In the entrepreneurial strategies discussed so far, the aim is to introduce an innovation. In the entrepreneurial strategy discussed in this chapter, the strategy itself is the innovation. The product or service it carries may well have been around a long time – in our first example, the postal service, it was almost two thousand years old. But the strategy converts this old, established product or service into something new. It changes its utility, its value, its economic characteristics. While physically there is no change, economically there is something different and new.
All the strategies to be discussed in this chapter have one thing in common. They create a customer – and that is the ultimate purpose of a business, indeed, of economic activity.1 But they do so in four different ways:
• by creating utility;
• by pricing;
• by adaptation to the customer’s social and economic reality;
• by delivering what represents true value to the customer.
English schoolboys used to be taught that Rowland Hill ‘invented’ the postal service in 1836. That is nonsense, of course. The Rome of the Caesars had an excellent service, with fast couriers carrying mail on regular schedules to the furthest corners of the Empire. A thousand years later, in 1521, the German emperor Charles V, in true Renaissance fashion, went back to Classical Rome and gave a monopoly on carrying mail in the imperial domains to the princely family of Thurn and Taxis. Their generous campaign contributions had enabled him to bribe enough German Electors to win the imperial crown – and the princes of Thurn and Taxis still provided the postal service in many parts of Germany as late as 1866, as stamp collectors know. By the middle of the seventeenth century, every European country had organized a postal service on the German model and so had, a hundred years later, the American colonies. Indeed, all the great letter-writers of the Western tradition, from Cicero to Madame de Sévigné, Lord Chesterfield, and Voltaire, wrote and posted their letters long before Rowland Hill ‘invented’ the postal service.
Yet Hill did indeed create what we would now call ‘mail’. He contributed no new technology and not one new ‘thing’, nothing that could conceivably have been patented. But mail had always been paid for by the addressee, with the fee computed according to distance and weight. This made it both expensive and slow. Every letter had to be brought to a post office to be weighed. Hill proposed that postage should be uniform within Great Britain regardless of distance; that it be pre-paid; and that the fee be paid by affixing the kind of stamp that had been used for many years to pay other fees and taxes. Overnight, mail became easy and convenient; indeed, letters could now be dropped into a collection box. Immediately, also, mail became absurdly cheap. The letter that had earlier cost a shilling or more – and a shilling was as much as a craftsman earned in a day – now cost only a penny. The volume was no longer limited. In short, ‘mail’ was born.
Hill created utility. He asked: What do the customers need for a postal service to be truly a service to them? This is always the first question in the entrepreneurial strategy of changing utility, values, and economic characteristics. In fact, the reduction in the cost of mailing a letter, although 80 per cent or more, was secondary. The main effect was to make using the mails con-venient for everybody and available to everybody. Letters no longer had to be confined to ‘epistles’. The tailor could now use the mail to send a bill. The resulting explosion in volume which doubled in the first four years and quadrupled again in the next ten, then brought the cost down to where mailing a letter cost practically nothing for long years.
Price is usually almost irrelevant in the strategy of creating utility. The strategy works by enabling customers to do what serves their purpose. It works because it asks: What is truly a ‘service’, truly a ‘utility’ to the customer?
Every American bride wants to get one set of ‘good china’. A whole set is, however, far too expensive a present, and the people giving her a wedding present do not know what pattern the bride wants or what pieces she already has. So they end up giving something else. The demand was there, in other words, but the utility was lacking. A medium-sized dinnerware manufacturer, the Lenox China Company, saw this as an innovative opportunity. Lenox adapted an old idea, the ‘bridal register’, so that it only ‘registers’ Lenox china. The bride-to-be then picks one merchant whom she tells what pattern of Lenox china she wants, and to whom she refers potential donors of wedding gifts. The merchant then asks the donor: ‘How much do you want to spend’? and explains: ‘That will get you two coffee cups with saucers’. Or the merchant can say, ‘She already has all the coffee cups; what she needs now is dessert plates.’ The result is a happy bride, a happy wedding-gift donor, and a very happy Lenox China Company.
Again, there is no high technology here, nothing patentable, nothing but a focus on the needs of the customer. Yet the bridal register, for all its simplicity – or perhaps because of it – has made Lenox the favourite ‘good china’ manufacturer and one of the most rapidly growing of medium-sized American manufacturing companies.
Creating utility enables people to satisfy their wants and their needs in their own way. The tailor could not send the bill to his customer through the mails if it first took three hours to get the letter accepted by a postal clerk and if the addressee then had to pay a large sum – perhaps even as much as the bill itself. Rowland Hill did not add anything to the service. It was performed by the same postal clerks using the same mail coaches and the same letter carriers. And yet Rowland Hill’s postal service was a totally different ‘service’. It served a different function.
For many years, the best known American face in the world was that of King Gillette, which graced the wrapper of every Gillette razor blade sold anywhere in the world. And millions of men all over the world used a Gillette razor blade every morning.
King Gillette did not invent the safety razor; dozens of them were patented in the closing decades of the nineteenth century. Until 1860 or 1870, only a very small number of men, the aristocracy and a few professionals and merchants, had to take care of their facial hair, and they could well afford a barber. Then, suddenly, large numbers of men, tradesmen, shopkeepers, clerks, had to look ‘respectable’. Few of them could handle a straight razor or felt comfortable with so dangerous a tool, but visits to the barber were expensive, and worse, time-consuming. Many inventors designed a ‘do-it-yourself’ safety razor, yet none could sell it. A visit to the barber cost ten cents and the cheapest safety razor cost five dollars – an enormous sum in those days when a dollar a day was a good wage.
Gillette’s safety razor was no better than many others, and it was a good deal more expensive to produce. But Gillette did not ‘sell’ the razor. He practically gave it away by pricing it at fifty-five cents retail or twenty cents wholesale, not much more than one-fifth of its manufacturing cost. But he designed it so that it could use only his patented blades. These cost him less than one cent apiece to make: he sold them for five cents. And since the blades could be used six or seven times, they delivered a shave at less than one cent apiece – or at less than one-tenth the cost of a visit to a barber.
What Gillette did was to price what the customer buys, namely, the shave, rather than what the manufacturer sells. In the end, the captive Gillette customer may have paid more than he would have paid had he bought a competitor’s safety razor for five dollars, and then bought the competitor’s blades selling at one cent or two. Gillette’s customers surely knew this; customers are more intelligent than either advertising agencies or Ralph Nader believe. But Gillette’s pricing made sense to them. They were paying for what they bought, that is, for a shave, rather than for a ‘thing’. And the shave they got from the Gillette razor and the Gillette razor blade was much more pleasant than any shave they could have given themselves with that dangerous weapon, the straight-edge razor, and far cheaper than they could have got at the neighbourhood barber’s.
One reason why the patents on a copying machine ended up at a small, obscure company in Rochester, New York, then known as the Haloid Company, rather than at one of the big printing-machine manufacturers, was that none of the large established manufacturers saw any possibility of selling a copying machine. Their calculations showed that such a machine would have to sell for at least $4,000. Nobody was going to pay such a sum for a copying machine when carbon paper cost practically nothing. Also, of course, to spend $4,000 on a machine meant a capital-appropriations request, which had to go all the way up to the board of directors accompanied by a calculation showing the return on investment, both of which seemed unimaginable for a gadget to help the secretary. The Haloid Company – the present Xerox – did a good deal of technical work to design the final machine. But its major contribution was in pricing. It did not sell the machine; it sold what the machine produced, copies. At five or ten cents a copy, there is no need for a capital-appropriations request. This is ‘petty cash’, which the secretary can disburse without going upstairs. Pricing the Xerox machine at five cents a copy was the true innovation.
Most suppliers, including public-service institutions, never think of pricing as a strategy. Yet pricing enables the customer to pay for what he buys – a shave, a copy of a document – rather than for what the supplier makes. What is being paid in the end is, of course, the same amount. But how it is being paid is structured to the needs and the realities of the consumer. It is structured in accordance with what the consumer actually buys. And it charges for what represents ‘value’ to the customer rather than what represents ‘cost’ to the supplier.
The worldwide leadership of the American General Electric Company (G.E.) in large steam turbines is based on G.E.’s having thought through, in the years before World War I, what its customers’ realities were. Steam turbines, unlike the piston-driven steam engines which they replaced in the generation of electric power, are complex, requiring a high degree of engineering in their design, and skill in building and fitting them. This the individual electric power company simply cannot supply. It buys a major steam turbine maybe every five or ten years when it builds a new power station. Yet the skill has to be kept in being all the time. The manufacturer, therefore, has to set up and maintain a massive consulting organization.
But, as G.E. soon found out, the customer cannot pay for consulting services. Under American law, the state public utility commissions would have to allow such an expenditure. In the opinion of the commissions, however, the companies should have been able to do this work themselves. G.E. also found that it could not add to the price of the steam turbine the cost of the consulting services which its customers needed. Again, the public utility commissions would not have accepted it. But while a steam turbine has a very long life, it needs a new set of blades fairly often, maybe every five to seven years, and these blades have to come from the maker of the original turbine. G.E. built up the world’s foremost consulting engineering organization on electric power stations – though it was careful not to call this consulting engineering but ‘apparatus sales’ – for which it did not charge. Its steam turbines were no more expensive than those of its competitors. But it put the added cost of the consulting organization plus a substantial profit into the price it charged for replacement blades. Within ten years all the other manufacturers of steam turbines had caught on and switched to the same system. But by then G.E. had world market leadership.
Much earlier, during the 1840s, a similar design of product and process to fit customer realities led to the invention of instalment buying. Cyrus McCormick was one of many Americans who built a harvesting machine – the need was obvious. And he found, as had the other inventors of similar machines, that he could not sell his product. The farmer did not have the purchasing power. That the machine would earn back what it cost within two or three seasons, everybody knew and accepted, but there was no banker then who would have lent the American farmer the money to buy a machine. McCormick offered instalments, to be paid out of the savings the harvester produced over the ensuing three years. The farmer could now afford to buy the machine – and did so.
Manufacturers are wont to talk of the ‘irrational customer’ (as do economists, psychologists, and moralists). But there are no ‘irrational customers’. As an old saying has it, ‘There are only lazy manufacturers.’ The customer has to be assumed to be rational. His or her reality, however, is usually quite different from that of the manufacturer. The rules and regulations of public utility commissions may appear to make no sense and be purely arbitrary. For the power companies that have to operate under them, they are realities none the less. The American farmers may have been a better credit risk than American bankers of 1840 thought. But it was a fact that American banks of that period did not advance money to farmers to purchase equipment. The innovative strategy consists in accepting that these realities are not extraneous to the products, but are, in fact, the product as far as the customer is concerned. Whatever customers buy has to fit their realities, or it is of no use to them.
The last of these innovative strategies delivers what is ‘value’ to the customer rather than what is ‘product’ to the manufacturer. It is actually only one step beyond the strategy of accepting the customer’s reality as part of the product and part of what the customer buys and pays for.
A medium-sized company in America’s Midwest supplies more than half of all the special lubricant needed for very large earth-moving and hauling machines: the bulldozers and draglines used by contractors building highways; the heavy equipment used to remove the overlay from strip mines; the heavy trucks used to haul coal out of coal mines; and so on. This company is in competition with some of the largest oil companies, which can mobilize whole battalions of lubrication specialists. It competes by not selling lubricating oil at all. Instead, it sells what is, in effect, insurance. What is ‘value’ to the contractor is not lubrication: it is operating the equipment. Every hour the contractor loses because this or that piece of heavy equipment cannot operate costs him infinitely more than he spends on lubricants during an entire year. In all these activities there is a heavy penalty for contractors who miss their deadlines – and they can only get the contract by calculating the deadline as finely as possible and racing against the clock. What the Midwestern lubricant maker does is to offer contractors an analysis of the maintenance needs of their equipment. Then it offers them a maintenance programme with an annual subscription price, and guarantees the subscribers that their heavy equipment will not be shut down for more than a given number of hours per year because of lubrication problems. Needless to say, the programme always prescribes the manufacturer’s lubricant. But this is not what contractors buy. They are buying trouble-free operations, which are extremely valuable to them.
The final example – one that might be called ‘moving from product to system’ – is that of Herman Miller, the American furniture maker in Zeeland, Michigan. The company first became well known as the manufacturer of one of the early modern designs, the Eames chair. Then, when every other manufacturer began to turn out designer chairs, Herman Miller moved into making and selling whole offices and work stations for hospitals, both with considerable success. Finally, when the ‘office of the future’ began to come in, Herman Miller founded a Facilities Management Institute that does not even sell furniture or equipment, but advises companies on office layout and equipment needed for the best work flow, high productivity, high employee morale, all at low cost. What Herman Miller is doing is defining ‘value’ for the customer. It is telling the customer, ‘You may pay for furniture, but you are buying work, morale, productivity. And this is what you should therefore be paying for.’
These examples are likely to be considered obvious. Surely, anybody applying a little intelligence would have come up with these and similar strategies? But the father of systematic economics, David Ricardo, is believed to have said once, ‘Profits are not made by differential cleverness, but by differential stupidity.’ The strategies work, not because they are clever, but because most suppliers – of goods as well as of services, businesses as well as public-service institutions – do not think. They work precisely because they are so ‘obvious’. Why, then, are they so rare? For, as these examples show, anyone who asks the question, What does the customer really buy? will win the race. In fact, it is not even a race since nobody else is running. What explains this?
One reason is the economists and their concept of ‘value’. Every economics book points out that customers do not buy a ‘product’, but what the product does for them. And then, every economics book promptly drops consideration of everything except the ‘price’ for the product, a ‘price’ defined as what the customer pays to take possession or ownership of a thing or a service. What the product does for the customer is never mentioned again. Unfortunately, suppliers, whether of products or of services, tend to follow the economists.
It is meaningful to say that ‘product A costs X dollars’. It is meaningful to say that ‘we have to get Y dollars for the product to cover our own costs of production and have enough left over to cover the cost of capital, and thereby to show an adequate profit’. But it makes no sense at all to conclude, ‘. . . and therefore the customer has to pay the lump sum of Y dollars in cash for each piece of product A he buys’. Rather, the argument should go as follows: ‘What the customer pays for each piece of the product has to work out as Y dollars for us. But how the customer pays depends on what makes the most sense to him. It depends on what the product does for the customer. It depends on what fits his reality. It depends on what the customer sees as “value”.’
Price in itself is not ‘pricing’, and it is not ‘value’. It was this insight that gave King Gillette a virtual monopoly on the shaving market for almost forty years; it also enabled the tiny Haloid Company to become the multi-billion-dollar Xerox Company in ten years, and it gave General Electric world leadership in steam turbines. In every single case, these companies became exceedingly profitable. But they earned their profitability. They were paid for giving their customers satisfaction, for giving their customers what the customers wanted to buy, in other words, for giving their customers their money’s worth.
‘But this is nothing but elementary marketing,’ most readers will protest, and they are right. It is nothing but elementary marketing. To start out with the customer’s utility, with what the customer buys, with what the realities of the customer are and what the customer’s values are – this is what marketing is all about. But why, after forty years of preaching Marketing, teaching Marketing, professing Marketing, so few suppliers are willing to follow, I cannot explain. The fact remains that so far, anyone who is willing to use marketing as the basis for strategy is likely to acquire leadership in an industry or a market fast and almost without risk.
Entrepreneurial strategies are as important as purposeful innovation and entrepreneurial management. Together, the three make up innovation and entrepreneurship.
The available strategies are reasonably clear, and there are only a few of them. But it is far less easy to be specific about entrepreneurial strategies than it is about purposeful innovation and entrepreneurial management. We know what the areas are in which innovative opportunities are to be found and how they are to be analysed. There are correct policies and practices and wrong policies and practices to make an existing business or public-service institution capable of entrepreneurship; right things to do and wrong things to do in a new venture. But the entrepreneurial strategy that fits a certain innovation is a high-risk decision. Some entrepreneurial strategies are better fits in a given situation, for example, the strategy that I called entrepreneurial judo, which is the strategy of choice where the leading businesses in an industry persist year in and year out in the same habits of arrogance and false superiority. We can describe the typical advantages and the typical limitations of certain entrepreneurial strategies.
Above all, we know that an entrepreneurial strategy has more chance of success the more it starts out with the users – their utilities, their values, their realities. An innovation is a change in market or society. It produces a greater yield for the user, greater wealth-producing capacity for society, higher value or greater satisfaction. The test of an innovation is always what it does for the user. Hence, entrepreneurship always needs to be market-focused, indeed, market-driven.
Still, entrepreneurial strategy remains the decision-making area of entrepreneurship and therefore the risk-taking one. It is by no means hunch or gamble. But it also is not precisely science. Rather, it is judgement.
1 As was first said more than thirty years ago in my The Practice of Management (New York: Harper & Row, 1954).