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Product/Service Rationalization in Large Enterprises

December 2013 Product

In his seminal article titled “Marketing Malpractice”1, Clayton Christensen noted that 90% of the 30,000+ consumer products launched annually fail.  This is quite astonishing, especially because marketers thoroughly analyze their target markets and potential demand from consumers.  While several factors can be attributed to the failures, the fundamental reason continues to be the inability of the product (or service) to satisfy the of consumers’ needs (implicit and explicit) in a profitable manner.

So why do some companies launch or continue to offer sub-optimal products that can be rationalized or retired?  One of the obvious reasons is the inherent fear, especially among the senior leadership, that destabilizing the processes and/or activities that enabled successful product management would be catastrophic.

While the situation is understandable, it is irrational and must not be accepted.  Continuing to offer unprofitable products would eventually decimate even the most successful firms.

To avoid going down the path of self-destruction, the senior leadership, especially the CEO, must clarify the organization’s strategic objectives and encourage managers at all levels to think creatively and rationalize their product portfolio that aligns with the corporate objectives.  This would enable any organization to develop a sustainable competitive advantage as well as maximize its margins.

In this article, we provide a comprehensive approach that would enable organizations, especially those carrying a large portfolio, to sustain profitable products and retire the unprofitable ones.  A step-by-step listing is presented below:

Step # 1 – Product Profitability Analysis

Typically, every organization identifies and maps its revenues to its products (or categories of products).  This information is usually captured per quarter or fiscal year, by region, et cetera.  This information must be contextualized with an in-depth analysis of the underlying cost structure (fixed costs, variable costs, marginal costs, etc.) to identify the profitability metrics (e.g. profit before tax and contribution margins).  It is essential to acknowledge that the profitability metrics vary across different companies in different industries–while firms that offer differentiated products focus on margins, others offering commoditized products focus on market share and volume.  The Framework presented in Figure 1 (below) enables analysts to extrapolate patterns and establish correlation between revenues, costs, and profits.

 

figure_1

Figure 1: Product Profitability Model

 

A deep understanding of product profitability forms the basis for identifying the value proposition derived from each product.

Step # 2 – Align Profitability with Strategic Imperatives

Any organization’s products can be mapped to one of the quadrants in the 2×2 matrix listed below.  The X-axis reflects product profitability (identified in the previous step) and the Y-axis reflects the alignment of value the products deliver to customers. The value proposition delivered by the products must be directly correlated to the strategic objectives of the organization.  If there is any lack of conformity, it is time to re-evaluate the organization’s strategic objectives.  It is incumbent upon the senior executives to clarify and lead the entire organization’s abilities in pursuit of its strategic objectives.

Figure 2: 2x2 Matrix for Aligning Products with Strategic Purpose and Profitability

Figure 2: 2×2 Matrix for Aligning Products with Strategic Purpose and Profitability

 

Plotting the products into the matrix must be conducted with rigor and include a diverse set of internal stakeholders. Here is an analysis of each quadrant.

  • Quadrant II – Often, less than 20% of products in this quadrant generate 80%+ of total profits.  Most of the cash cows lie here and organizations must create sufficient barriers to prevent cannibalization by competitors.
  • Quadrant III – Products in this quadrant must be retired quickly.  While this seems to be a straightforward exercise, senior leadership must have the focus to act quickly and execute the projects cost-effectively.
  • Quadrants I and IV – For the products in these quadrants, management must conduct a thorough product-rationalization exercise, which is a part of the exercise listed below.

Step # 3 – Product Rationalization

Over the course of their existence in business, each organization adopts certain tools/frameworks to develop, market, and manage its product portfolio. As they become successful, these tools become deeply entrenched into the company’s business and operating models. Even in the face of calamity, companies seldom abandon these tools.

This familiar situation, that has repeated itself several times across several industries, can be easily avoided.  Organizations need to conduct the fundamental exercise (Figure 3) for understanding how their product portfolio helps achieve objectives.

 

Key Tenets

Activities to Consider

Vision
  • What are the different types of product offerings we are pursuing for the future (short-to-medium term in the next 1-3 years & medium to long-term in the next 3-5 years)?
  • How do we enhance business value to all stakeholders?
  • What organizational capabilities are needed to achieve our objectives?
Risk
  • How are our competitors addressing the opportunity?  How would customers react to them?
  • How do we cluster products?  Are our assumptions about overlapping features valid?
  • What are the different constraints (political, economic, social, regulatory, et cetera)?  How do they impact the different clusters?
  • What are the different customer profiles?  What is the impact of clustering products on different profiles?
  • How do we align different products categories and clusters to the company’s strategic objectives?
Value
  • How do we identify the list of prioritized products, based on value delivered to customers?
  • What are our Pricing Strategies2?
  • How do we identify the different costs (fixed, variable, marginal, etc.) associated with developing, marketing and maintaining the product portfolio?  How do we continually cut costs and optimize profitability?
  • What financial models (typically FCF analysis) justify launching new products and rationalizing the existing portfolio?
  • How do we quantify the impact of the new, reduced product portfolio on the organization

Figure/Table 3: Strategic Product Planning 

 

The results from this exercise can be used to develop the price-benefit mapping3 (below).  The results from this figure would provide sharp insights on the value derived from the product portfolio.

figure_3

Figure 4: Price-to-Benefits Map

Conclusion

With a resilient will to succeed, organizations must relentlessly focus on differentiating their offerings.  While entrepreneurial firms maintain laser-sharp focus and continually innovate their portfolio, others drift into the shadows of obsolescence.  To avoid the trap of uncertainty, organizations must conduct this exercise on a periodic basis and complement their strategic planning activities to achieve a position of leadership in their industry.

References:

  1. “Marketing Malpractice” by Clayton Christensen – Harvard Business Review – Dec 2005
  2. “Pricing Strategy” by Tim J. Smith
  3. “Beating the Commodity Trap” by D’Aveni
  4. “Competitive Solutions: The Strategist’s Toolkit” by R. Preston McAfee


About the author

Kamesh Chelluri is a Principal with the CME (Communications, Media and Entertainment) practice at Infosys Consulting. He has worked with major Telcos in the US including Verizon, AT&T, Sprint, Nextel, Sprint-Nextel and US Cellular. In his current role, he is responsible for developing Business Implementation Strategies for Wireless/Wireline Products and Services, Convergence/Quad-play, Value-added services, and OSS/BSS consolidation. He holds a Master’s degree in Marketing Analysis and an MBA in Business Strategy, both from DePaul University, Chicago. He can be reached at kameshc@yahoo.com .

Kamesh Chelluri
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