Weekly Thoughts: Understanding Why, Delivery Gap, and Middlemen
Here are three things that caught our eye this week:
Earlier this week, we were fortunate enough to attend a CEO panel discussion on the topic of branding. While there were many interesting insights to take away from the dialogue, perhaps the most compelling was how little time each CEO spent thinking about his or her brand in the context of product. Instead, across industries, the CEOs spent all their time highlighting what their brand stood for, their foundational values.
This dynamic was most extreme in the case of Harley Davidson. Obviously the company has a well-known, world class brand known for one type of product. However, if you were to ask CEO Matt Levatich, we suspect he would tell you that the company doesn’t sell motorcycles. Instead, Levatich would say his company sells freedom, independence, strength, adventure, and a bit of rebellion that are packaged with two wheels and an engine. As Harley Chief Marketing Officer Mark Richer put it:
“’Harley is not automotive. It might have an engine, it might have wheels, and it might run on roads, but that’s where the similarities stop,’ Mr. Richer said. ‘They’re really different customers. … The ideals they reach out for when they buy cars are different from what they’re reaching out for with Harley-Davidson. We’re really not about transportation; it’s not about getting from Point A to Point B. It’s about living life in the way you choose.'”
Levatich gave a detailed account of how everything the company does from pricing, to design, to dealer relations, is informed by its core principles. This commitment goes a long way to explaining the enduring nature of the brand despite significant economic volatility and a few existential crises. More broadly, the notion that people buy Hogs not because of what Harley makes but why it makes them reminded us of one of our favorite Ted Talks of all time on the same subject. In the talk, author Simon Sinek noted that people are biologically wired to respond more to beliefs than to physical things. From the talk:
“Let me give you an example. I use Apple because they’re easy to understand and everybody gets it. If Apple were like everyone else, a marketing message from them might sound like this: ‘We make great computers. They’re beautifully designed, simple to use and user friendly. Want to buy one?’ ‘Meh.’ That’s how most of us communicate. That’s how most marketing and sales are done, that’s how we communicate interpersonally. We say what we do, we say how we’re different or better and we expect some sort of a behavior, a purchase, a vote, something like that…
Here’s how Apple actually communicates. ‘Everything we do, we believe in challenging the status quo. We believe in thinking differently. The way we challenge the status quo is by making our products beautifully designed, simple to use and user friendly. We just happen to make great computers. Want to buy one?’ Totally different, right? You’re ready to buy a computer from me….”
It is easy to get caught up in the ‘what’ and the ‘how’ of ongoing business initiatives. Levatich’s comments on the panel were a crucial reminder that a clear understanding of why we do what we do is just as important. While the specific ‘why’ of each portfolio company may vary slightly, at Chenmark we believe in free enterprise, entrepreneurship, incremental improvement, and unlimited potential. We feel very lucky that we are able to work in service of those ideals on a daily basis.
We’ve all likely heard some version of Dave Barry’s quote that “the one thing that unites all human beings, regardless of age, gender, religion, economic status, or ethnic background, is that, deep down inside, we all believe that we are above-average drivers.” As one might expect from a Pulitzer Prize winning author, Barry’s quip is not only humorous, it’s also highly insightful. The notion that most of us have overconfidence and blind spots is an insight that has personal and professional applications beyond just driving skill.
For instance, we recently learned of a 2005 Bain & Company report which surveyed the quality of customer service at 362 top firms. The report found that 80% of leaders believed they provided customers with a “superior experience.” However, as shown in the chart below, when Bain asked customers the same question, only 8% agreed:
So what is driving the 72% perception mismatch? Bain noted the “delivery gap” is somewhat paradoxical, because almost every CEO recognizes the importance of customer satisfaction. In fact, the survey found that over 95% of management teams “claim to be customer focused.” Bain opined on the situation further:
“We’ve found that the delivery gap exists for two fundamental reasons. The first is a basic paradox in business: Most growth initiatives damage the most important source of sustainable growth— a loyal, profitable customer franchise. When a business tries to increase its revenue per customer, it tends to do things, like raising transaction fees, that end up alienating its core group of buyers. It compounds the problem when it tries to expand its customer base, as pursuing new customers distracts management from serving the all-important core…
…The second reason the delivery gap exists is that good relationships are hard to build. It’s extremely difficult to understand what customers really want, keep the promises you make to them and maintain the right dialogue to ensure that you adjust your propositions according to customers’ changing or increasing needs.”
Digging further into the research, Bain found that only 50% of companies specifically tailored their products and services to address customer needs, only 30% organized internal functions to optimize for customer service, and only 30% maintained ongoing customer contact via feedback loops. Conversely, the 8% who actually delivered superior customer experience “rigorously focus on treating their most profitable customers in ways that ensure they come back for more and recommend the company to friends.” And as consultants typically do, Bain put their observations into a framework called the “Three D’s” — Design, Deliver, and Develop. The firm explains further:
“We call them the ‘Three D’s’: They design the right propositions for the right customers. They deliver those propositions at the lowest system cost. And they develop the institutional capabilities to do it again and again. Each of these Three D’s reinforces the others. Together, they ensure the company is continually led by the voices of its customers.”
Bain also noted some tactical similarities between the 8%. For instance, many get out of the office and into the field to directly solicit feedback from customers via interviews and focus groups. Once they have established this connection, these firms establish institutional processes (i.e. loyalty rewards programs, customer surveys, etc.) to maintain an ongoing dialogue with key customers. Finally, to ensure they are obtaining feedback from multiple perspectives, these firms internally organize themselves into cross-functional teams.
While the companies included in Bain’s research are magnitudes of scale larger than Chenmark, we suspect this framework can be applied to all companies, regardless of size. Furthermore, we welcomed the opportunity to learn about the magnitude of the delivery gap, as it spurred us to spend some time thinking about our own blind spots.
One of the most popular narratives surrounding the rise of the internet, and technological disruption in general, is that such processes create efficiency and reduce transaction costs by eliminating middlemen. This line of thinking is particularly prevalent in finance where it is easy to observe how spreads have collapsed and how human market makers have left the trading floors of the various exchanges. Given this backdrop, we were surprised to learn this week that the role of middlemen in the economy has actually increased in the last two decades. From a Fast Company article on the topic:
“Daniel Spulber, the Kellogg School economist who’s studied the matter more than anyone, calculated that back in 1999 middlemen contributed 25% to the gross domestic product (GDP) of the United States; by 2010, the last year for which enough data was available, that had grown to 34%: more than a third of the U.S. economy was made up of the efforts of middlemen at a time when middlemen were supposed to be drifting into irrelevance.”
The reasons for this counter-intuitive trend seem to be two-fold. First, while technology has made it easier to connect buyers and sellers directly, it has also massively increased the availability of different choices. Second, while transaction costs have come down for the producer and consumer, they have also come down for the intermediaries. Combining these two observations, middlemen have retained their value by filtering the ever increasing mass of information and by doing so in ever more cost-effective ways. Again from Fast Company:
“…the Internet reduces everyone’s transaction costs, including those of middlemen. And if middlemen can harness the Internet’s power more efficiently than the rest of us—which the best of them can—then they’re still a great value.
One of the middlemen I interviewed, the micro-VC Mike Maples, Jr., put it well when he pointed out that in our highly connected world, ‘things and entities that accelerate connections are going to be more valuable.’ This is why Maples is bullish on so many Internet businesses, having made early investments in Twitter, Lyft, and TaskRabbit, among others. ‘That’s what a middleman does,’ Maples says: ‘They connect nodes in a network to increase the value of the network.'”
We frequently talk internally about how our potential success is closely tied to our ability to connect a wide variety of different networks in order to promote the sharing of information, thought processes, business ideas, and analytical frameworks. Understanding the continuing importance of middlemen is an encouraging reminder that a focus on connecting nodes can pay dividends, regardless of the technological age.
Your Chenmark Capital Team