’ locations) are in landfill-restricted areas,
where the cost of disposing of thecontainers is higher than at otherlocations. Greif’s service – which, as
we said, includes retrieving the containers – not only eliminates this cost
but also indemnifies its customers
against improper disposal by the end
users, protecting them from fineslevied by the Environmental Protec14

tomers to help them save money inareas such as maintenance, inventory, and energy consumption – anymeasurable area other than purchasing. The results were collected inwhat AIT calls documented valueadded savings, which is now thecornerstone of the company’s partnering efforts.
AIT trains all of its employees –from branch managers to field associates to delivery drivers – to look forways to improve customers’ operations, and the company rewards
them for their successes. And to support their efforts, the company has
developed a customized software
program that calculates cost savings.
Sales representatives can run the
program on laptops while visiting
customers. Working with customers’
managers, representatives input
data for potential value-adding andcost-reduction variables – variables
that AIT and the customer have previously agreed on. Then, either on aquarterly or a semiannual basis, AIT
presents each customer with a report that documents the savings, allowing customers to assess firsthandthe value AIT has delivered.
In order to establish credibility for
its reports, AIT asks customers tosign and return a copy. The company
keeps track of the performance ofeach cost-savings initiative and aggregates the totals. AIT calculates
that last year it provided more than$100 million in cost savings to its
customers.

Delivering Superior Valueand Getting an Equitable
ReturnUnderstanding value in businessmarkets and doing business basedon value delivered gives suppliers
the means to get an equitable returnfor their efforts. The essence ofcustomer value management is todeliver superior value and get an equitable return for it, both of which
depend on value assessment. W.W.
Grainger, the MRO supplies distributor, is an excellent example of acompany that has realized the benefits of measuring and monitoringvalue for its customers. The company
has even established a consulting
arm, Grainger Consulting Services,harvard business review

November–December 1998

u n d e r s t a n d w h at c u s t o m e r s va l u e
specifically to help customers understand the total cost of MRO
supplies management. (See the insert “Understanding Value: How
W.W. Grainger and Its Customers
Benefit.”)
Perhaps equally compelling,
though, is an observation made by aharvard business review

senior manager at one company that
does business based on value: “Selling only on price – where’s the fun in
that?” This manager recognized thatwhen there is market pressure on
price, his business unit needs to respond by demonstrating that it has
something different to offer – some-November–December 1998

I D E A S AT W O R K

thing that will provide superiorvalue. Assessing and truly understanding value in business markets
is the beginning of the path to profitable fun.
Reprint 98601
To place an order, call 1-800-988-0886.

15

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