Take Your Cues From Customers

A profound but silent transformation of our society is afoot. Our industrial system is generating more goods and services than at any point in history, delivered through an ever-growing number of channels. Superstores, boutiques, online retailers, and discount stores proliferate, offering thousands of distinct products and services. This product variety is overwhelming to consumers. Am I buying the right digital camera? Am I getting the best treatment for my chronic ulcer? Am I signing up for the right service? Simultaneously, thanks to the propagation of cell phones, Web sites, and media channels, consumers have increased access to more information, at greater speed and lower cost, than ever before. But who has the leisure and the proficiency needed to sort through and evaluate all these products and services? The burgeoning complexity of offerings, as well as the associated risks and rewards, confounds and frustrates most time-starved consumers. Product variety has not necessarily resulted in better consumer experiences.

For senior management, the situation is no better. Advances in digitization, biotechnology, and smart materials are increasing opportunities to create fundamentally new products and services and transform businesses. Major discontinuities in the competitive landscape—ubiquitous connectivity, globalization, industry deregulation, and technology convergence—are blurring industry boundaries and product definitions. These discontinuities are releasing worldwide flows of information, capital, products, and ideas, allowing nontraditional competitors to upend the status quo. At the same time, competition is intensifying and profit margins are shrinking. Managers can no longer focus solely on costs, product and process quality, speed, and efficiency. For profitable growth, managers must also strive for new sources of innovation and creativity.

Thus, the paradox of the twenty-first-century economy: Consumers have more choices that yield less satisfaction. Top management has more strategic options that yield less value. Are we on the cusp of a new industrial system with characteristics different from those we now take for granted? This question lies at the heart of this book.

The emerging reality is forcing us to reexamine the traditional system of company-centric value creation that has served us so well over the past hundred years. We now need a new frame of reference for value creation. The answer, we believe, lies in a different premise centered on co-creation of value. It begins with the changing role of the consumer in the industrial system.

Product design and development
In the traditional value chain, companies use product variety to help cope with a heterogeneous consumer base. The game is a specifications war focusing on quality, fit, finish, or features. In the new value co-creation space, the basis for product development changes dramatically; the challenge shifts from meeting a different set of specs to developing unique ways to co-create value with consumers.

This challenge is tough, especially because overcoming company think is hard. The trained professional, socialized as an engineer, production manager, accountant, business analyst, or service representative, does not readily think and feel as a consumer would. Only by experiencing the business as consumers do, and gaining a deep understanding through the lens of consumer experience, can managers and employees truly resonate with and share the consumer's dreams, desires, and aspirations.

Experience design
Think of the product as an artifact around which consumers have experiences. Or as an evolving interface between two equal problem solvers, the consumer and the firm. Product design must incorporate the problem-solving skills and behaviors of both sides to facilitate the co-construction of an individualized experience. It opens up or forecloses future capabilities, and introduces or eliminates constraints on both the consumer and the firm. Therefore, engaging the product development team in exploring how consumer experiences evolve can profoundly affect product and service design.

Consider the Vietnam Veterans Memorial in the Mall in Washington, D.C. Architect Maya Lin decided to list the names of the American soldiers chronologically. Some people lobbied for a more conventional alphabetical listing, but Lin pointed out that dozens of similar names (e.g., "Smiths") would appear together. Imagine six or eight consecutive "Robert Smiths." Which engraving represents my Robert?

A chronological arrangement put the human losses into the historical context of time, rendering a far more moving monument. But when families of the war casualties visited the memorial wall, they often could not locate their loved ones because they could not remember the exact dates. Families became frustrated and angry. Now, an alphabetical index stands in book form near the wall to solve the interface problem.1

In contrast, consider something many families consume several hours a day: television. People around the world now have dozens, even hundreds of available channels. Yet millions still have trouble finding something worth watching. New interactive systems like TiVo and satellite TV provide an alphabetical index, which works when I know what I'm looking for, like the name of the show or its genre. Half a century after the very first broadcast, why has no one developed an equally effective, simple means of locating a program that might actually entertain me?

Evolvability
In the era of co-creation, companies must design products not for final use (however defined) but for evolvability, thus enabling future modifications and extensions based on consumers' changing needs and the firm's changing capabilities. For instance, whenever possible, products should contain enough embedded intelligence to recognize an individual consumer's patterns of use and evolve accordingly, like the most-used features of menu-based interfaces floating to the top, or revealing more sophisticated product functionality as the user evolves. Certain video games already perform in this fashion; why not televisions, mobile phones, kitchen appliances, cameras, or light fixtures?

Pricing, accounting, and billing
All adaptive, dynamic, and variable pricing methods—what we might call heterogeneous pricing—base prices on experiences, not on a company-centric set of product specifications or on the firm's costs.

Consider auto insurance. OnStar-style telematics enable insurance companies to ascertain not only a car's make and model but also its owner's driving history, risk factors of the current trip, and even its location and speed at any time. Analysis of such data could yield a fair premium for insurance coverage on a per-trip basis. Progressive Insurance and other firms are already experimenting with similar concepts.

Heterogeneous pricing will also alter accounting and billing systems. Designed to reflect stable business models and fixed assets, traditional accounting reinforces the belief that maximizing the use of physical assets leads to profitability. It cannot reflect the need to reconfigure resources constantly (thereby shifting budget categories), allocate scarce capital (including talent not located on the balance sheet), or adopt the auction pricing model (which bears no direct relation to costs). To run daily operations, managers can no longer use traditional accounting models, though legally required for public reporting. Instead, they need critical new tools like flexible program-oriented budgeting (rather than budgeting driven by administrative categories), contribution thinking, and real-time cash flow analyses.

Closely associated with heterogeneous pricing is microbilling, increasingly one of the major infrastructure capabilities needed to compete in the new experience space. Telephone utilities have always had powerful, by-the-minute accounting and billing systems; other firms must create similar systems. Auction pricing and personalized product and service bundles create further levels of billing complexity.

Billing systems are also repositories of embedded customer information as well as part of the customer interface—which is to say, a social instrument. For all these reasons, billing must no longer be treated as an obscure, back-room operation but as a potentially valuable tool for enabling a personalized experience and extracting economic value from it.

Channel management
In many established organizations, the traditional channel structure is a major impediment to personalized experiences. For example, the auto dealerships have long resisted the sale of cars on the Web by Ford and General Motors. Similarly, the brokers at traditional financial services firms like Merrill Lynch and Aetna weren't eager to allow for trading stocks or buying insurance via the Internet, and traditional travel agents opposed the migration of their industry to the Net. The tensions are understandable—and very real.

Established firms and traditional channel partners, locked in the traditional frame of value creation, have found it difficult to implement a multichannel experience environment necessary to create a variety of consumer experiences through channel choice. The predictable result: Industry newcomers like Expedia.com and E*TRADE have taken the lead in exploiting new opportunities.

The need to view multiple channels not just as a cost-saving mechanism but as an integral part of the experience environment suggests that businesses must develop new information capabilities. For example, how does a bank keep track of every customer encounter, whether via ATM, PC, telephone, mail, or in person? If different channel interactions provide different experiences and therefore differing levels of customer value, should the bank treat them the same? How do the pricing and billing systems differentiate among these multiple experiences? Should banks attempt to migrate their customers to lower-cost channels, or adapt to accommodate a customer's preferred modality? Few traditional organizations currently have the infrastructure capabilities to answer these questions effectively.

Excerpted with permission from The Future of Competition: Co-Creating Unique Value with Customers. Harvard Business School Press. Copyright 2004, C. K. Prahalad and Venkatram Ramaswamy.

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C. K. Prahalad is the Harvey C. Fruehauf Professor of Business Administration at the University of Michigan Business School.

Venkat Ramaswamy is the Michael R. and Mary Kay Hallman Fellow of Electronic Business and professor of marketing at the University of Michigan Business School.