April 2003

Value Propositions – The Guide to Profitable Growth

As young companies move through growth stages, changing business objectives drive the way they think about their market:

• During formation - when business plan development and initial funding are critical - growth companies focus on understanding the size, structural characteristics and overall potential of the entire target market.
• As companies shift to development of their product or service, the business objective shifts to finding initial customers, to prove the viability of the offering and often to test the first version of the product. Market perspective turns to defining the characteristics of the "average" company in the market.
• Acquiring major customers who provide both volume and credibility becomes the driving goal as companies enter the revenue-generation stage. At this point, it is necessary to begin segmenting the market, and the initial focus is on large customers, especially that small number of reference customers who lead the market.

However, to successfully transition from revenue-generation to consistent profitability, young companies must make a quantum leap to a richer, more detailed understanding of their markets, and use that insight to set clear priorities about which segments offer the best initial opportunities for profitable growth and which must be avoided until a later stage. A market segmentation based on structural characteristics such as size will not provide this level of insight. Instead, a company must understand the alignment between customer business needs and buying motivations on the one hand, and their product offering and delivery capability on the other. In other words, to sustain profitable growth, markets must be segmented according to common business needs, and evaluated according to the company's ability to deliver a compelling value proposition.

This approach offers several important benefits for growing companies. First it enables segment-specific marketing and sales strategies, which are more likely to resonate with customers than a single, market-wide approach. Secondly, value propositions can be used to tailor product and service packages to meet the needs of a specific segment. This in turn leads to the opportunity for differential pricing for each segment.

Bottom line, value propositions can help a senior management team maximize the return on invested capital by identifying the segments and customers most likely to deliver profitable growth

Bottom line, value propositions can help a senior management team maximize the return on invested capital by identifying the segments and customers most likely to deliver profitable growth.

Let's examine the concept of value propositions, look at how they can be used as a basis for market segmentation, and discuss how to leverage them, drawing on examples from information technology and life sciences industries.

What is a Value Proposition?

A value proposition describes unique benefits or value that a product or service offers to a customer, stated in terms that make sense to that specific customer. Value propositions are not function or feature descriptions, and they go beyond generic product benefit statements. They are developed within the customer context, and describe how the product/service will help the customer solve a business issue or achieve a specific goal:

The most effective value propositions are simple, and capture the essence of the differentiated benefits that the solution offers to the customer. They can include both tangible (such as reduced error rates) and emotional (a greater sense of control, for example) benefits. Most importantly, a well-developed value proposition makes sense to the customer.

Value propositions can be developed for a single customer, creating a powerful selling tool that translates generic product benefits into specific advantages for the prospect. (Companies often develop value propositions for individual major customers.) Alternatively, value propositions can be developed for a group of customers who share common issues or objectives. It is in this context that they become the basis for evaluating market opportunity.

Defining Needs-Based Market Segments and Value Propositions

The process of defining needs-based market segments and using value propositions to characterize them begins by defining the business objectives and challenges that distinguish one group of customers from the rest of the market:

The key is to understand the mindset of the customer – objectives, issues, choices and motivations.

The key is to understand the mindset of the customer – objectives, issues, choices and motivations. Unfortunately, this intimate customer knowledge is often lacking in start-up companies and when it exists, is spread among marketing and sales executives. As a result, it is often necessary to collect additional information, by talking to customers through interviews or focus groups. Once the initial value propositions have been developed, it is a good idea to test them with customers and the marketing and sales team.

The resulting segmentation bears little resemblance to structurally-defined market segments, and is much more valuable. For example, the market for an extranet-based vendor management solution can be segmented according to four distinct sets of needs and corresponding value propositions:

Evaluating Segment Opportunities and Developing Strategies

Once compelling value propositions have been defined for each of the segments in a market, they can be used to set clear priorities and drive marketing and sales strategies. The first questions that a CEO and his management team must answer are:

• Which segments offer the best match with our current capabilities and the differentiating value proposition, and therefore the best opportunity for entry and profitable growth?
• Which segments should we avoid, based on the need to make further investments in product and support in order to consistently deliver the required value proposition?

Once the priority segments have been identified, the value propositions can also guide offer definition, marketing and sales planning, and future product development: The key questions are:

1. How can we package current products and services in a way that maximizes the value offered to a segment?
2. What marketing strategies and messages will be most effective in reaching our priority segments?
3. What tools and training are necessary to help sales staff and distributors assign customers to the correct segment, and deliver the key messages?
4. What opportunities do we have to develop new products and delivery capabilities that will increase the value we offer to a specific segment?

Following the example above, knowledge of the value propositions that define customer segments allows the development of clear priorities and segment-specific strategies:

Putting Value Propositions to Work

To decide if it would be worthwhile to look at the market through the value proposition lens, the CEO of a growing company must answer a few simple questions:

1. Given our stage of development, what is the appropriate framework for us to use in thinking about our market?
2. Do we have an accurate way of assessing our ability to meet customer needs in a way that will differentiate us?
3. Are we clear on our strategy for segmenting the overall market and focusing our resources on that portion where we can be successful?
4. Can I reassure my investors that our marketing budgets are being spent on reaching those customers who offer us the greatest opportunity for profitable growth?

Depending on the answers, value propositions may be an effective way to identify the best opportunities in your market.