Customer Differentiation System: Compatibility of Value Creation and Cost Management

A C T A U N I V E R S I T A T I S L O D Z I E N S I S

FO LIA O EC O N O M IC A 173, 2004

Ij)reta Valaniiené*, Vytautas Boguslauskas**, Bronius Neverauskas***

CUSTOMER DIFFERENTIATION SYSTEM: COMPATIBILITY OF VALUE CREATION AND COST MANAGEMENT

Abstract. The novelty o f the research and its scientific value are defined by theoretical

and practical results, which proved the usefulness o f the application o f custom er differentiation system in practice, i.e. showed th at the application o f the decision m aking m ethodology makes it possible to efficiently design m anagem ent decision structures, conform ing to the conditions of the changing environm ent and to evaluate their im pact on maximizing utility rate, which integrate the com pany’s profitability and custom er satisfaction rale.

All this serves as a background for advance rejection o f ineffective custom er m anaging solutions, selecting long-term relationships between com pany and custom er. Based on the accum ulated research results, the paper states th at the new custom er differentiation system derived ensures the quality o f m anagem ent decisions as well as positive results o f a company. It particularly reflects custom er satisfaction and com pany’s profitability rales. The paper took the first step in the im plem entation of custom er differentiation systems and in m aking an empirical exam ination o f cost managem ent and value creation perspective integration in a m anagem ent system. It is probable th at the received and dissem inated theoretical and practical results will become a starting point for the further researches.

1. Introduction

As in most countries, the decision making process in Lithuanian companies has been subject to substantial changes, which have challenged the structure o f the organization and led to strong com petition and environm ent changes. Loyal and profitable custom ers cannot be considered a guarantee for

* K aunas University o f Technology, Economics and M anagem ent Faculty, A ccounting D epartm ent; lvalanciene@ hotm ail.com

*• K aunas University o f Technology, Economics and M anagem ent Faculty, A ccounting D epartm ent; vytautas.boguslauskas@ vf.ktu.lt

*** K aunas University o f Technology, D ean o f Economics and M anagem ent Faculty; dekvf@ adm .ktu.lt

long-term success. M anagement consultants and researchers agree that com pa­ nies should be m ore customer-focused, should m ake different decisions to different customers. It means that companies should develop integrated perspective of cost m anagem ent and custom er value creation. M anagem ent changes increase the urge o f knowledge and inform ation. N aturally, the necessity o f creating new m anagement systems comes to the surface. This seems to be a difficult task. The researchers o f m anagem ent (B i t n e r, H u b b e r t , Z e i t h a l m , F a r a n d a 1997; G r i f f i t h s , E l s o n , A m o s 2001; et al.), m anagem ent accounting ( K a p l a n 1997; S t o r b a c k a 1997; F i c k e r t 1998; N i e l s e n , B u k h , M o l s 2000; M c N a i r , P o l u t n i k , S i l v i 2001; et al.) and m arketing ( K o t i e r 1994; C a e s o n , G i l m o r e , M a c l a r a n 1998; D i b b 2001; et al.) have studied this. However, m ost of these studies provide us with qualitative tools only. An exception is studies related to product cost planning (such as target costing, kaizen costing or value analysis). Accordingly, the scientific problem explored in the paper is form ulated as follows: a lack of knowledge enabling integration o f cost management and value creation perspective in m anagem ent decision-making.

The aim o f the present paper is to show and to prove the efficiency o f customer differentiation methodology, which could ensure cost management and value creation compatibility in m anagem ent decision-m aking processes.

2. The scarch of compatibility: customer differentiation system

The new conditions for business survival are connected, on the one hand, with the ability to satisfy custom ers’ needs - with an offer (goods' quality in relation to prices) that is better than that o f the com petitors (Z e i t h a m 1 et al., 1990; C a r u , C u g i n i 1999, et al.). On the other hand, the conditions for survival are related to the readiness of custom ers to pay a price for the goods that is higher than their production cost. Both these conditions require integral consideration of the value perspective for the custom er and business profitability.

Referring to the first condition of survival (value creation to custom er), goods often are an aggregation of intangible attributes, which can be assembled in various ways as a function of the utility desired by individual customer. The form ulation o f the goods structure o f the offer m ust result from considering the principal benefits being sought by custom ers. The m ain problem is to recognize the im portance o f different goods attributes

1 G oods are naturally everything which is in the m arket and could meet custom er’s requirem ents and expectation.

(attendant services, products, etc.) for individual custom ers and to m ake offer for specific demand custom er or customer clusters.

As to the second condition o f survival (cost m anagem ent), the definition o f price that should be fair by customer and at the same time profitable for the company ( K o t i e r 1994; G a t t o r n a , W a l t e r s 1996; I u r n e у 1996, et al.). It should be estimated that value is the am ount custom ers are ready to pay for all the attributes the com pany supplies them with.

Both o f these conditions require integral consideration of the value perspective for the custom er and business profitability, which is impossible to achieve without a relevant measurement system. There are some im portant reasons, which block up the realizing o f an integral approach (compatibility o f value creation and cost m anagem ent) in conventional inform ation systems (such as marketing or cost management information system). They are: • Traditional strategic thinking in companies;

• Lack o f functional integration between m arketing and m anagem ent accounting departm ents ( S t o r b a c k a 1997; C a r u , C u g i n i 1999); • I'he same concepts tend to m ean different things to the people in sales

and m arketing departm ents and to the m anagem ent accountants, in other words discrepancy between the notions ( S t o r b a c k a 1997; В 1 a 11 b e r g, G e t z , T h o m a s 2001);

• Unclearness of activity cost, especially cost of custom er servicing activities ( R e i c h e l d, S a s s e r 1990; F i c k e r t 1998);

• Existing tools could not easily identify how to integrate m easurem ents and interpretations o f com pany phenom ena in a double perspective of m arket effectiveness and internal efficiency ( S i m o n s 2000).

They show that bringing together custom er value creation and cost m anagem ent perspectives calls for the development o f m easuring techniques which allow the language o f two disciplines to be a unified and integrated vision of objectives (internal efficiency and m arket effectiveness). A customer is a value creation object in m anagem ent, and also a basis of a com pany’s cost form ation in m anagem ent accounting. T h at is why custom er differen­ tiation analysing custom er requirements and value was chosen as a m eans to solve the compatibility problem o f two different perspectives.

3. Development of customer differentiation system and methodology of management decision-making

Trying to liquidate the discussed reasons the m easurem ent systems should give inform ation about activity, which does not only consume resources, but also creates value for customers. The custom er differentiation systems were form ulated within the frame o f the following aspects:

• The priority object o f reference for correlation o f value generated and costs is customer, but not products or services;

• This correlation cannot occur in itself, but it has to be coherent with the com pany’s activity, which is the link between costs and value created to a customer.

The first aspect o f custom er differentiation was im portant because the custom er generally correlates the goods with the perform ance from which he obtains benefit ( H e s k e t t et al. 1997; Z e i t h a m l , B i t n e r 1996). lt does not m ake sense to strengthen an offer if the custom er does not perceive the improvement as significant. W here custom ers pay the same price but use the service purchased to different extents, there is an effective subsidizing of those who have a m ore intense enjoym ent of the service by those who use less. In this way entry opportunities are created for new com petitors who can segment the m arket m ore effectively. The variability o f the final offer system requires a calculation of cost o f individual elements o f the goods, which can be aggregate in different offers in relation to preferences expressed by custom er or clusters of customers.

Regarding the second aspect of system creation, the actual value for the custom er is generated by individual activities which a com pany carries out in designing, producing, selling and distributing its goods (products and services) ( H e s k e t t et al. 1994, 1997). T h at is why a com pany m ust understand the dynamics o f its cost structure and factors, which determine it. Trying to get to the point companies m ust define business processes as a set o f interrelated activities and analyse activity chains.

Custom er differentiation system enables approaches of com pany (cost m anagem ent) and customer (meet the requirem ents) in respect of goods to be integrated. Based on custom er differentiation system, decisions on the structure o f goods are determined by these conditions:

• Selected structure of goods should be conditioned by the lower growth of custom er costs AC„ -» min;

• Selected structure of goods should be conditioned by the top perceived customer value growth A Y yq -* max.

In the light of formulated conditions, the methodology of decision-making consists o f five stages. In order to illustrate the stages, a reference to a Lithuanian pharm aceutical company case was used. The com pany has 124 customers. All custom ers were divided into 3 clusters by their attributes, which define custom ers to company. The stages are:

1. The identification of the goods structure (А-alternative o f goods structure). Table I shows the results o f com pany’s offered and custom er required goods structures. Relevance of the alternative goods structures offered by the Com pany to custom er needs is m arked qr:

4. ■ ₀1, i f x d = x ' d _. (1)

where

t]t - simulated variable, which shows the presence or absence of custom er

required goods attribute level in com pany’s alternative,

x rJ - goods attribute level required by custom er, x ' d - goods attribute level offered by company.

T a b l e 1 Illustration of possible goods alternatives

(research o f customer and com pany approach)

G oods attributes

A ttribute « t = 1 £ = 2 £ = 3 e = 4 £ = 5 e — 6

N um ber o f attribute i level (Lt) L, = 3 L 2 = 3 L 3 = 2 L,, - 2 L s = 3 i . “ 2 Com pany’s offered alternative (A') x ' _{л II X 21 x i i •* *i X 52 * ' . i} Custom er desirable alternative (Я) _{* 1 2 •*21 *ii * 4 2 ■*53 •*6i}

In conformity with customer needs 0 1 1 1 0 1

The Lithuanian com pany research results show th at in the third cluster o f custom ers (the best customers) there were m aximum 2 variances of custom er required goods structure, but in the first cluster of custom ers (the worst customers) there were 5 variances o f structure.

2. The formation of alternatives for customer. T he qu an tity o f the possible goods alternatives depends on quantity o f attributes levels, which are n o t relevant to custom er requirem ents (if r]e = 0). E valuation of alternatives shows changes of cost (2) and custom er perceived value (3) (see Table II).

AC = С - С (2)

where

A С - changes o f customer v serving cost (custom er cost) after attribute level changing,

- v custom er cost, which occurred after attribute level changing, С - custom er v cost, which occurred in prim ary (offered by com pany) structure o f goods.

A ľ ? “ Гя - y ; = I ( Ą (q) - (ío)) (3)

where

A J * '- changes of customer v perceived value after attribute level changing,

Yq - custom er evaluation o f q alternative, when q = ( Í7 Q ), e - concerted attribute, e. = (1, E ) ,

x arJ - utility of attribute level o f alternative, qQ - offered by company goods structure.

T a b l e 2

Illustration o f goods structure evaluation in cost and value aspects

The heap of goods alternatives

Form ulation o f alternative Description of alternative Changes o f costs (AC,), Lt Changes o f value ( A p ­ point А, ш A' ( У ц , -?2| > * S2> W ithout changes 0 0 12> -*21 > * 3 1 ' -®42> X iV *«> Exchangeable: Jf12 + 16 1<)4,51 + 0,17 (■ * \l> ^21" -^31' ^52> ^ i l ) Exchangeable: jfs, + 6 134,76 + 1,26 At = Ä (-^12» ^2I> *31> ~^*2’ Exchangeable: x 12, x si + 22 239,27 + 1 ,4 3

3. Determination of company’s purpose priorities. C ustom er differentiation system is used as a tool for two different purposes or their compatibility. U tilisation o f the system should estim ate integral result. Priorities of purpose should be fixed. P R Il shows a priority o f cost m inim ization, P R I2 shows a priority of maximizing the efforts for meeting customer requirements. Sum of priorities is equal 1. If one priority is nonessential, then it is equal 0.

4. Ranking of alternatives and their selection according to defined priorities. Figure 1 shows illustration of alternative ranking and its selection according to a given situation, which is determined by the im portance o f priorities (meeting custom er requirem ents or business profits).

Deviation o f different priorities rank is defined as follows:

A R A q = R A q (ACt) - R A q ( A Y vq) (4)

where

AR A q - deviation o f alternative q according to priorities (cost or value),

C o n d itio n o f se le c tio n p r i o r it y ( P R I ,= P R b )

R a n k RA 1 2 3 4

R a n k in g by co st M in M ax

A lte r n a tiv e s r a n k i n g b y c o sts PRI, A , a2 •A«

R a n k in g by c u s to m e r v a lu e L .M ax — ...1--- --- i — .../ M in

A lte rn a tiv e s ra n k in g b y c u s to m e r v alu e P R I2 _... ... T W ~ ▼ A i Г A]

2. P riority o f custom er v alu es b e in g m ore im portant:

C o n d itio n o f se le c tio n p r i o r it y ( P R I i< P R l2>

R a n k RA 1 2 3 4

R a n k in g by co st M in M ax

A lte rn a tiv e s r a n k in g b y c o sts PR I, ▲ A, A , _{▲ A i} Ац

R a n k in g by c u s to m e r v a lu e M ix

T

A lte r n a tiv e s ra n k in g by c u s to m e r v a lu e P R I2 A , 1 & A , A ,

3. Priority o f custom er values being m ore im portant:

C o n d itio n o f se le c tio n p r i o r it y (P R Ii> P R I: )

R a n k RA 1 . 2 3 4

R a n k in g by co st M in M ax

A lte r n a tiv e s r a n k in g by co sts PR I, > > Ы A j

R a n k in g by c u s to m e r v a lu e M ax * "i i M in

A lte r n a tiv e s r a n k i n g b y c u s to m e r v a lu e P R I2 A4 ▼V % A,

Fig. 1. Illustration o f th e process for selecting alternatives -j

C u st o m e r D if fer en tia tio n S ystem: C o m p a tib ili ty of V al ue C re a ti o n ...

Selection o f the alternative is based on these conditions: • M inimum deviation o f different priority ranks,

• Rank o f selected alternative should be minimal according to a defined priority.

5. Economic estimating of the selected alternative. The purpose function ensures optim al selection o f alternative according to the priorities. Integral rate evaluates the purpose achievement:

Tq

(РГ‘У*!'

(vp‘f Rl2

where

Tq - utility o f alternative q selection,

prt - com pany’s profit achievement level, defined as proportion of

planned and achieved profit,

vpt - custom er requirements meeting level, PRIy - priority o f cost minimization,

P R I2 - priority of customer requirem ents m eeting maximization,

v - custom er, v = ( 1 , V).

When the selected alternative of goods is optim al, the integral rate gets the biggest value Tq = max ( T ).

Table 3 presents summarized results of this research. F o u r situations of decision m aking in the Lithuanian com pany were analysed:

• 1 he first situation - all decisions are made without customer differentiation, • I he second situation - different decisions are m ade for different clusters

according to the internal (cost m anagem ent) perspective,

T a b l e 3 Results o f research according to a selected decision-m aking situation

Results Basic state 1 situation 2 situation 3 situation 4 situation Planned profit, thousand

L i 5 257,03 5 439,69 5 514,63 5 479,55 5 595,86

Planned costs o f customer

servicing, thousand Li 971,94 789,27 714,34 526,91 633,11

Profitability rate 0,2182 0,2257 0,2289 0,2263 0,232

Structure o f custom er (cluster z = 3)

V, 29 30 33 33 34

К 53 71 61 53 50

У, 42 23 30 38 40

Level o f custom er requi­

■ The third situation - different decisions are m ade for different clusters according to the external (customer value creation) perspective,

• The forth situation - different decisions arc m ade for different clusters according to the integrated perspective (cost m anagem ent and value creation).

The research results show that the Lithuanian com pany has a potential to achieve its profitability (8,47%) and meet its custom er requirem ents (22,2%). It means that it proves the effectiveness of custom er differentiation system as a compatibility tool of cost m anagem ent and value creation in alternative m anagem ent decisions making.

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Isoreta Valančiené, Vytautas Boguslauskas, Bronius Neverauskas

SYSTEM RÓŻNICOWANIA KLIENTÓW: KOMPATYBILNOŚĆ KRKOWANIA WARTOŚCI I ZARZĄDZANIA KOSZTAMI

(Streszczenie)

W artość przeprowadzonego badania polega na uzyskaniu teoretycznych i praktycznych wyników, potwierdzających użyteczność systemu różnicowania klientów w praktyce. Wyniki badań wykazały, że stosowanie metodologii decyzyjnej pozwala na ustalenie właściwej struktury założeń decyzyjnych, odpowiadającej zmienności otoczenia oraz na ocenę ich wpływu na maksymalizację korzyści, intergrującą stopę zysku przedsiębiorstwa i stopień zaspokojenia potrzeb klienta.

Wszystko to służy jako podstaw a do odrzucenia nieefektywnych rozw iązań i wyboru w ariantu, zapewniającego korzystne długookresowe relacje firm a-klient. N a podstawie prze­ prow adzonych badań stwierdzamy, że opracow any przez nas system różnicow ania klientów zapewnia wysoką jakość decyzji oraz pozytywne wyniki przedsiębiorstwa. A rtykuł ten to pierwszy krok w kierunku wprowadzenia systemu różnicowania klientów oraz empirycznej weryfikacji efektywności stosowania zintegrowanego podejścia w zarządzaniu. M ożna przypuszczać z dużym prawdopodobieństwem, że uzyskane na podstawie przeprowadzonych badań teoretyczne i praktyczne wyniki będą stanowić punkt wyjścia do dalszych prac w tym zakresie.

Loreta Valančiené, Vytautas Boguslauskas, Bronius Neverauskas

VARTOTOJV DIFERENCIACIJOS SISTEMA: VERTÉS KCRIMO IR KAŚTIJ VALDYMO SUDERINAMUMAS

(Santrauka)

A plinkos pokyčiai sąlygojo im oniij valdym o perm ainas ir kartu pad id in o żinii} bei informacijos reikmę. Ypač svarbi tapo informacija, igalinanti naujom is verslo sąlygomis priimti valdym o sprendim us, kuriais siekiama ne tik geriau nei k o nkurentai tenkinti v arto to ją poreikius, bet taip pat laikytis ekonom iśkum o principą. Straipsnio tikslas- atskleisti varlotoji) diferenciacijos sistemos reiksmę ir poveik( kasty valdymo ir vertés kurimo procesy suderinamumui.

Mokslinéje visuomenéje aktyviai diskutuojam a apie im onés kaštv valdymo ir vertés, kuriam os vartotojam s, sudcrinam um o biitinybę kaip vieną iš svarbiausin ir sunkiausiai pasiekiam i4 verslo valdymo uždavinitj. Pažangios mokslinés studijos siülo ivairiausias priem ones

kašty valdymo ir vertés, kuriam os vartotojam s, procesu derinim ui atlikti. Sią priemoniy pagrindinis trükum as yra vadovavimasis tik imonés viduje užsibréžta vertés kürim o vartotojam s perspektyva, dar ant prielaidą, jog imonés perspektyva atitiks vartotojij požiúri. Todél straipsnyje yra aptariam a vartotojij diferenciacijos sistem a ir jo s sudarym o principai, kurie remiasi vartotojy pasitenkinim o ir imonés kaštij santykio svarbos pripažinim u, šio ryšio išreiškimu apskaitos m atais bei šios informacijos veiksmingumo valdymo sprendimij priém im o procesui užtikrinim u.