Wednesday, February 18, 2009

The Endowment Effect

I recently met with some local software business leaders to discuss how the economy is affecting us. Driving to the meeting, I tried to think up a course of action that makes sense during these times. Best I could come up with were:
  • Focus - Remove distractions and concentrate on the narrowest scope of business that has the greatest chance of success. This is an opportunity to make some hard decisions about what you're doing and what you're willing to concentrate on.
  • Leverage existing success - Go back to your existing installed base and make sure they're happy, and upsell them as much as possible. Do this with existing products rather than the newer, riskier products.
  • Plan for the future - Assuming your ability to focus and leverage existing success allows you to weather the storm, this will be a unique opportunity to exploit the ensuing landgrab that happens after the weak have been eliminated from the competitive landscape. Don't sacrifice this future investment for some short-term gain.
The interesting point is the second, "Leverage existing success." Something about this felt right, but I couldn't really explain why. This morning I was reminded of a psychological phenomenon called the Endowment Effect. This tells me that my existing customers value our relationship and the products I've sold them more than new customers value that same potential relationship and my new products. I'm going to have much better luck leveraging existing customers more than I am acquiring new ones.

We all know that it costs much more to gain a new customer than to service an existing customer. The Endowment Effect underscores the importance of the asset that is an existing, happy installed customer base.

Another point of validation for the third point, to plan for the future, came yesterday by a Harvard Business Review's blogger entitled Prepare Your People for the Upturn. Good advice.


Blogger EGarabedian said...

I just read your post on the endowment effect. Good post. The last part where you reference the HBR is where I started to smile and thought I'd comment on what you had mentioned about companies during hard economic times. Typically when most companies are facing economic, financial, branding, etc. hardships they tend to turn to their roots to solve the issue and then branch off from there. If you look at the majority of Fortune 500 companies, they at one point or another went through a lasting hardship that threatened the company as a whole. Be it the when Caterpillar and Komatsu went head to head overseas, or when Coke stole Pepsi's Venezuelan distributor because Pepsi was getting cocky, or when Kimberly Clark needed continued innovation to meet a growing demand, or when Vick's tried to introduce new products onto the market using a "home remedy" marketing plan. These hardships usually cost the companies a CEO forcing them to replace with someone of hopefully greater value. What's odd, and what tons and tons of HBR cases teach people/companies is that each one of these new CEOs brough the companies back to their roots and it allowed them to devise a frame to re-build the company upon. A clean slate of sorts but by using the foundation that the company was built upon. I once had the pleasure of meeting Marilyn Tam (executive at Nike, Reebok, and a few other big companies that I can't remember). She told me that when companies brought her in they were undergoing some sort of hardship. And aside from the fact that she invoked multiple labor laws in countries that didn't give two shits about quality or cleanliness of the workforce culture, she said that when faced with tough decisions you always go back to your roots...and I think my parents tell me that too. :)

Take each one of your points. You can attribute the first two points to "going back to your roots" as a company and your final point to "getting ready to move forward with a plan".

Focus...companies during hard times should remember the principles that they originally built their framework upon and i think by "concentrating on the narrowest scope of business" they will end up at their beginning values. At this point they're strengthening their framework and refreshing their values.

Leveraging existing success...So here you talk about leveraging existing products vs new products and I think that's part of the answer. The other part of the answer is "relationships"...which you touch on when you say "make sure they're happy". I think that's a very important statement. One of the things that the large companies of today did when they were the small companies of yesterday was they stuck close to the customer. It was before the days of the internet and email and it forced companies to get their salesforce out and know the customers and build was back in the day when customers knew the salesman's first name, last name, and family. I'm not saying that same level of commitment or relationship is necessary at present (or maybe it is, who knows), but the idea of building relationships and making sure relationships are strong is. I know a few CEOs and COOs and they have one thing in common. They focus day and night on building relationships and making sure people are happy. One of the CEOs goes to work everyday with just his address book. All he needs is to be able to contact people. Kinda like the commercial of the guy who gets on a plane and flies to a meeting somewhere with only his cell phone, does what he needs in the meeting, gets back on the plane and flies back to the office. He could've saved a lot of money if he actually used that cell phone and called into the meeting but get the point. Back to leveraging products. By leveraging existing products you're essentially taking a step back and leveraging the products that you built your success upon. And by getting more involved with the customer you're taking a step back and building upon the core competency of a successful business...people.

Plan for the future...This is where you actually get to re-start your branching out process and think about your future. You've cut the branches back and centered yourself so-to-speak. You rebuilt upon the groundwork that you laid when you started your business and you've focused on the values that you believed in when you created your brand. Now you have a chance to hone in on what's important to drive your company to a successful landing place. This is where the future comes into play as you see it. It's exciting stuff. The important thing here is that a company doesn't stray away from it's plan. It's like racing a sailboat. At some point you're going to have to turn your sails away from one wind to another. And when you find that new wind you're not going to be able to go back and forth between them both, you need to stick to one and let people follow you. Blue ocean.

I think a lot of companies go through this sort of cyclical process of building and rebuilding themselves. I read somewhere (and i wish i could find it) that when a company is very successful and grows very large in size, it is in that company's best interests to divide the entity up into smaller parts that can compete with each other...which by general design is a way to rebuild a company. Interesting huh.

9:21 AM  
Anonymous Robert Schultz said...

Great post, and I agree with you 100%. Wish more people had the same understanding when it came to valuing existing customers!

10:03 AM  

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