Giving value to both customers and shareholders can be a tricky business. Customer productivity is one way of achieving this goal

When one solution does not fit all

Arevolution is exploding in the pulp, paper and packaging industry and the companies that will eventually win the battles currently being waged will do so by creating distinctive positions in the marketplace and inspiring strong customer loyalty. These players are already enjoying faster growth, better returns and higher stock market multiples, often with much lower capital bases.

Figure 1 So far, consolidation has created size, not value

But don't just take our word for it. The following cases drawn from major segments of the industry present just a few examples of the revolution that is under way. For example:

• corrugated packaging brokers in the UK

have decided to be more responsive to customer needs. They lease warehouses near customers, make box plants bid on designs to ensure the lowest prices and deliver just-in-time (JIT) shipments in full truckloads. With very little capital, these brokers have already captured over 20% of the profitable local and national UK corrugated business

• a beverage packaging company now offers

customers full turnkey design and installation of equipment, provides preventive maintenance contracts and offers rapid parts replacement to ensure its customers high equipment uptime and profits

• one fine paper company is now developing

a proprietary web site that will improve both service and prices for its customers and create the potential for a $2 billion market cap for its shareholders.

These revolutionary pulp, paper and packaging companies focus on creating value for their customers - and their customers' customers - instead of just buying market share. In turn, they capture value for their shareholders. This practice can be referred to as "customer productivity". It is a powerful way to generate value from customers and for customers.

The only way to get this value from customers is to design value propositions, based on what specific customers really want. Companies that do not follow this customer productivity mandate risk being "stuck in the middle", forcing one set of products, services and prices to serve an increasingly fragmented customer base.

On the brink

The pulp, paper and packaging industry is plagued by treacherous cycles, increasing capital intensity and punishing environmental demands. Customers are consolidating and increasing their clout, while low-cost competitors are entering from overseas. On top of all this, the industry suffers from a relentless price/cost squeeze of 2-3% per year. As a result, the industry has earned its cost of capital only once in the past decade.

In response to this poor performance, the industry is pushing hard on cost and capital productivity and driving a wave of consolidation. Unfortunately, these moves alone will not make the industry healthy. Ironically moves to flatten and lower industry cost structures actually increase pressure on margins and returns. As the cost difference between low-cost and high-cost producers evaporates, producers must go far beyond simply squeezing out costs if they hope to earn a profit.

Similarly, consolidation has so far failed to create value in the industry, with only a few exceptions (Figure 1). Because the sector is so fragmented, regional and focused on machine utilization, even the larger scale acquisitions have not yet resulted in sustainable margin increases or other significant benefits.

Pulp, paper and packaging companies could continue to respond to industry pressures in the same old ways. But industry players cannot afford to turn a deaf ear to the outcry coming from two very important groups - their shareholders and their customers. If companies do not stage a revolution and improve performance of their own accord, these industry outsiders will force them to.

The medium is the message

New technology offers yet another potential blow to the industry. The threat comes from industry outsiders like PaperExchange.com and FreeMarkets Online. These electronic exchanges make the best prices in the industry available to any customer, anywhere, at any time. As a result, they make markets even more transparent and efficient, as well as driving prices down even further.

If you doubt that electronic exchanges will eventually make an impact, consider this potential scenario. Major customers such as Unilever and RR Donnelley, faced with their own price/cost squeeze, intensify their supplier management efforts and demand that their suppliers trade through the exchanges, or at least that they lower prices to the levels set by exchanges. Asian papermakers use their low-cost position and over seven million tons/yr of new capacity developed over the past six years to provide liquidity to the exchanges. These exchanges take off, driving down margins in Europe and North America. Paper exchanges become even more attractive and evolve into fully-fledged distributors with financial and third party logistics services in the same manner as the E-chemicals exchange. And finally, "intelligent agent" technology makes the exchanges more attractive for producers by protecting existing customer-supplier relationships where desired. This will give them the incentive to offer more volume on the exchange, making the exchange more attractive to customers in a "virtuous cycle".

Figure 2 Buyers are increasingly preferring highly-specialized selling models

This is only a scenario, but it points to the threat that technology can pose to the industry over time. Managed correctly though, customer productivity turns this technological threat into an opportunity.

Industry dynamics and new technology all point to the customer and the new industry watchword must be customer productivity. Essentially, this means creating more value for customers and capturing more of this value for shareholders. It requires a fundamentally new way of thinking about customers and, in turn, their customers. Companies need to use both new technology and new forms of customer relationships to tailor products and services to different kinds of customers. As a result, companies can avoid getting "stuck in the middle" with a one-size-fits-nobody product on offer.

New technology and forms of customer relationships are creating two distinct types of customers. On the one hand, there are customers who care mostly about price and will insist on the brutally low prices enabled by electronic exchanges. On the other hand, there are those customers who want, and will pay for, differentiated products and services in three dimensions. These dimensions are based on product, process and relationship benefits. On top of product benefits, these service-oriented customers look for process benefits, including ease of access to product information, simplified assisted decision making, convenient transactions and automated product replenishment. They also look for relationship benefits including customized service, information sharing and differentiated loyalty rewards.

These service demands are starting to filter through into the pulp, paper and packaging industry. For example, lumber and corrugated packaging customers who buy based on process and relationship benefits already make up a third to half of the market.

Increasingly, it is becoming impossible to make one set of products, services and prices to serve all customers. The dilemma that companies face is getting prices low enough to please price-sensitive customers, while at the same time providing the service that value-added customers seek. In an industry with overcapacity, flat cost curves and high price transparency, getting stuck in the middle ensures declining prices and unacceptable returns. Customer productivity means getting rid of "one-size-fits-all" value propositions and serving customers based on what they find most valuable.

Customers' customers

The first step in creating customer productivity is to understand who your customers sell to. Revolutionary companies have become adept at targeting their customers' customers. For example, a fine paper company found that its customers' customers - a selected segment of book publishers - had very specific logistics and service needs based on the school year order cycle. These non-product needs made both process and relationship benefits key to serving textbook publishers. The paper company won a profitable 50% market share by accommodating the specific seasonal needs of their customers' customers.

In another example, a European packaging company developed specialized corrugated products for the fresh produce grower/packer segment. These packaging products use a proprietary technology to control gas exchange in the box and keep produce fresh twice as long. The packaging company can even custom-modify gas exchange rates for different kinds of produce. As a result, their customers' customers (the produce brokers or exporters) gain two enormous benefits - less spoilage and the ability to send transatlantic shipments by ship rather than air at a substantial freight savings. This insight and innovation came as a direct consequence of the attempt to understand whom their customers are selling to.

1. Link marketing capability building to company performance objectives. Great marketing is not an end unto itself.
2. Focus on the two to three marketing/sales skills that matter most in your own circumstances (Figure 3).
3. Make tough people decisions to create a critical framework of customer-focused
4. managers.
5. Redesign planning processes to hardwire marketing and company goals.
6. Use "integrators" to ensure high return development and delivery of marketing promises across different products, services and customer segments.
7. Design self-funding programs to build early credibility and momentum.
8. Keep the marketing capability building programs at the top of the CEO's agenda.

Figure 3 - Customer Productivity Skills

Customer productivity can require companies to take some fairly dramatic courses of action, for example, redesigning products and services in targeted ways and tailoring the sales approach taken to accommodate individual cases. These activities reinforce each other and help companies grow the potential profit pie, rather than just buy a bigger slice. Put simply, companies can capture more profit with less capital.

Most companies will not want to serve just one type of customer though. In order to serve customers who value fundamentally different products and services, they will have to tailor their selling approaches, just as they tailor their products and services.

The traditional selling model used in the industry has been "transactional" and this technique will continue to be important for customers who simply want the lowest price for a commodity-style product. But recently, some companies have embraced "consultative" selling. This approach brings the full power of the supplier to the customer through value-added technical and product support, collaborative research and development (R&D), integrated logistics, etc.

In a world where creating customer productivity is crucial, the question is not which of these selling models is more appropriate. A company needs to be able to use both kinds of selling models cost-effectively, while tailoring the selling approach to the specific customer segments in its portfolio (Figure 2).

Redesigning product and service offerings helps meet the demands of fragmented customer segments. And given these different segments, it is clear that selling techniques should be flexible and responsive. But the obvious issue then is to question how a company can cost-effectively manage the extra complexity that comes with multiple value propositions and multiple selling models. Or to put it another way, how can a company reinvent itself for each new customer?

IT opportunities

To gain a competitive edge, companies need to take advantage of information technology (IT), especially the internet. Technology can allow a company to grow and improve the bottom line by driving down costs. On top of that, technology helps companies maximize margins by better tailoring their services to their main sources of profit.

Software packages that provide features such as "collaborative filters" and "pattern recognition" can help to personalize web sites for specific customers. In addition, enterprise application integration (EAI) software from companies such as Ariba can link an extranet site in real time to an enterprise resource planning (ERP) database like SAP.

For example, if a customer regularly accesses extranet sites for statistical process control (SPC) data or production schedules, new technologies can coordinate these information requests with the data in ERP systems and then customize the site for that customer. The features can be "mass customized" to include service offerings, prices and loyalty rewards. Customers appreciate this level of responsiveness and are rewarded for loyalty.

An extension of mass customization is continuous relationship marketing, or CRM. CRM allows the marketing department to improve its understanding of the customer and target services more efficiently by continuously "mining" their data for patterns that indicate customer preferences, etc. This allows companies to experiment with new services, promotions and prices. As a result, the customer information can help increase margins and stimulate growth.

IT can also lower marketing and sales costs. A good, functional extranet site transforms selling from a predominantly "push" undertaking to a "pull" or "self-serve" enterprise, since customers can access, query and modify data as well as planning themselves. "Self-serve" technology lowers the selling cost of serving medium/small customers that are not big enough to justify frequent sales calls and opens the door to bypassing merchants.

A good technology system also gives customers a way to help companies cut production and logistics costs. For example, the German corrugated board converter, Prowell, offers its customers real-time, online access to its production and logistics schedules so customers can plan order assortment, size and timing. This service takes costs out of the entire supply chain.

The next step in the process is to transfer these advantages to the bottom line. Customer productivity creates value for shareholders by allowing for insightful pricing, capturing new profit pools, as well as creating and leveraging brands. Everybody knows that the list price is not what actually goes into a company's pocket. Looking through the lens of customer productivity, it is clear that process and relationship benefits are either being over-delivered or underpriced. In our experience, companies that carefully tailor and realign the process and relationship benefits offered to specific customers have improved pocket prices by 1-3%. A 2% increase would boost the average company's earnings by 35-45%.

Companies that have a very clear sense of the benefits that customers want can also use the concept of differential pricing. The airline industry estimates that differential pricing tools generate 5-7% in incremental revenue, the vast majority of which flows directly to the bottom line. With customer productivity, pulp, paper and packaging companies have a similar opportunity to price their products based on process and relationship benefits, as well as on capacity and competitive factors.

Expanding the pool

Truly understanding the needs of customers - and their customers - will also allow companies to target a much bigger profit pool. For example, a packaging converter found that only 70% of its customers' total cost of packaging came from the packaging itself. The rest came from packaging line operations (18%), damage (9%) and warehouse, handling and procurement costs (3%). The packaging company redesigned its products and services to lower its customers' total cost of ownership. By sharing in this value creation, the packaging company increased variable margin per machine hour by 33% and increased capacity utilization 3.3 times.

Besides looking at total cost of ownership, companies can also capture new profit pools by helping customers, and their customers, to grow. For example, if a magazine paper manufacturer could guarantee JIT delivery, the company could help printers and their customers (the publishers) to profitably grow by avoiding high inventory costs or running out of stock due to seasonal consumption surges and/or promotions. At the same time, the magazine paper producer would be growing its own profit pool.

Customer productivity also provides a new perspective on the value to be created from an industrial "brand". For example, Sonoco, a global packaging company, earns approximately twice the industry average price/earnings (P/E) multiple and much of that success can be attributed to the fact that customers seek out its brand. Sonoco's brand promises functional benefits such as increased product shelf life and higher filling line speeds. The company also delivers process benefits including globally coordinated logistics to minimize customer lead times and inventories. On top of that, Sonoco delivers relationship benefits, such as customized product and equipment development and tailored technical and maintenance services.

The customer productivity revolution is exploding in the pulp, paper and packaging industry (Figure 4). The threats and opportunities from new technologies and new forms of customer relationships will only increase the differences between customers who are intensely price sensitive and those who value - and are willing to pay for - new product, service and pricing models.

The winners in this revolution will generate faster growth, high returns and better stock market multiples by targeting their products, services, selling approaches and pricing to these very different customer groups. The losers? They will be stuck in the middle and may find themselves left behind with both customers and shareholders.

Steffen Karlsson and Jeff Lane are senior consultants in McKinsey's Stockholm and Atlanta offices, respectively, while Campbell Langdon is a principal at McKinsey in New York

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