The term "diversity" is often pigeonholed to have a very narrow meaning. For some, it has a negative connotation. For others, it spells opportunity. In business, diversity can be capitalized to enable strategy, foster innovation, improve operations and mitigate risk. Exploring diversity in this context and applying it to the development and deployment of intellectual assets (i.e., customer capital, structural capital and human capital) will allow you to see how an organization can use this as a vehicle for growth, differentiation and profi-tability. Once again, this is another one of those leadership issues!
This will be a three-part series that will explore the impact of maximizing the return on each of the three types of intellectual assets - customer capital, structural capital and human capital, starting with diversification of the customer capital as this relates to the basic revenue stream. Next month's article will cover diversity and structural capital, concluding with diversity and human capital.
Securing the Revenue Stream
It's well known that it's not advisable to have all of your eggs in one or two customer's baskets. So you could apply the ten percent rule and say that your customer mix must be such that no one customer will contribute more than ten percent of the revenue to the income statement in any one fiscal year. This requires diversity in customers using revenue (sales) as the qualifier. It is a way of managing risk at the top-line.
There are other types of customer capital diversity that can play an equally important role. All of the methods require a thorough knowledge of the industry if one wants a high degree of success and a solid short-term return on investment. Knowing a customer is not enough! One must also understand the dynamics of buying, manufacturing and distribution in the industry - it's the when and how. Once there is a basic understanding of the industry, the supply chain must be researched to understand the rules of competition and the timing - what is bought by whom and when? Where are the components, subassemblies and assemblies built? These are but a few of the parameters.
Following are some of the additional ways to build diversification with customer capital.
Diversity of Market Segments
Market segment diversification can be an effective tool for managing revenue and cash flow risks as well as to level out the capacity demands in the factory. From a risk viewpoint, this can improve fiscal fitness during those times when external changes in the business environment appear to be chaotic. It also allows the company to capitalize on opportunities that surface during these periods of change. If the market segments are selected carefully, the capacity demands in the factory have a tendency to append the peaks and valleys since one segment's demand curve for capacity requirements may complement or offset another segment's needs.
Market segment diversification takes time up front to research the segments and isolate key targets of opportunity. It must, however, be done expediently since today's market dynamics are changing rapidly. Consider what is easier to do: get more of the same type of work in the same segment or expand the breadth of markets served? What has been your experience?
When diversifying market segments, seasonality is often a complementary feature. A representative example might be working with companies that produce snowmobiles and companies that produce lawnmowers. One is for distribution in the spring, the other in the fall. The build cycles and model changeovers are typically offset by several months. Depending on time-to-market issues within the industries, this may provide complementary capacity demands for both the OEM (Original Equipment Manufacturer) and the supply chain. If so, the market segments would provide an inherent method of reducing capacity demands (e.g., peaks and valleys) and provide a sustaining level of demand.
For some, one might consider this as a way of just making the peaks last longer. Indeed they will! But if growth is one of your strategic objectives, this is a positive problem to have rather than high-frequency, high-amplitude peaks and valleys. Note that the industries are also diversified segments. This helps to manage risk and also can support the ten percent customer mix rule.
If a company chooses to use seasonality as one of the criteria for diversifying customer capital, then there must be at least two non-dependent market segments chosen that have the same seasonality manufacturing requirements. This measure is for risk abatement in the case where demand in one of the segments dissipates for whatever reason. Unless you have found a way to insure that your customers are not only leaders in their respective field of competition but also that they control consumer spending, redundant seasonality segments are recommended.
Seasonality as an evaluation factor alone can be tricky unless you know the market. For example, the manufacture of lawn-mowers may be the big show in late fall and early winter for the northern hemisphere, but 180 days out for the southern hemisphere. This leads to location as yet another criteria.
The location of customers can also be thought of as a way of diversifying customer capital. In the example above, assuming manufacturing of snowmobiles and lawnmowers is done predominantly on only one continent, the capacity peaks may be continuously high albeit staggered in fiscal quarters: demand for lawnmowers - snowmobiles - lawnmowers - snowmobiles. Here is where the redundancy factor comes into play. If there is a global warming trend next winter in both the United States and in Australia, and your customer makes only snowmobiles, the two peaks for snowmobile production may flatten abruptly. Having a second segment that exhibits the same seasonality characteristics as snowmobiles but is non-recreational or dependent on snow can minimize the impact and lower the pain threshold for lost sales due to lack of demand for snowmobiles.
Customer location can also be viewed from an operating viewpoint as well. If geographic development is the growth strategy, the opportunity for customer development would be based on region. This may impact positioning of direct sales staff, engineering staff, location of additional manufacturing arms (i.e., acquired, merged and new starts) and the allocation of services. If a company builds tools and the secondary operations such as heat-treating, plating or special coatings are required, one may consider locating secondary operations in the regions selected. This not only puts the last operation near the customer base, but also provides business and technical presence within the region near the customers. The possibilities are unlimited.
Business Type, Maturity, Stability and Vision
Some companies will also evaluate the customer's business type, maturity and the stability as selection factors. This is a form of portfolio strategic management related to managing both revenue and financial risks.
A typical US company might select customers based on ownership types - a certain percentage of the companies, based on revenue, that are incorporated divisions with an American parent company; a percent that are incorporated divisions with an offshore parent company; a percent that are incorporated start-ups and a certain percent that have off-shore owners. The breakdown may also be based on whether the company is privately (investors and/or family businesses) or publicly owned. In each of these cases, the goal is to minimize the surprises downstream by keeping your eyes wide open during the customer dating and mating season. Ask the question: What factors outside of my immediate control could put my customer out-of-business or thwart the customer's ability and desire to pay me for work performed? Then select carefully to minimize potential risk. It's okay to have some customers that offer high potential and have correspondingly high risk as long as there is a counterbalance and offset.
Maturity, stability and vision often go hand-in-hand with the business type. One of the key discriminators to look for in terms of stability is the probability that the customer company will become a target for acquisition or merger. One may also evaluate customers in terms of their relative leadership position in their market segment; the technology incorporated and useful life of their products; their ability to manage changes in their markets and their vision of the future. These factors will impact your business and thus represent potential risks.
Assessing the needs of customers and diversifying business opportunities into groups of like needs is another strategic decision related to the development and deployment of customer capital. For example, if a company chose to add or expand the demand for a certain group of services that are being offered, then customers may be selected using this criteria. This is the internal vantage point. Externally, business needs are typically tied to issues related to the customer's market differentiation, time-to-market, market timing, delivery and lead times and product support. This may further translate into prototyping, production quantities, lot sizes and release frequency, product features and materials.
The supply chain must be a player in meeting these needs. If a customer base is particularly focused in only one area (e.g., prototyping), it may be worthwhile to balance the mix with production work. One company used business needs as a category to help create diversity in customer capital by insuring that at least seven and one-half percent of the orders it received was rapid-prototyping work, another ten percent was small lot, production prototype work, and the balance of the orders was production runs. This mix formula was applied to the entire customer base along with several of the other evaluation parameters listed above as a means of guiding the strategy for customer selection, managing risk, maintaining growth and profitability and improving operations.
The needs area is a responsiveness issue. This means that internal operations such as quoting responsiveness and delivery lead times are directly tied to the customer capital.
There are many ways to unleash diversity as a strategic enabler. As an exercise, take a list of your customers and evaluate each one using the criteria above. Then estimate your company's relative at-risk position and opportunities for growth based on customer capital.
In the end, each of you has total control of your company's risk. Effective leadership in this area is the key to designing and implementing strategies for diversity that pay big dividends.
Next month you will see how the diversification of structural capital including space and equipment, processes and organization must parallel and support the development and deployment of the customer capital.