The Long-Term Perspective & the Value of Life-Cycle Revenue

Mar 1, 2001 12:00 PM, Alan Kruglak

IN BUSINESS, HOW YOU LOOK AT something, your perspective on whether the proverbial glass is half-empty or half-full, can often mean the difference between profit and loss, success and failure. That became evident when we hired a consultant to review our marketing and sales program in 1991. During his review of our sales organization, he probed and asked questions about our clients. He asked how long our clients stayed with us. Why did they remain loyal? What would cause them switch to a competitor? What would happen if we didn't win a project? Which type of client and products generated the greatest profit? And so on. His questions forced us to re-examine the nature of our relationship with clients.

CHALLENGING THE TRADITIONAL VIEW

Prior to his arrival, we viewed our relationship with clients as a mutually beneficial one the client had needs that we would meet, supported by a high level of service. Regardless of whether the business was from an existing account or a prospect, all orders and projects had to meet minimum profit levels. Since our sales compensation plan was directly tied to gross margin, the more competitive a project was, the lower the commission would be for the sales rep. If competitive pressure required our prices to drop below a certain threshold, no commission would be possible, and we would walk away from the project. We did that because all potential projects were evaluated financially as stand alones single projects with single payoffs for the immediate bottom line.

Of course, when you walk away from an order, no one in your organization is happy. To rationalize our response, we would commiserate, asking each other how our competitor could be so stupid as to contract at such a low price. We would think, Boy, are they going to get clobbered! What fools! When we went after any project, we didn't consider the potential for additional revenue that could be generated from projects down the road. Our focus was always on how much gross margin the project could generate today.

With our consultant's help, we started to re-examine our relationships with most of our clients. Like a whack on the side of the head, the findings were eye-opening, permanently changing our business strategy.

DISCOVERY 1:
LIFE-CYCLE REVENUE

As a systems integrator, we discovered that winning a new client usually meant the client would be with us for as long as they survived as an entity. We defined the length of our relationship somewhere between five and 10 years as the client's life cycle. And we defined all the revenue generated from a client over the duration of the business relationship as Life-Cycle Revenue.

Analyzing our relationships with our largest clients, our records showed that over the years a new client would, on average, generate LCR of more than 500% of the initial contract amount! Although we didn't believe it at first, the numbers proved otherwise. In fact, that 500% was true for our industry as a whole.

The Source of LCR. Our company earned LCR from a number of sources. The biggest chunk came from additions and re-orders. Another substantial amount of LCR came from recurring revenue sources such as service contracts. Considerable LCR also came from referrals. Companies in the same industry watch to see which products and services their competitors use. The thinking is, If it's good enough for our competitors, then it's good enough for us. This is how we won Sprint as a client: they saw our successful work for MCI and sought us out.

Lateral employment moves also improve LCR. Say a key contact at an existing client switches companies. The first thing he or she will do when procuring systems integration products and services is call a familiar face with a good performance track record that's you! Cases like this are a major contributing factor to LCR.

DISCOVERY 2:
FAILURE IS NOT AN OPTION

A review of our client relationships also showed that our client attrition rate was negligible. Obviously, a good part of our success and retention rate was the result of doing what we said we would do providing the best solutions and supporting them with a strong technical infrastructure.

But it goes beyond that. Reviewing our past wins and losses, our research showed that losing a new project made it nearly impossible for us to penetrate that same account over the subsequent five years, even if our competitor provided mediocre service. This means that failure to win a new account is clearly not an option.

In the early 1990s, we were competing against seven companies bidding on a system at a local airport. Throughout the pre-bid process, the client would bang his hand on the table, stating in an assured tone, We want quality, and we'll pay for quality. But we lowered our margins anyway to be more aggressive.

After all of the bids were submitted, six of the bids, including ours, were clustered around $1 million. But there was one bid at the $500,000 mark. Our brains turned sideways. We knew our costs were higher than that. How could anyone bid that low? Besides, the client wanted quality, right?

The low-bid competitor took exception to almost every condition in the specification, reducing his costs and, sure enough, he won the project. Despite the client's insistence on quality, price became the overriding factor. My first mistake was believing that price wouldn't be an issue. My second mistake was misjudging my competitor. I thought their low price meant they were incompetent and would go paws up. That's not what happened.

All of the LCR over the next five years from this project, totaling more than $4 million, went directly to our competitor. Although our intelligence indicated that our competitor's service performance was below average, the client refused to allow us to bid on changes or take over the service work. This continued for five long years, until a new operations manager came to the airport and decided to replace low-performing service providers.

WHY DOES LIFE-CYCLE REVENUE WORK?

Whether you sell security systems, fire alarms, audio-visual, interconnect or any other type of low-voltage solution, the concept of LCR is universal and works to increase sales and profits. However, there are some caveats that directly affect the power and financial return of LCR. I call this the Commodity Versus Proprietary Product Continuum.

On one side of the continuum are commodity products. A commodity is defined as a product or service that is perceived as the exact same thing no matter where you buy it. The more your product is perceived as a commodity, the more susceptible your company is to price competition and predation, substantially reducing the power of LCR. From a client's perspective, the company providing the commodity product or service adds little or no value to the final delivered product. Examples of commodity items are water, cola and consumer electronics.

On the other side of the spectrum are proprietary products. A proprietary product is a product or service that is exclusively available from a single source. The more your product is perceived as proprietary, the less susceptible your company is to price competition. This substantially increases the power and effect of LCR. Products that fit into this category include additions to existing technical systems and/or products, highly complex technical products, products only available through your company and so on. The more unique the product, the greater the proprietary nature and the power of LCR.

Once you understand this continuum, it's easier to see why it is difficult for a competitor to penetrate your existing accounts and why LCR works.

The Power of Established Relationships. Once the system or product has been purchased and delivered, the client-vendor relationship is typically well-established. It's a difficult bond to break, even if your competitor is offering the same product or solution. Why? Switching to another vendor may jeopardize a manager's job security. For most corporate managers, job security is attained by providing products and services that work reliably and do not disrupt daily business activities. More times than not, this is the reason prospects are reluctant to break a relationship with an existing vendor they are afraid of the risk associated with change.

There are, however, three conditions under which clients might be willing to seek alternatives to a current vendor. First, the client perceives the current vendor's product as a commodity, with the vendor adding little or no value. Second, the client's job is on the line as a result of the vendor's non-performance. Third, the product/service delivered does not meet the client's performance expectations. When any of these conditions exists, the client will consider breaking the client-vendor relationship, interrupting the flow of LCR.
Technology-Specific Solutions. The more technically sophisticated your product, the greater the power of LCR. Although the technology may not be under your exclusive purview, most technical products are distributed on a limited basis through a select network of dealers. Limited distribution blocks most firms from serving your clients' systems.

The same rules apply to security systems, fire alarms, information technology and other electronic systems. The technological barrier to providing quality support is too high, increasing the risk of changing to another supplier.

The power of LCR becomes absolute if you are the sole manufacturer and/or provider of a specific technical product. Providing a 100% proprietary product makes you the sole-source provider, locking in any and all future LCR.
Inertia and the Path of Least Resistance. Customers are reluctant to change companies because they are concerned about transition trauma. They generally take the path of least resistance by maintaining the existing vendor relationship. That means a lost bid results in all of the spoils of victory going to your competitor over the next five years.

Of course, the reverse holds true if you win the initial project your competitors have to hurdle the same five-year barrier while you're sitting pretty. That's another reason why failure can't be an option.

DO ALL PRODUCTS FIT THE LCR MODEL?

Not all products sold to end users have substantial LCR power. As stated earlier, commodity products have low LCR potential and are more subject to price sensitivity and competition. But selling commodity products doesn't necessarily mean you have to sit there twiddling your thumbs as your competitors eat away at your business. You can use branding to give any commodity-type product a more proprietary nature.

The concept of branding is straightforward and can apply to all companies. The idea is to give a unique name and identity to a common product or service to enhance its perceived value in the market place. There are dozens of examples of effective branding. One example of great branding is Godiva chocolate. It comes elegantly wrapped in a gold box. Although my wife insists Godiva chocolate is better than Hershey's, I can't agree that it's worth 900% more per ounce! The Godiva example illustrates that the appropriate branding of a commodity product enables you not only to sell it easily, but at premium prices.

At my former company, we took a select number of limited-distribution products, gave them a brand name and printed marketing literature with the new name and our logo. Even though the same product was being distributed by others in our market, our clients perceived that it was proprietary to our company. As a result, all additions and re-orders were placed through our company, adding to the LCR.

Branding can also be applied to services. We used branding to differentiate our service support program from our competitors. Our Full Service Program included unique features like guaranteed instant replacement, minimum response times, maximum down-time providing significant added value. Branding works because it increases the real or perceived value of your product. It also can shift your product from the commodity toward the proprietary end of the continuum, increasing the power of LCR.

Did we ever misjudge LCR potential? Sure, but more times than not we were right on target. By officially adopting LCR as part of our new sales compensation plan, we were able to expand our client base, increase our revenue from existing clients and boost profits all by simply changing our perspective.

This article is an excerpt from Alan Kruglak's new book, Sales Compensation, The Hunter-Farmer Way, a step-by-step guide to creating the ultimate compensation program to drive the sales process. Universal to almost any business in the systems integration industry, this book provides new strategies for compensation, productivity, territories, incentives, pricing and more. For more information, please call ARK Solutions at 301/365-7522 or visit the Web site at www.arksolutions.net.

What We Learned and What We Did

AFTER REVIEWING OUR CLIENT BASE with our consultant, we discovered the following:

LCR Exists. Although not an official part of our sales strategy, LCR exists throughout our customer base.
Failure is Not an Option. The key to generating life-cycle revenue is being there first. If you fail to do that, you'll have a difficult time breaking the client-vendor relationships of your competitors.
Deliver Quality Products and Services. Selling to a new client is only part of the battle the client must perceive that you deliver good service and/or products. I say perceive because the client's perception is what determines repeat business. Sometimes inertia takes over even when you've done a less-than-superior job, but if you provide good service and deliver a good product, it's safe to assume that the majority of your clients will not only do the easy thing, they'll also do the right thing they'll stick with you.
Branding Increases the Proprietary Nature of Products. By renaming our products and services, we secured more revenue from existing clients and eliminated predation by competitors.
Power of LCR. LCR was one of the key reasons for our high gross margins and revenue growth.

Recognizing the results, we changed our perspective. We redirected our sales strategy to take a more aggressive posture toward new clients. Instead of looking at the financial merits of a specific order at one point in time, we looked at the entire potential revenue stream that could be generated from a client over time. If a client had significant LCR potential, we would reduce our pricing to whatever level necessary to win the order.