Tag Archives: mutual fund

How to Avoid Commoditization

How can a company liberate itself from the death spiral of product commoditization?

Competing on price is generally a losing proposition—and an exhausting way to run a business. But when a market matures and customers start focusing on price, what’s a business to do?

The answer, as counterintuitive as it may seem, is to deliver a better customer experience.

It’s a proposition some executives reject outright. After all, a better customer experience costs more to deliver, right? How on earth could that be a beneficial strategy for a company that’s facing commoditization pressures?

Go From Commodity to Necessity

There are two ways that a great customer experience can improve price competitiveness, and the first involves simply removing yourself from the price comparison arena.

Consider those companies that have flourished selling products or services that were previously thought to be commodities: Starbucks and coffee, Nike and sneakers, Apple and laptops. They all broke free from the commodity quicksand by creating an experience their target market was willing to pay more for.

They achieved that, in part, by grounding their customer experience in a purpose-driven brand that resonated with their target market.

Nike, for example, didn’t purport to just sell sneakers; it aimed to bring “inspiration and innovation to every athlete in the world.” Starbucks didn’t focus on selling coffee; it sought to create a comfortable “third place” (between work and home) where people could relax and decompress. Apple’s fixation was never on the technology but rather on the design of a simple, effortless user experience.

But these companies also walk the talk by engineering customer experiences that credibly reinforce their brand promise (for example, the carefully curated sights, sounds and aromas in a Starbucks coffee shop or the seamless integration across Apple devices).

The result is that these companies create something of considerable value to their customers. Something that ceases to be a commodity and instead becomes a necessity. Something that people are simply willing to pay more for.

That makes their offerings more price competitive—but not because they’re matching lower-priced competitors. Rather, despite the higher price point, people view these firms as delivering good value, in light of the rational and emotional satisfaction they derive from the companies’ products.

The lesson: Hook customers with both the mind and the heart, and price commoditization quickly can become a thing of the past.

Gain Greater Pricing Latitude

Creating a highly appealing brand experience certainly can help remove a company from the morass of price-based competition. But the reality is that price does matter. While people may pay more for a great customer experience, there are limits to how much more.

And so, even for those companies that succeed in differentiating their customer experience, it remains important to create a competitive cost structure that affords some flexibility in pricing without crimping margins.

At first blush, these might seem like contradictory goals: a better customer experience and a more competitive cost structure. But the surprising truth is that these two business objectives are actually quite compatible.

A great customer experience can actually cost less to deliver, thanks to a fundamental principle that many businesses fail to appreciate: Broken or even just unfulfilling customer experiences inevitably create more work and expense for an organization.

That’s because subpar customer interactions often trigger additional customer contacts that are simply unnecessary. Some examples:

  • An individual receives an explanation of benefits (EOB) from his health insurer for a recent medical procedure. The EOB is difficult to read, let alone interpret. What does the insured do? He calls the insurance company for clarification.
  • A cable TV subscriber purchases an add-on service, but the sales representative fails to fully explain the associated charges. When the subscriber’s next cable bill arrives, she’s unpleasantly surprised and believes an error has been made. She calls the cable company to complain.
  • A mutual fund investor requests a change to his account. The service representative helping him fails to set expectations for a return call. Two days later, having not heard from anyone, what does the investor do? He calls the mutual fund company to follow up on the request.
  • A student researching a computer laptop purchase on the manufacturer’s website can’t understand the difference between two closely related models. To be sure that he orders the right one for his needs, what does he do? He calls the manufacturer.
  • An insurance policyholder receives a contractual amendment to her policy that fails to clearly explain, in plain English, the rationale for the change and its impact on her coverage. What does the insured do? She calls her insurance agent for assistance.

In all of these examples, less-than-ideal customer experiences generate additional calls to centralized service centers or field sales representatives. But the tragedy is that a better experience upstream would eliminate the need for many of these customer contacts.

Every incoming call, email, tweet or letter drives real expense—in service, training and other support resources. Plus, because many of these contacts come from frustrated customers, they often involve escalated case handling and complex problem resolution, which, by embroiling senior staff, managers and executives in the mess, drive the associated expense up considerably.

Studies suggest that at most companies, as many as a third of all customer contacts are unnecessary—generated only because the customer had a failed or unfulfilling prior interaction (with a sales rep, a call center, an account statement, etc.).

In organizations with large customer bases, this easily can translate into hundreds of thousands of expense-inducing (but totally avoidable) transactions.

By inflating a company’s operating expenses, these unnecessary customer contacts make it more difficult to price aggressively without compromising margins.

If, however, you deliver a customer experience that preempts such contacts, you help control (if not reduce) operating expenses, thereby providing greater latitude to achieve competitive pricing.

Putting the Strategy to Work

If your product category is devolving into a commodity (a prospect that doesn’t require much imagination on the part of insurance executives), break from the pack and increase your pricing leverage with these two tactics:

  • Pinpoint what’s really valuable to your customers.

Starbucks tapped into consumers’ desire for a “third place” between home and work—a place for conversation and a sense of community. By shaping the customer experience accordingly (and recognizing that the business was much more than just a purveyor of coffee), Starbucks set itself apart in a crowded, commoditized market.

Insurers should similarly think carefully about what really matters to their clientele and then engineer a product and service experience that capitalizes on those insights. Commercial policyholders, for example, care a lot more about growing their business than insuring it. Help them on both counts, and they’ll be a lot less likely to treat you as a commodity supplier.

  • Figure out why customers contact you.

Apple has long had a skill for understanding how new technologies can frustrate rather than delight customers. The company used that insight to create elegantly designed devices that are intuitive and effortless to use. (Or, to invoke the oft-repeated mantra of Apple co-founder Steve Jobs, “It just works.”)

Make your customer experience just as effortless by drilling into the top 10 reasons customers contact you in the first place. Whether your company handles a thousand customer interactions a year or millions, don’t assume they’re all “sensible” interactions. You’ll likely find some subset that are triggered by customer confusion, ambiguity or annoyance—and could be preempted with upstream experience improvements, such as simpler coverage options, plain language policy documents or proactive claim status notifications.

By eliminating just a portion of these unnecessary, avoidable interactions, you’ll not only make customers happier, you’ll make your whole operation more efficient. That, in turn, means a more competitive cost structure that can support more competitive pricing.

Whether it’s coffee, sneakers, laptops or insurance, every product category eventually matures, and the ugly march toward commoditization begins. In these situations, the smartest companies recognize that the key is not to compete on price but on value.

They focus on continuously refining their brand experience—revealing and addressing unmet customer needs, identifying and preempting unnecessary customer contacts.

As a result, they enjoy reduced price sensitivity among their customers, coupled with a more competitive cost structure. And that’s the perfect recipe for success in a crowded, commoditized market.

This article first appeared on carriermanagement.com.

Reinventing Life Insurance

Many life insurance executives with whom we have spoken say that their business needs to fundamentally change to be relevant in today’s market. Life insurance does face formidable challenges.

First, let’s take a hard look at some statistics. In 1950, there were approximately 23 million life policies in the U.S., covering a population of 156 million. In 2010, there were approximately 29 million policies covering a population of 311 million. The percentage of families owning life insurance assets has decreased from more than a third in 1992 to less than a quarter in 2007. By contrast, while less than  a third of the population owned mutual funds in 1990, more than two-fifths (or 51 million households and 88 million investors) did by 2009.

A number of socio-demographic, behavioral economic, competitive and technological changes explain the trends — and the need for reinventing life insurance:

  • Changing demography: Around 12% of men and an equal number of women were between the ages of 25 and 40 in 1950. However, only 10% of males and 9.9% of females were in that age cohort in 2010, and the percentage is set to drop to 9.6% and 9.1%, respectively, by 2050. This hurts life insurance in two main ways. First, the segment of the overall population that is in the typical age bracket for purchasing life insurance decreases. Second, as people see their parents and grandparents live longer, they tend to de-value the death benefits associated with life insurance.
  • Increasingly complex products: The life insurance industry initially offered simple products with easily understood death benefits. Over the past 30 years, the advent of universal and variable universal life, the proliferation of various riders to existing products and new types of annuities that highlight living benefits significantly increased product diversity but often have been difficult for customers to understand. Moreover, in the wake of the financial crisis, some complex products had both surprising and unwelcome effects on insurers themselves.
  • Individual decision-making takes the place of institutional decision-making: From the 1930s to the 1980s, the government and employers were providing many people life insurance, disability coverage and pensions. However, since then, individuals increasingly have had to make protection/investment decisions on their own. Unfortunately for insurers, many people have eschewed life insurance and spent their money elsewhere. If they have elected to invest, they often have chosen mutual funds, which often featured high returns from the mid-1980s to early 2000s.
  • Growth of intermediated distribution: The above factors and the need to explain complex new products led to the growth of intermediated distribution. Many insurers now distribute their products through independent brokers, captive agents, broker-dealers, bank channels and aggregators and also directly. It is expensive and difficult to effectively recruit, train and retain such a diffuse workforce, which has led to problems catering to existing customers.
  • Increasingly unfavorable distribution economics: Insurance agents are paid front-loaded commissions, some of which can be as high as the entire first-year premiums, with a small recurring percentage of the premium thereafter. Moreover, each layer adds a percentage commission to the premiums. All of this increases costs for both insurers and consumers. In contrast, mutual fund management fees are only 0.25% for passive funds and 1% to 2% for actively managed funds. In addition, while it is difficult to compare insurance agency fees, it is relatively easy to do so with mutual fund management fees.
  • New and changing customer preferences and expectations: Unlike their more patient forebears, Gens X and Y – who have increasing economic clout – demand simple products, transparent pricing and relationships, quick delivery and the convenience of dealing with insurers when and where they want. Insurers have been slower than other financial service providers in recognizing and reacting to this need.

A vicious cycle has begun (see graphic below). Insurers claim that, in large part because of product complexity, life insurance is “sold and not bought,” which justifies expensive, intermediated distribution. For many customers, product complexity, the need to deal with an agent, the lack of perceived need for death benefits and cost-of-living benefits make life products unappealing. In contrast, the mutual fund industry has grown tremendously by exploiting a more virtuous cycle: It offers many fairly simple products that often are available for direct purchase at a nominal fee.

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Reasons for optimism

Despite the bleak picture we have painted so far, we believe that reinventing life insurance and redesigning its business model are possible. This will require fundamental rethinking of value propositions, product design, distribution and delivery mechanisms and economics. Some of the most prescient insurers are already doing this and focusing on the following to become more attractive to consumers:

  • From living benefits to well-being benefits: There is no incentive built into life policy calculations for better living habits because there traditionally has been very little data for determining the correlation between these behaviors and life expectancy. However, the advent of wearable devices, real-time monitoring of exercise and activity levels and advances in medical sciences have resulted in a large body of behavioral data and some preliminary results. There are now websites that can help people determine their medical age based on their physical, psychological and physiological behaviors and conditions. We refer to all these factors collectively as “well-being behaviors.” Using the notion of a medical age or similar test as part of the life underwriting process, insurers can create an explicit link between “well-being behaviors” and expected mortality. This link can fundamentally alter the relevance and utility of life insurance by helping policyholders live longer and more healthily and by helping insurers understand and price risk better.
  • From death benefits to quality of life: Well-being benefits promise to create a more meaningful connection between insurers and policyholders. Rather than just offering benefits when a policyholder dies, insurers can play a more active role in changing policyholder behaviors to delay or help prevent the onset of certain health conditions, promote a better quality of life and even extend insureds’ life spans. This would give insurers the opportunity to engage with policyholders on a daily (or even more frequent) basis to collect behavioral data on their behalf and educate them on more healthy behaviors and lifestyle changes. To encourage sharing of such personal information, insurers could provide policyholders financial (e.g., lower premiums) and non-financial (e.g., health) benefits.
  • From limited to broad appeal: Life insurance purchases are increasingly limited to the risk-averse, young couples and families with children. Well-being benefits are likely to appeal to additional, typically affluent segments that tend to focus on staying fit and healthy, including both younger and active older customers. For a sector that has had significant challenges attracting young, single, healthy individuals, this represents a great opportunity to expand the life market, as well as attract older customers who may think it is too late to purchase life products.
  • From long-term to short-term renewable contracts: Typical life insurance contracts are for the long term. However, this is a deterrent to most customers today. Moreover, behavioral economics shows us that individuals are not particularly good at making long-term saving decisions, especially when there may be a high cost (i.e., surrender charges) to recover from a mistake. Therefore, individuals tend to delay purchasing or rationalize not having life insurance at all. With well-being benefits, contract durations can be much shorter — even only one year.
  • Toward a disintermediated direct model: Prevailing industry sentiment is that “life insurance is sold, not bought,” and by advisers who can educate and advise customers on complex products. However, well-being benefits offer a value proposition that customers can easily understand (e.g., consuming X calories per day and exercising Y hours a day can lead to a decrease in medical age by Z months), as well as much shorter contract durations. Because of their transparency, these products can be sold to the consumer without intermediaries. More health-conscious segments (e.g., the young, professional and wealthy) also are likely to be more technologically savvy and hence prefer direct online/call center distribution. Over time, this model could bring down distribution costs because there will be fewer commissions for intermediaries and fixed costs that can be amortized over a large group of early adopters.

We realize that life insurers tend to be very conservative and skeptical about wholesale re-engineering. They often demand proof that new value propositions can be successful over the long term. However, there are markets in which life insurers have successfully deployed the well-being value proposition and have consistently demonstrated superior performance over the past decade. Moreover, there are clear similarities to what has happened in the U.S. auto insurance market over the last 20 years. Auto insurance has progressively moved from a face-to-face, agency-driven sale to a real-time, telematics-supported, transparent and direct or multi-channel distribution model. As a result, price transparency has increased, products are more standardized, customer switching has increased and real-time information is increasingly informing product pricing and servicing.

Implications

Significantly changing products and redesigning a long-established business model is no easy task. The company will have to redefine its value proposition, target individuals through different messages and channels, simplify product design, re-engineer distribution and product economics, change the underwriting process to take into account real-time sensor information and make the intake and policy administration process more straight-through and real-time.

So, where should life insurers start? We propose a four step “LITE” (Learn-Insight-Test-Enhance) approach:

  • Learn your target segments’ needs. Life insurers should partner with health insurers, wellness companies and manufacturers of wearable sensors to collect data and understand the exercise and dietary behaviors of different customer segments. Some leading health and life insurers have started doing this with group plans, where employers have an incentive to encourage healthy lifestyles among their employees and therefore reduce claims and premiums.
  • Build the models that can provide insight. Building simulation models of exercise and dietary behavior and their impact on medical age is critical. Collecting data from sensors to calibrate these models and ascertain the efficacy of these models will help insurers determine appropriate underwriting factors.
  • Test initial hypotheses with behavioral pilots. Building and calibrating simulation models will provide insights into the behavioral interventions that need field testing. Running pilots with target individuals or specific employer groups in a group plan will help test concepts and refine the value proposition.
  • Enhance and roll out the new value proposition. Based on the results of pilot programs, insurers can refine and enhance the value proposition for specific segments. Then, redesign of the marketing, distribution, product design, new business, operations and servicing can occur with these changes in mind.