Balancing Act

by Rob Landley (TMF Oak)

AUSTIN, TX (April 12, 1999) -- "Creating value" is a popular buzz phrase these days. Commentators on CNBC toss it around as they discuss companies whose stock prices have raced skyward. Executives are also fond of discussing how they've "created value." But, what exactly is the process of creating value? Do all profitable companies create value.

Not necessarily. Today, I'm going to discuss the balancing act of creating value for customers while collecting profits from them.

To set the stage for this discussion, I must briefly discuss some basic economics (yuck! I know). I proceed cautiously into this discussion based on my firm belief in Bentley's second Law of Economics: The only thing more dangerous than an economist is an amateur economist! (More econ jokes here.)

Successful companies can balance conflicting goals. The classic example of this is the Law of Supply and Demand. (Remember those funky graphs with two axes, where the horizontal one is labeled "P" and the vertical one is labeled "Q," and there's a line sloping downward from right to left?) The Law of Supply and Demand says that raising the price of a commodity reduces the quantity sold, and raising the quantity supplied reduces the price paid. If the company charges too much, it prices itself out of the market, and nobody buys its products. If the company ships too much, it floods the market so that the only way to sell everything it shipped is to charge less than the cost of the goods sold.

Somewhere in between lies the best balance, where a medium amount of product can be sold at a medium price which, when multiplied together, results in more money than any other possible combination. Successful companies are masters at finding this balance. Greedy companies that ignore the reality of the marketplace in favor of what they want it to be often get themselves in trouble with over-capacity, uncompetitive prices, and angry shareholders marching on corporate headquarters with pitchforks and flaming torches.

A similar balancing act that companies perform is between creating and collecting value. If this seems just like the production/pricing issue all over again, you'll understand why it's so easy for companies to fall into the trap of thinking of their customer relationship in purely financial terms.

Money is like oxygen to a company, but oxygen doesn't prevent you from starving to death, or falling down a flight of stairs and breaking your leg. To customers, value is more than price. Price is actually a negative quantity to a customer. It's what she pays, rather than what she gets out of the deal. A customer's wants and needs are more nebulous things that include perceived quantities like brand name, customer service, and wrong color. Value creation can be the ego boost of a BMW blue-and-white propeller wheel, the stylishness of wearing the latest drawstring pants from Old Navy, or the feelings of confidence that come from reading The Wall Street Journal. (By the way, that last example is a joke. Does anybody agree that the WSJ has some of the dumbest ads on television?)

The value customers get from a company is the reason they give money to that company. A company that doesn't understand its customers may have trouble keeping them.

For example, a bean counter at the corporate headquarters of Widget Inc. may decide to discontinue the low-margin MegaWidget (tm) product, and devote the resources to new higher-margin products. This may annoy a large customer that has deployed thousands of MegaWidgets, whose business depends on them, and can suddenly no longer get replacement parts. If the company suddenly discontinues all support for the old MegaWidgets without any warning, the ex-customer may take all its business (not just MegaWidgets but everything) to competitor Widget World, which may be twice as expensive, but which will still service and support every widget it ever sold. At the end of the year, the product transition decision that looked so good on paper could put Widget Inc. out of business.

"Re-gruntling" a disgruntled customer isn't always possible, let alone easy. But looking at the entire world in terms of cash flow can make the value creation process downright impossible. For example, which creates more value for consumers -- lowering the price of tuna or making it "dolphin safe?" A company that truly understands its customers can create value for them. Even if the value the customer wants is as psychological as a cool brand name, it's still what she is looking for, and what she's willing to pay for.

Every company faces the difficult challenge of balancing its own needs versus the needs of its customers. To successfully tackle this challenge, a company's best asset is a clear and detailed understanding of the wants and needs of its customers. Any time a company develops products or services based more on what the company wants to sell rather than on what the customers want to buy, expect disaster. More on that tomorrow.

- Oak


Last week's Question of the Week regarding T. Rowe Price's (Nasdaq: TROW) stock options was quickly and quietly resolved by Foolish poster "elann." She posted an excellent table detailing the potential stock option dilution in each of our ten Rule Makers. Thanks for your Foolish efforts, Elan. For more detail on our misunderstanding with T. Rowe's options, click here.

For this week's challenge, we're going to start an on-going archive of the Rule Maker rankings for as many companies as you are interested in ranking. I'll regularly update the aggregated results in a single post with links to all of the companies that have been ranked, sorted by total points. This should be a fun project and an awesome resource for us all. As time goes by, hopefully we'll accumulate a sizable list of current rankings that can be a ready source of research. All of the details are available here.

Finally, we now have a Rule Maker FAQ. Check it out, and please post any and all ideas you have for improvement.

Enjoy your evening,

Matt (TMF Verve)

04/12/99 Close

Stock  Change    Bid
AXP   +7 1/16  135.44
CHV   +1 1/2   95.50
CSCO  -  3/8   117.75
KO    +1 1/8   61.88
GPS   +1 15/16 76.63
EK    +  1/16  63.00
XON   +  3/4   75.44
GM    +2 1/2   88.13
INTC  -4 11/71 61.25
MSFT  -1 1/4   93.00
PFE   +4 1/8   150.13
SGP   +  15/16 60.75
TROW  -  7/16  32.13
YHOO  -4 1/16  202.94
                    Day   Month    Year  History
        R-MAKER  +0.36%   7.32%  19.54%  51.25%
        S&P:     +0.76%   5.62%  10.85%  37.10%
        NASDAQ:  +0.22%   5.57%  18.52%  57.23%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     93.00   137.64%
    5/1/98   55 Gap Inc.      34.37     76.63   122.94%
   6/23/98   34 Cisco Syst    58.41    117.75   101.59%
    2/3/98   22 Pfizer        82.30    150.13    82.41%
   2/17/99   16 Yahoo Inc.   126.31    202.94    60.67%
   2/13/98   44 Intel         42.34     61.25    44.67%
   5/26/98   18 AmExpress    104.07    135.44    30.14%
   8/21/98   44 Schering-P    47.99     60.75    26.58%
    2/6/98   56 T. Rowe Pr    33.67     32.13    -4.60%
   2/27/98   27 Coca-Cola     69.11     61.88   -10.46%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     88.13    21.71%
   3/12/98   20 Exxon         64.34     75.44    17.26%
   3/12/98   15 Chevron       83.34     95.50    14.59%
   3/12/98   20 Eastman Ko    63.15     63.00    -0.23%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   48 Microsoft   1878.45   4464.00  $2585.55
    5/1/98   55 Gap Inc.    1890.33   4214.38  $2324.05
   6/23/98   34 Cisco Syst  1985.95   4003.50  $2017.55
    2/3/98   22 Pfizer      1810.58   3302.75  $1492.17
   2/17/99   16 Yahoo Inc.  2020.95   3247.00  $1226.05
   2/13/98   44 Intel       1862.83   2695.00   $832.17
   5/26/98   18 AmExpress   1873.20   2437.88   $564.68
   8/21/98   44 Schering-P   2111.7   2673.00   $561.30
    2/6/98   56 T. Rowe Pr  1885.70   1799.00   -$86.70
   2/27/98   27 Coca-Cola   1865.89   1670.63  -$195.27

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1498.13   $267.24
   3/12/98   20 Exxon       1286.70   1508.75   $222.05
   3/12/98   15 Chevron     1250.14   1432.50   $182.36
   3/12/98   20 Eastman Ko  1262.95   1260.00    -$2.95

                              CASH    $185.03
                             TOTAL  $36391.53

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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