How Auto Auctioneer Manheim Tested a New Offering

Since its launch in 1945 as an auctioneer of used automobiles between car dealers, Manheim has grown into a multibillion-dollar global enterprise. Now based in Atlanta and a subsidiary of $17.5 billion Cox Enterprises, Manheim remarkets about 7 million used vehicles a year. The company provides not only the auction services, but also a host of ancillary services to help dealers buy and sell vehicles from each other: financing, title work, transportation, and repair.

In 2011, Manheim leaders considered launching a service that would give dealers the option to return the vehicles they purchased within a certain time period, no questions asked. The additional peace of mind for the dealers could accelerate conversion and sales—or so the thinking went.

The concept generated great excitement in the top management team at Manheim when they first met to discuss this idea. Some executives were convinced of the new service's appeal. They believed the new return policy offering was a surefire winner. Their gut feeling was that they didn't need a business case. They told themselves, “In the interest of time, we should get moving.” There were some who wanted to take a more conservative approach to the new offering. They suggested testing it in a small way—say, a limited offering with a few dealers or region of dealers—before committing a lot of funds to it. A few others doubted the viability of the concept from a risk and returns standpoint. “What if dealers return too many cars?” they asked. “What if it costs us too much to provide such a guarantee? What if we need to pull back after launch?”

This situation would be familiar to most of you. A new idea always has proponents and people who question its efficacy. When met with such a situation, many companies end up in decision paralysis, and the new product idea sits on the shelf rotting. This was definitely not the case with Manheim, which has a great culture oriented toward taking action. The product strategy and leadership team agreed to test the idea in the market, conduct customer research, and develop a robust business case before embarking on a long journey of productizing.

Vishaal Jayaswal, Manheim's head of pricing and value management, was asked to help figure out whether customers would value the service in the first place and, if so, how much they would be willing to pay for it under various conditions.

Jayaswal began to assess what factors would impact WTP, such as a time limit on returns, the make and model of a car, or a car's mileage. What would the demand for such money-back guarantees look like at different prices?

To get that, Jayaswal commissioned a value research study in 2012 and began having early WTP talks with customers (talks of the type we discussed in Chapter 4). The company discovered dealers loved the idea and were willing to pay for it. More important, Jayaswal found WTP varied by dealer and situation. For example, dealers that were more price-sensitive and willing to assume more risk were only willing to pay for a short-term guarantee.

Other dealers were more risk-averse. They were willing to pay a higher price for a 21-day return option, which gave them more time to spot deal-ending defects. Their WTP also varied by the type of car (defect rates on used cars can vary substantially from brand to brand and model to model) and its condition.

Ultimately, Jayaswal's pricing strategy recommendations were based on several elements: a) the business risks Manheim was assuming; b) the value to customers of different guarantee services; c) customers' WTP for them; and d) how much demand changed at different price points (the price elasticity curve, explained in Chapter 8). In other words, the recommendation tied the four critical elements together—price (WTP), value (to customers), volume (the expected demand at those price points), and costs in delivering the service (including the risks based on probability of car failure within the warranty period). That helped the product strategy and leadership team develop an airtight business case. It was a business case built on a foundation of real customer feedback rather than on internal assumptions and opinions.

With statistically significant survey data, the product team could simulate how demand would vary across different price points. They could point to the type of inventory on which Manheim would offer guarantees, as well as the revenue potential those guarantees generated. They could simulate what would happen if Manheim lowered its price significantly, and how much more market share the company was likely to gain if it chose a penetration strategy.

And most important, the business case demonstrated what these and other scenarios would mean to Manheim's revenue and profits—its bottom line.

The executive management had the data they needed to make a concrete decision. Manheim had based its business case for this new service on undeniable facts, especially the two most important ones for any new offering: Will customers buy it, and if so, at what price?

Branded as the DealShield Purchase Guarantee,¹ the new service debuted in 2012. Today, it lets dealers who purchase a vehicle at a Manheim auction return it for any reason for up to 21 days and 500 miles from the time of purchase at any Manheim auction location. The price for the service depends on the risk of the transaction, including the condition of the vehicle, reconditioning expenses to get the auto ready for retail sale, and market conditions.² By 2015, DealShield had protected billions of dollars in vehicle purchases and generated significant revenue and profit for Manheim.

Why WTP Is Essential For Your Business Case

Think back to the last business case you or your colleagues were asked to write for a new product. How did you arrive at your prices? Did you compare your product to other products in the marketplace, or did you actually ask customers what they'd pay for it? Did you know in advance what would happen if you increased your price by, say, 20 percent—how it would affect demand and thus volume?

If you are like thousands of companies we've seen over the years, you probably didn't. These firms did have business cases. But only about 5 percent had the essential information, on customers' WTP.

When you think about it, that's amazing.

If you don't know how much customers might pay for your proposed product, how much they value it, how demand (that is, volume) will likely change based on its price, then how can you trust your business case? The answer is, you can't. Put another way, if there is minimal WTP, you would rather find that out as early as possible (before sinking in too many resources).

Much in the same (sane) way we helped Manheim create a solid business case for DealShield, we convinced the top executives at a software-as-a-service provider to dump plans for a new low-priced entry product. (It was a “freemium” model of the type we discussed in Chapter 8.) The price for the base service was to be zero so customers would sign up en masse. The hope was many or most would move to the premium service at some point. Several of the firm's top executives were emotionally attached to their freemium model. This company had enjoyed rapid revenue growth, and they had good reason to believe in their pricing instincts.

However, when we helped the company create a detailed business case, we became the bearer of bad news to this faction of the top team. Our model revealed a freemium service would greatly cannibalize the firm's low-priced products, which had gainfully served as the entry-level offerings. In no way would the additional number of freemium customers offset the sizable revenue lost from customers switching from the low-priced to the freemium version. After hearing that, the executive management walked away from the concept, thanking us heartily for bringing them the bad news. Better now than later.

Your business case must model the linkages among the four elements of price, value, volume, and cost. When you do that, your monetary forecast will be far more precise.

Building a robust business case with these linkages will help you avoid the monetizing innovation failure types. How so? Making this kind of business case will alert you to a product that will be dead on market arrival—the dreaded undead. In some cases, customers will be willing to pay much more than you anticipated. If you don't know this, you'll underprice your innovation and leave money on the table (i.e., produce a minivation). To prevent a feature shock, a business case that prioritizes features based on how much customers are willing to pay for them will show which features you should focus on and which you should discard. You will be able to discover whether a market does exist for some newfangled offering and is willing to pay a sizable price for it (thereby uncovering a hidden gem).

A business case should be a living document that keeps you grounded on the true monetization potential of your innovation. As time goes by, the problems of business cases lacking information on value, price, cost, and volume only get compounded. Companies make isolated adjustments to one of the four elements without taking into account their interdependencies. For instance, the R&D team increases its cost estimates, leading finance to raise prices to hit target profit margins, all without addressing volume or value. Finance raises the price, but the company has no idea whether customers will actually pay it and what demand will look like after the price adjustment.

That's why you need a strong business case with WTP information and the linkages intact. That's why you can't succeed without one. Without it, you're just guessing about your innovation's monetization potential.

You can get the customer WTP in many ways. We listed them in Chapter 4. The essential point here is to do it and include it in your business case.

Nine Steps to Build a Living Business Case

We hope we have convinced you of the need to craft what may be a much different business case than the type your company has required to date for new products. So how do you create such an airtight business case, one that will help you monetize your new offering?

Here are nine steps to build a business case that will maximize the value of your new products or services over time. The first is the most important:

1. Forget the way you do business cases today. Nearly every business case we've reviewed in our firm's 30-plus years of business is a static document whose purpose is securing funding for a new product. By static, we mean it's created once to get funding approval, and then it's put on a shelf where it collects dust. Instead, a business case must be a living document, one you update before and after launch with new data on pricing, costs, volume, and value. You can use it to test assumptions about these four elements and how they interact with one another throughout the product life cycle, not just at the funding stage. It will help you respond effectively to competitors' moves before and after your new offering hits the market.
2. Assemble the basic ingredients. Incorporate market size, volume, customer segments, offer structure (configurations and bundles), value, WTP, a monetization model, costs, and competing products and their pricing.
3. Include price elasticity. Most companies avoid exploring price elasticity at this point, but we find it to be the critical element in business cases. When the price of a product goes up, sales volume tends to go down. If you've included that dynamic in your business case, you can make more accurate and better decisions if you add features that affect pricing. For example, you'll know how much volume will go down if you raise your price. Now the tough discussions can begin: Do we really need a certain feature that's costing us a lot and driving up our price? Do customers value it? What is the demand?
4. Apply data-verified facts. You need to use figures based on real facts. Without data, many are tempted to overstate the size of their target market, for example, or to create unrealistic adoption assumptions. Such guesses will come back to haunt you later, when you have to explain why sales are grossly under target. Topics that typically require data-validity checks include market size, ramp-up times, churn, and cannibalization assumptions.
5. Add risk assumptions. You need to attach risk assumptions to any input parameters that are inherently uncertain. For example, your manufacturing cost per unit will increase if a key supplier goes belly up and you must source from higher-priced suppliers. If that's possible, you must mention that in your business case. To pressure-test your business case, you should add these risks and calculate best- and worst-case outcomes of input parameters. A more sophisticated tactic would be using Monte Carlo simulations. They will enable you to gauge the probabilities of your projected outcomes and model uncertainty using probabilistic distributions. Software such as Oracle's Crystal Ball (a popular plug-in to Microsoft's Excel spreadsheet software) allows you to model such assumptions easily.³
6. Be realistic about goal tradeoffs. It's nearly impossible to maximize a new product's profit, revenue, volume, and margin all at once. You have to prioritize your goals. Raising prices almost always lowers volume and thus revenue. Lower prices typically increase volume. Understanding and making these trade-offs through “what if” scenarios is a key ingredient for a best-in-class business case.
7. Consider competitive reactions. Make sure your business case models your rivals' possible reactions. Will they reduce prices? Will they increase service levels? Then, plan for how you'll respond to those reactions. An effective business case is dead serious about these competitive scenarios, and it quantifies their impact. We'll discuss this in Chapter 12.
8. Don't focus the business case on just the new product. As much as your business case must financially justify your new product, make sure you assess its overall impact on your company. If the new product will cannibalize sales of existing products, you must factor that in. And, of course, if it cannibalizes too much, you won't have a strong business case.
9. Keep checking in. A strong business case will help you make decisions throughout the product development process and beyond. At each decision point, make sure the four pillars remain integrated, consistent, and in line with your company's strategy. Your model for pricing, volume, cost, and value needs to hold up at each stage of the development process.

Shaping a business case that gathers reliable information on customer WTP, value, volume, and cost is not simple. It takes time, effort, and money. However, the return will far outweigh the investment.

Most of all, a strong business case will help you turn your hopes of launching a successful new product—defying the 72 percent new-product failure rate—into informed confidence that you actually will succeed. By helping you create the right ambition for your new offering, a strong business case will let you extract your new product's full market potential.