25 Jul 2005  Research & Ideas

An Organization Your Customers Understand

Defining your primary customer is an ideal "outside-in" approach to better designing your whole organizational structure. In this excerpt from his new book, Levers of Organization Design, HBS professor Robert Simons describes how to do it.

 

Imagine an organization made up of a variety of three-dimensional shapes. Rectangular blocks represent the functions: manufacturing, R&D, and sales and marketing. The spheres are regional offices. Pyramids represent product groups—one for, say, automotive, another for industrial, a third for consumer products. Finally, a series of cubes represents major customers.

The shapes lie scattered on your desk. Your job is to fit the pieces together. Do you place the spheres on top of the blocks so that functions report to the regions? Or should it be the other way around, with the regions subordinate to the functions? Maybe you should organize by product, with separate units set up to serve specific markets. You play with the different combinations in your hands. How to decide ...

This is the most obvious—and vexing—problem of organization design: grouping work units according to specific criteria. A study by the Conference Board came to the following conclusion:

There appears to be little evidence to suggest which of the [various] organizational formats would be best to assure the business's overall success, or even why it uses a specific format. This is largely due to the fact that the role of organization in regard to a business unit's success, or in the choice of which structure to use, is intertwined with a large number of other important factors. These include the strategy of the business, the quality of its leadership and work force, the excellence of its products, and its administrative heritage; also, the "fit" or alignment among important organization design elements such as structure, business systems, staffing, rewards, and tasks.1

In other words, the problem is too difficult. There is no clear pathway to a solution.

This [section] offers an approach to solve the organization structure problem. The solution will be derived through analysis of the first of our four Cs: customer definition. Using an "outside-in" approach, we will start by designing units that work most closely with customers and markets; then we will progressively move inside the firm to create subunits that define the operating core. As you will see, responsiveness is the critical objective for units close to the customer; economic efficiency and cost control are more important for units in the operating core.

Who is your customer?

A great deal has been written in the strategy and marketing literature on the importance of creating customer value. In our everyday language, we think of a customer as someone who buys goods or services. But we have recently witnessed an explosion in the definition of a customer.

By labeling everyone a customer, the organization becomes confused about its purpose and whom it is designed to serve.

In popular marketing textbooks, students are taught that a customer is any person or organizational unit that plays a role in the consummation of a transaction with the organization. This definition includes buyers, users, and payers. For example, an office assistant may order office products to be used by fifty people in a department and paid for by a central accounts payable facility. All these entities are customers. The advice to managers: "Look at all your business relationships as if they were customers . . . By viewing everyone as a customer, you fundamentally change the nature of the value proposition that exists between you and the entities with whom you interact."2

This theme is echoed in another recent book, Everyone Is a Customer: "Today, the term customer not only means the traditional customer but every entity that interacts with you in a significant manner."3 This claim is repeated in the book The Customer Is CEO, which defines a customer as "the recipient of any kind of product or service provided by an organization, a recipient inside or outside."4 The author adds, "When thinking about which customers to pay attention to, the wisest choice is to cast the net broadly. They are all important."

According to these authors, everyone is a customer of someone else. There are internal customers and external customers: The manufacturing division is a customer of the R&D division, and the marketing department is a customer of manufacturing. In some accounts, employees are customers of management.

Although people may like being called customers—to foster their sense of importance and self-worth—following this well-intentioned fad can lead to an unintended, but insidious, outcome. By labeling everyone a customer, the organization becomes confused about its purpose and whom it is designed to serve. If everyone is a customer, then no one is—and focus on the real customer is lost.

We made this mistake at Harvard Business School in the mid-1990s when a new administration began telling our students that they were customers. In hindsight, the result was predictable: As paying "customers," students demanded that their professors respond promptly to their preferences. Professors and courses had become products that students were purchasing: If customers were unhappy, they reasoned, the product should be changed. Militant demands displaced an environment of mutual respect and shared learning. Needless to say, the practice of telling students they were customers was quickly stopped.

Managers must still segment the customer market and decide which segments to focus on.

In fact, the customer is too important to follow the practice of calling everyone a customer. As managers at GE have stated, "Customers are seen for what they are—the lifeblood of a company. Customers' vision of their needs and the company's view become identical, and every effort of every man and woman in the company is focused on satisfying those needs."5

Accordingly, the most critical decision in designing any organization is deciding who the primary customer is: the person or group that the organization is designed to serve. All significant structures and systems should be configured to ensure that the firm delivers superior value to these (and only these) customers. Making this critical decision involves two steps.

Step 1: Identify your constituents
The first step is to identify all the constituents of an organization. From this set of constituents, managers must choose their primary customer—and organize accordingly.

A constituent is a person or group that receives utility from the value creation process of the organization and transacts routinely with the organization through markets. Note that I have limited the definition of a constituent (and ultimately a customer) to include only those who transact with the firm through markets. As a result, this analysis considers only organizations whose customers have choices. I include business firms, non-profit organizations, and universities; however, I exclude government agencies (in which service provision is mandated by law) as well as monopolies (in which customers have no real alternatives).6 Also excluded are internal business functions (e.g., human resources and information technology) unless they operate in a true market setting—that is, they are run as profit centers and users can choose to outsource or select an alternative service provider.7

Let's look at each of these conditions in turn.

The first condition states that a constituent finds value in the firm's outputs. Who satisfies this definition? Consider two firms providing products to a neighborhood pharmacy: a pharmaceutical company selling prescription drugs, and a consumer products company selling personal care products such as shampoo and beauty aids.

A consumer filling a medical prescription or purchasing face cream would certainly qualify as a constituent: Utility is received from the medication, which alleviates a health problem, or the face cream, which enhances skin care. But other individuals and groups also satisfy our definition: Pharmacy chains, distributors, hospitals, physicians, and research scientists all benefit in one way or another from the products of these two firms.

To meet the second condition, a constituent must transact routinely with the firm through the markets. Consumers clearly satisfy this condition. But do pharmacies, distributors, hospitals, physicians, and scientists also meet this second condition?

Responsiveness is the key objective for the design of market-facing units.

To answer this question we must recognize that there are several markets that are important to the success of organizations. Let's consider the pharmaceutical firm. In its product and service markets, the list of constituents includes consumers, pharmacists, retail pharmacy stores, wholesalers, and distributors. But we should also include clinical physicians and independent research scientists, who transact through knowledge markets. And we must also add shareholders and lenders, who participate through financial markets, and employees in labor markets. All these individuals, groups, and firms are constituents. But who is the primary customer?

Step 2: Based on your strategy, determine your primary customer
Organizations can be designed effectively to serve only one master. Accordingly, the pharmaceutical and consumer products companies are designed very differently to serve different customers. Other constituents, important as they may be to the firm's success, are treated differently.

The consumer products firm has identified retail consumers as its primary customer. As a result, the firm emphasizes consumer preference feedback, focus groups, product development, and intensive retail marketing programs. Hospitals, pharmacies, and research scientists are managed as constituents; efforts are made to ensure only that they feel fairly treated in their transactions with the firm.

The pharmaceutical company has chosen a very different path. Because its strategy focuses on basic scientific discovery, it has identified clinical physicians and scientists in the broad research community as its primary customers. Accordingly, the firm is organized to support pure and applied research and the interchange of ideas in the scientific community. Other groups, including retail consumers, are treated as constituents in the process and are managed accordingly.

Identifying the primary customer is not, of course, the end of the story. Managers must still segment the customer market and decide which segments to focus on. For the consumer products company, segmentation focuses on customer demographics: Will products be designed to appeal to wealthy, middle-market, or low-income customers? For the pharmaceutical business, segmentation is by therapeutic class: Will the firm focus on research related to oncology, psychotherapy, or cardiovascular drugs?

Footnotes:

1. Kramer, Organizing for Global Competitiveness, 7-8.

2. Sheth et al., Customer Behavior, 5, 12.

3. Shuman et al., Everyone Is a Customer, 1.

4. Massnick, The Customer Is CEO, 7.

5. GE Annual Report 1990, as reported in Sheth et al., Customer Behavior, 16.

6. In government organizations, where positions are filled by elected officials and their appointees, the political process influences strongly how resources are allocated. Accordingly, in such circumstances it is essential to have structural checks and balances in place to ensure that the interests of constituents are protected. For a discussion of these issues, see Wilson, Bureaucracy, chapters 7 and 11.

7. When these conditions are met, the next logical question is why the internal function is not spun off as a separate stand-alone entity. In other words, what is the economic rationale for keeping these units in the firm?

About the author

Robert Simons is a professor at Harvard Business School.

Excerpted by permission of Harvard Business School Press from Levers of Organization Design. Copyright © 2005 Robert Simons; all rights reserved.

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