Leveraging product mix to boost sales

CASE STUDY  Customers were willing to spend more when given a better selection of high quality goods, but management had to change its perspective first

A company increased revenue per customer by replacing most of an under-performing product line with a better assortment of new products. The initiative focused on improving quality, expanding selection, and increasing margins. Customers responded by purchasing fewer low-end items and more mid-level and luxury goods. This discussion reviews the actions taken and tracks both short term and long term results based on detailed data collected over three years. The ultimate key to success was management's ability to adopt a customer's perspective and realize the company could do more.

Background

A service company generated an additional twenty percent of its revenue selling products sourced from third-party manufacturers. Product sales were more profitable than labor-intensive services, but management devoted little attention to this secondary business. Subsequently, customers were indifferent toward the product line and usually limited purchases to low-price goods—even while paying extra for premium services. 

During a four-month period ("baseline") product revenue per customer fell by 25%. Although part of the drop was due to seasonality, the product line was under-performing compared to the company’s services business. Many of the products were economically priced and provided acceptable quality but were otherwise unexceptional. In addition, the line received little marketing or promotional support.

Product Strategy

Management decided to reevaluate its product line strategy and make significant changes. The revised plan focused on offering higher quality merchandise over a wider range of prices. The intent was to improve customer satisfaction by providing good value at every price point from inexpensive entry-level products to esteemed luxury goods. A portfolio planning methodology identified opportunities to extend the product line, and a rigorous evaluation process ensured all products would meet the new quality requirements. Only one-quarter of the existing product line measured up; the remainder was discontinued.

The company also increased its marketing efforts and improved the level of integration with its services business. Opportunities were identified to drive complementary demand by promoting and cross-selling the entire portfolio of products and services.

Revenue through Year 2

Sales rebounded quickly as a result of the increased attention. Point of purchase displays, marketing collateral, demonstrations, and promotions helped spur demand. Over the following months the company depleted inventory of discontinued stock and introduced several new products. Product line breadth doubled and later almost tripled. 

Insight

Buying patterns began to shift as better options were added to the lineup. Customers were willing to spend more when presented with a better assortment of high quality goods. The improved quality, selection, and marketing materials gave customers more confidence in finding the right product at the right price. In addition, extending the line to higher price points increased the perceived value of mid-level merchandise. 

Margin Improvement

The company also initiated a program to improve margins. An analysis of sales during the baseline period revealed that margins were below average for five of the ten best selling products (including the top two).  

Several actions were taken to address the situation:

• Reviewed economic order quantities to optimize supplier discounts

• Negotiated better pricing with key suppliers

• Evaluated alternative suppliers

• Increased the price of select products where cost reductions were not possible

• Discontinued low margin products and identified viable substitutes

As a result of the initiative average margin for the product line went up by approximately two percent of sales. Of the five top-ten products with below-average margins during the baseline period, three maintained brisk sales with margins above or near the new average. The other two items from the baseline top-ten were moved to niche roles until on-hand inventory was consumed.

Target Margin Model

Management was satisfied with the margin improvements among top selling products. However, wide variability still existed across the rest of the product line. In addition, concerns were raised that sales of luxury goods might be constrained if prices were too high.

During Year 2 the strategy was refined by developing a target margin model that related selling price to cost of goods sold. The model incorporated the following guidelines:

• mainstream products should have the highest margin percentage

• low-price, entry-level products could forgo some margin for the sake of market penetration, but should still make strong contributions overall

• low-volume luxury products should be priced more aggressively to entice customers to move upmarket

In Year 3 the product line generally aligned with the target model. Average margin was lower than Year 2 but still better than the baseline period. More notably, revenue per customer and average-price-per-unit-sold continued to go up.

Insight

Margin became a consideration for how products would be positioned within the line. Value-based prices were set in accordance with product features and quality, and then cost targets were established to generate the desired margins. New products would not be added if cost, price, and margin were not aligned. When suppliers implemented cost increases, existing products were repositioned to higher price points (if quality and features supported it), or the products were discontinued, or management accepted lower margins until viable substitutes were identified. 

Implications

This case reveals insights into practical matters of product line management, and underlying factors related to management's perspective and values.

Product Management

Make money on the best selling products. High volume products have the largest impact on a company's overall performance, and, therefore, deserve special attention. Often there is a tendancy to be satisfied with large revenues, but it is imperative to manage high volume products with discipline.

• Product features should be clearly defined to provide a compelling value proposition that meets customer expectations within an established cost target. Managers must assess the tradeoff between product benefits and cost to determine an optimal balance among customer, competitive, and financial requirements. This becomes increasingly important at lower price points.

• Improving quality and product performance often leads to greater customer satisfaction, higher revenue, and fewer returns. In some cases, though, performance (feature) compromises are acceptable when customers place greater emphasis on other factors such as speed-to-market, availability, or price, for example.

• Discounts and incentives should be applied to core products strategically to ensure the incremental increase in sales generates even bigger advantages through economies of scale or market penetration. If the products would otherwise sell anyway, discounts just sacrifice margin for volume.

• Expenditures should be managed closely to hit the required cost targets. Identify unnecessary labor, materials, discretionary spending, infrastructure, and administrative activities. Look for opportunities to consolidate suppliers.

• Maintaining an inventory of high volume products might be appropriate when there is high certainty of selling the stock and competitive position is improved through increased availability and/or lower cost. In general, raw material inventory with short production lead time is preferred over finished goods. Care should be taken to moderate the risk of building inventory to forecasted demand especially with respect to new product introductions and economic down-turns.

Create a product lineup that fulfills different roles. The product line was segmented based on user applications, and price points were established within each segment. Individual products fulfilled one of four general roles depending on price and/or sales volume:

• Core—the few best-selling products measured by revenue

• Entry—lowest priced products, often with a limited set of features

• Prestige—high quality, feature-rich products typically at the highest price points; sometimes referred to as halo products

• Niche—moderate to low volume products that satisfy a variety of needs; typically most of the product line consists of niche products

The product introduction strategy and marketing mix might vary for each role and in each segment. As discussed above, high volume core products should receive more attention. Entry level products should also be managed closely to prevent feature-creep and margin erosion. Low volume niche and prestige products allow more flexibility with respect to pricing and promotions, but care should be taken to limit the level of resources committed to support these products (personnel, equipment, inventory, product revisions, et cetera).

Management Perception

Beyond margin analysis and the technical aspects of product line management, the ultimate key to success was management's ability to adopt a customer's perspective and realize the company could do more. The initial perception was that product quality, pricing, and value were good; the low sales figures could be explained by seasonality and high price-sensitivity among customers—i.e. external factors that the company could not control. However, an alternative interpretation suggested that selection was poor, many products were of moderate quality, and marketing collateral and communications were insufficient.

Management originally mis-characterized customers' motivations. The preference for inexpensive products had been attributed to lack of interest in the product line; management thought customers were focused on the main service and wanted to minimize cost when purchasing the accompanying products. Therefore, the initial plan was to add more low-end items and focus on cost reduction to improve margins. In addition, marketing communications were cut back and the sales team tried to push customers to purchase additional volume.

An alternative interpretation agreed that customers were focused on the company's main services, but attributed their preference for inexpensive products to a lack of knowledge and confidence. From this perspective customers were buying small quantities of low-price products as a risk reduction strategy to minimize the impact of making a poor choice. A largely untapped potential existed to generate the same level of excitement and passion that surrounded the company's services business. In response, the team worked to improve product quality and marketing communications. Several high-end and niche products were added while the low-end was culled to a few high-value selections. Sales representatives leveraged the broad selection to find a better fit for each customer's needs. Marketing programs supported the effort with better product information, samples, access to product knowledge experts, and promoting all the external recognition the new products received.

The product line came to represent the company's values. Once management internalized its rationale for the decrease in revenue, it adopted a philosophy of, "We can do better." Discontinued products were replaced with higher quality alternatives that offered better value. A structured, multi-stage product introduction process filtered through thousands of potential new products to identify the ones that represented excellent value at every price. The organization could stand behind its renewed product line with confidence knowing it truly complemented the services business and provided customers with better experiences.