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Corporate Executive Board® Teleconference Materials

The Collapse of Demand
Understanding It and Responding to It

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Road Map for Today’s Presentation

The Crisis So Far

What Is Happening with Demand

What the Best Companies Will Do

How We Can Help

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Where We Left Off
Recent Months Have Dramatically Changed World Economies
Recent Economic Events and Stock Market Performance Selected Highlights Fannie Mae and Freddie Mac placed in conservatorship. September Lehman Brothers files for bankruptcy. Fed buys short-term commercial debt. October A.I.G. saved by $85B loan from the Fed. Coordinated interest rate cut; UK triggers bailout scheme. November $700B Troubled Asset Relief Program (TARP) signed into law. U.S. GDP shrinks 0.3%; UK and Eurozone in recession. Japan in recession. U.S. in recession since December 2007. December

Major Stock Indices September–December 2008
11,250 6,000 DJIA FTSE 100

10,000

5,000

DJIA
8,750 4,000

FTSE 100

8,500 0 September
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3,000 0 December

October 4

November

Source: Corporate Executive Board research.

Credit Markets Still in Hiding
Massive interventions have helped loosen credit somewhat…
TED Spread* May 2008–December 2008
5.0

…but lenders remain cautious
Percentage of Loan Officers Tightening Standards Commercial/Industrial and Credit Card Loans

100% Credit Cards C&I 50%

Hundreds of Basis 2.5 Points

0%

(40%)

1996

1998

2000

2002

2004

2006

2008

Median WACC for A-Rated Companies S&P 500
10% 0.0

Ma y

Jun e

be

Jul

Au gu

be

be

No ve m

pte m

Oc

De

ce m

to

be

9.1%
5%

y

st

r

r

Se

r

r

5.7% 4.9%

0%

Q3 2006
* Difference between LIBOR and U.S. T-Bill rates—an indicator of banks’ willingness to lend.
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Q3 2007

Q3 2008

Source: U.S. Federal Reserve, Senior Loan Officer Survey; Corporate Executive Board research.

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Road Map for Today’s Presentation

The Crisis So Far

What Is Happening with Demand

What the Best Companies Will Do

How We Can Help

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6

Beyond Supply—What About Demand?
Plummeting consumer demand…
Change in Real Personal Consumption Expenditures U.S., Durable and Nondurable Goods

…is dragging down business orders
ISM New Order Diffusion Index U.S., Manufactured Goods

Durable Goods 20% Nondurable Goods 65

50

Percentage Change from Previous Period

0%

Index

45

(20%) Q1 Q2 2006 Q3 Q4 Q1 Q2 2007 Q3 Q4 Q1 Q2 2008 Q3

25 2007 2008

Period

Period

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Source: Bureau of Economic Analysis; Institute for Supply Management; Corporate Executive Board research.

More to the Story
Customer Demand Will Remain Weak—for Reasons Beyond Access to Credit
Drivers of Changes to Demand

Declining Wealth

De-Leveraging

Behavioral Shifts

• Asset Value Deterioration • Real Income Contraction

• Debt Reduction • Savings Increases

• New Sensibilities • Imprinting/Trait Formation

Source: Corporate Executive Board research.
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Driver #1: Declining Personal Wealth
Consumers feel poorer as their asset values shrink…
Percent Change Year-on-Year to Case-Shiller Index
20

…and rising prices squeeze budgets
Consumer Price Index, 12-Month Changes 1998–2008 (YTD)
6%

10

0

(10)

(20) 3% (30) 2000 2004 2008

U.S. Retirement Assets Nominal Dollars, 2000–2008 (Q1)
$18

Trillions of Dollars

11.7 11.3 10.6 12.5
$9

13.8 14.9

16.7 17.0 17.7

18.1 18.0 17.1

0% 1998

2000

2002

2004

2006

2008

$0

20

00

20

01

20

02 0 03 0 04 0 05 0 06 0 07 0 07 0 07 0 07 0 08 2 2 2 12 22 32 42 2 2 1 Q Q Q Q Q
9

Source: Bureau of Economic Analysis; The U.S. Retirement Market, First Quarter 2008, Investment Company Institute; Haver Analytics; Corporate Executive Board research.

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Driver #1: Declining Personal Wealth

An Inconvenient Truth
Consumers face a looming income drop…
Decrease in Income During Downturns
0%

…with decade-old income levels
Median Real Household Income 1993–2007, 2007 Dollars Incomes have just recovered to levels preceding last downturn.
$55,000

1969–1971

(3%)

U.S. Dollars

$42,500

1999–2004

$30,000
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20

Year
1973–1975
(6%) Top of the Cycle One Year Later Two Years Three Years Four Years Five Years Six Years $350,000

1989–1993

1978–1983

Inflation-Adjusted Pre-Tax Family Incomes U.S. 1990–2007, by Quintile

Top 5%

U.S. Dollars

$175,000

1st Quintile 2nd 3rd 4th 5th
1994 1998 2002 2006

$0 1990
Note: Median household income data are not available before 1967.
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Source: Leonhardt, David, Next Victim of Turmoil May Be Your Salary, The New York Times, 15 October, 2008; Income, Poverty and Health Insurance in the United States: 2007, U.S. Census Bureau, Current Population Survey, 1968 to 2008 Annual Social and Economic Supplements; Corporate Executive Board research.

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Driver #2: De-Leveraging
After a decade of credit-fueled consumption…
Household Liabilities as a Percentage of Assets 1955–2007
24% 12.0%

…consumers are reining in debt…
Household Debt Growth 1990–2008 (Q2)

Percentage

Percentage
55 65 75 85 95 05

14%

6.0%

4%

0.0%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Q1 Q2 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 08 08 20 20

Year

…and bringing savings back in line
Household Savings As a Percentage of Income, 2000–2008 (Q3)

5.0

2.5

0.0 (1.0) 2000
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2001

2002

2003

2004 11

2005

2006

2007

2008
Source: Bureau of Economic Analysis; Federal Reserve, Flow of Funds Accounts of the U.S.; Haver Analytics; Corporate Executive Board research.

Driver #3: Behavioral Shifts
As consumers re-think what they are willing to buy…
Hierarchy of Needs Self Actualization Esteem Belonging Safety Survival

…new sensibilities and norms are emerging
Top Changes Consumers Have Made Percentage of Respondents Making Significant Change
Eat Outside the Home Less Eat at Less Expensive Restaurants Eat at Fast Food Restaurants Less Frequently Pack Lunch for Work Eat More Leftovers Order Less Food When You Go Out to Eat Reduce Number of Vacations Take Cheaper Vacations (Closer to Home) Attend More “Free” Activities (e.g., Hiking, Beach, Museums) Entertain Friends at Home Instead of Going Out

43.2% 39.3% 35.4% 34.8% 32.4% 29.7% 28.1% 28.1% 28.0% 27.0% 38.0% 32.4% 32.1% 31.8% 30.9% 28.3% 36.5% 35.5% 34.8% 33.0% 33.0% 1.7% Reducing Driving Frugal Shopping Spend More Time at Home, Less Away

Prevalent Buying Mindset

Buy Sale Items Buy More Store-Label Groceries (Not Buying Top Labels) Use Coupons Shop at Less Expensive Stores Fewer Impulse Purchases at Register Shift Away from More Expensive to Less Expensive Versions Drive Less Overall Take Fewer Shopping Trips

Conspicuous Consumption

Cool to Be Frugal

“Our retail and manufacturing clients are seeing almost an aversion to consumption.” Todd Lavieri CEO, Archstone Consulting November 2008

Shop at Stores Closer to Home Cut Down on Non-Work Driving Top 20 of All Changes Made (Average) Bottom 20 of All Changes Made (Average)

Source: Leinwand, Moeller and Shriram, “Consumer Spending in the Economic Downturn,” Booz & Co., 2008; Saranow, Jennifer, “Luxury Consumer Scrimp for Sake of Planet, and Because It’s Cheaper,” Wall Street Journal, 4 November 2008; Corporate Executive Board research.
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Driver #3: Behavioral Shifts

Etching in Stone
The likely duration of the downturn…
Duration of U.S. Recessions
50

…will “imprint” new behaviors on a key segment
U.S. “Economically Formative” Population Versus Selected Country Total Populations 2008
40

43

Months in Contraction

25

13
0

8

11 10

8

10 11

16 6 8 8

12

Millions of People

35

? 1 5 0 9 1 5 3 8 4 8 0 1 93 93 194 194 195 195 196 197 197 198 199 200 07– 0 r r y er il y h uly ch h 1 ne 1 er 2 r e r e a c c ar –J ar –Ju tob tob –M Ap rua mb er ar mb –M 937 Oc Oc 953 57– Feb ove 3–M 980 0–M ove emb 1 c – 7 9 – 29 1 – 9 1 19 ay 945 948 uly st 1 960 9–N r 19 ary 19 1–N De J 6 u uly 00 u l1 1 r1 st M y 9 g be Jan i J 2 gu ar be Au Apr er 1 vem ch Au ru em b ar o m N eb ov M F N ce De

30 U.S. "Economically Formative" Population (17–25 Years Old) Total Population of Poland Total Population of Canada

Comparison of Generational Economic Perspectives
Cohort Depression Boomers Millenials

Period

Estimates of Time to U.S. Economic Turnaround*
National Association of Business Economists
Mid 2009

Prevailing Economic Conditions
End of 2009

• Loss of wealth • High unemployment

OECD

• Unbroken economic growth • Low real interest rates

• Income stagnation • Unprecedented volatility

Jerome Levy Forecasting Center

Contraction Through End of 2009

“Contained Depression” 2011 ~ 2018

Resultant Economic Behavior

• Risk aversion • Compulsive saving

• Debt tolerance • High consumption

• K IN OR RE S S • W G

PRO

* GDP growth greater than 1% .

Source: Levy, David, Entering a “Contained Depression,” Institutional Investor, (October 2008); Economists Predict Recession to Last Through 2009, CNN Money.com, (3 November 2008); National Bureau of Economic Research, Business Cycle Expansions and Contractions; U.S. Census Bureau, Monthly Estimate of Population; Corporate Executive Board research.

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Changes in Business Demand Are Unfolding Similarly
Businesses also feel less wealthy…
F500 Operating Margin After Depreciation, 2000–2008 (Q3)

…and are learning new behaviors
CFO Responses to the Economic Downturn

16%

Reduce All Other Discretionary Spending

82 66 70 52

Reduce Future Hiring 8% Reduce Current Employee Numbers

57 38 56 38

2008 Q3 2008 Q1

Reduce Capital Spending 0% 2000 2002 2004 2006 2008 Reduce Spending on Advertising and Marketing

41 25 29 13 16 3
0 50 100

Median WACC for A-Rated Companies S&P 500
10%

Shift Production or Support Functions Overshore

9.1%
5%

Reduce Dividend Payments

5.7% 4.9%
n = 105.

0%

Q3 2006

Q3 2007

Q3 2008
Source: Computstat; Deloitte; Corporate Executive Board research.

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In Summary
A Significantly Different Environment Poses New Problems for Executives
Our View

Because: • We are only at the beginning of a significant economic shift in developed economies and the norms that economic conditions create. • Customer behaviors are in flux. • The “real” downturn is likely to persist for more than four quarters—regardless of GDP recovery—as debt, spending and income return to sustainable levels and excess capacity is absorbed. • Many customers will carry behaviors learned during the downturn for life. Executives will struggle to: • Overcome uncertainty. • Distinguish important customer behaviors. • Compete on dimensions other than price. • Adapt their value proposition—quickly. • Profitably manage their product/service portfolios.

Source: Corporate Executive Board research.
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15

Road Map for Today’s Presentation

The Crisis So Far

What Is Happening with Demand

What the Best Companies Will Do

How We Can Help

MLC1ASLIY5 © 2008 Corporate Executive Board. All Rights Reserved.

16

Recessions Radically Restack the Competition
Economic downturns change how investors perceive the value of your sales relative to industry peers…
Change in Relative Market Cap to Sales Ratio 1990–1991 Downturn, Versus Industry Peers Downturns can more than double the likelihood that a firm significantly changes its industry ranking.
19%
2.5

…with implications that last for years
Relative Market Premiums Before and After Downturns Top Versus Bottom Quartile, Indexed Firms who made it into the top quartile during a downturn can significantly increase and sustain their premium over bottom quartile firms.

15%

Percentage of Firms Moving Up or Down at Least One Quartile in Market Cap to Sales Ratio

2.3x

13% 12% 11% 11%

8%

Premium for Top Quartile Versus Bottom Quartile Firms, Market Cap to Sales
(indexed at 12 months before economic bottom)

2.0

1.5

1.0

0.5

0.0 1989 1990 1991 1992 1993 1994 1995 -12 0 +12 +24 +36 +48 +60

n = 5,400 Companies Globally.

n = 5,490 Companies Globally.

Source: Compustat; Corporate Executive Board research.
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Tactic #1: Embed Uncertainty in Planning
Sabre Builds Out Near-Term Scenarios as Part of Its Planning Process
Sabre’s Competitive Dynamics Modeling Exercise 2001
Origin of Disruption

Suppliers

Competitors

New Entrants

Buyers

Nature of Disruption

Airlines Drive Transformation

Intermediaries Drive Transformation

New Entrants Drive Transformation

Socioeconomic Retrenchment Drives Transformation

Named Scenario Description

1 “Portal Power” Airline alliances stabilize through equity ownership or asset sharing. • Defend against airline strategies that adversely impact nondirect channels. • Invest aggressively in operational and marketing CRM.

2 “Solidarity” Alignment of agencies and reservation systems increase customer-centric services. • Operational efficiencies enable intermediaries to lower distribution and marketing fees. • Regulatory environment constrains airline consolidation.

3 “Newcomers” Nontraditional marketing powerhouses enter travel retailing. • Create new business models and align with innovative intermediaries to meet customer service and distribution needs.

4 “Global Cocooning” Economic, political, and social turmoil reduce appetite and ability to travel. • Reservation systems and travel agencies consolidate and survive on significantly reduced revenue streams. • Improve ease and comfort of travel experience.

Implications

Source: Sabre Holdings Corporation; Corporate Strategy Board research; Business Leadership Forum research; Corporate Executive Board research.
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If—Then
Insights from Scenario Process Guide Intelligent Response
Scenario-Driven Management Decisions

Insight

Severe drop in demand under a “Global Cocooning” scenario would put a premium on a lean cost base.

Ability to compete against merged agencies and reservation systems will be crucial to success under the “Solidarity” scenario.

Strong relationships with travel agencies will enhance Sabre’s competitiveness under the “Solidarity” scenario.

Despite industry hype about “game-changing” interactive television, genuine signals for “Newcomers” scenario are flat.

SG&A

Action

Sabre embarks on a global costcutting program designed to save $100 million annually, prior to the travel slump caused by the 11 September 2001 attacks.

Sabre takes full control of partially owned Travelocity online portal to ensure direct access to buyers; increases European presence through Travelocity.co.uk.

Sabre shares “Solidarity” scenario with agencies to make the case for collaboration and subsequently rolls out the “Empowering Agenda,” a five-point plan designed to help travel agencies revamp their business models.

Unlike competitors, Sabre avoids making sizable, premature investments in the iTV distribution channel, which has not yet yielded the revenue anticipated by many.

Source: Michels, Jennifer, “Power Up: Sabre’s New Empowering Agenda Is Designed to Help Agents Take Control of Their Future,” Travel Agent, (27 May 2002): 39; “Sabre Announces World Wide Strategic Cost-Cutting Initiative,” PR Newswire, (28 August 2000); Sabre Holdings Corporation; Corporate Strategy Board research; Business Leadership Forum research; Corporate Executive Board research.
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Tactic #2: Surface Changes in Value Drivers
As customers rapidly re-prioritize needs…
Hierarchy of Needs for Customers Illustrative

…the best companies are hunting for buying behavior changes
Approach #1: State and Test Key Assumptions “We Assume”
• Demand is inelastic for loyal customers • Service is key component of offer • •

“But We Verify”

Association/Image

Convenience Cost/Value Identify assumptions underpinning current market strategy. Test them in key markets using short cycle research

Functional Utility Leading Market United Kingdom

Approach #2: Track Lead Customers Extreme Customers Key Questions
Purchases Increase • What were you buying before? • Why did you shift to this product? Purchases Decrease • What are you substituting with? • What drove the decision?

Trust/Security

Use customers in leading markets who exhibit “extreme” behavior…
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…to spot shifting priorities that may “spread.”
Source: Corporate Executive Board research.

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Tactic #2: Surface Changes in Value Drivers

Tell Me What You Want
Caremark Forces Customers to Trade-Off Product Attributes to Identify Key Value Drivers
Caremark Customer Scorecard
Joint discussion of metrics provides insight into customer performance drivers. In the act of weighing performance metric importance, customers are forced to make trade-offs between wants and needs.

Caremark Partnership Evaluation Form Business Objective: Build a strong, long-term partnership including joint strategic planning, proactive account management, and delivery of innovative clinical initiatives to achieve customer satisfaction focusing on health and cost containment. Customer: Initech Corp. Performance Category Value Key Performance Definition • Value in Caremark’s products and services provided to you as measured in financial terms, and improvements in financial performance and cost over time • Caremark’s ability to fulfill service commitments in a timely manner; this includes on-time delivery of the appropriate product or service • Proactive communication of industry news and information. e.g., New Drug Review • The degree of excellence achieved in core delivery areas • Caremark’s investment in time and resources, to develop new products and/or service offerings to anticipate your needs • General perception of Caremark’s services, products and behavior • Flexibility and the ability to respond to constant change and reactive requests Key Performance Measures • Quarterly Review of program savings • Annual Client Review Relative Caremark’s Importance Performance 30% 4

Delivery

• • • •

Mail turnaround time __% Paper Claim turnaround time __% Call Center stats 30 sec. ASA, 5% ABN rate Quarterly review of communication efforts

40%

4

Quality

• Mail Order accuracy of 99.9% • Paper Claim accuracy of 99% • Reporting accuracy of 100% • Plan administration accuracy of 100% • Increase electronic access to prescription benefit for patients and Caremark Rx • Client Report Card • Customer Service Responsiveness; Automated Call Center Survey • Account Management Responsiveness Totals

20% 0% 10%

5 n/a 5

Innovation

Satisfaction

Concurrence: Caremark Name:

100%

4.5

Michael Bolton Bill Lomberg

Signature:

Date:

01/07/2001 01/07/2001

(Name) Client Name:

Signature:

Date:

Record of performance against customer goals over time serves as valuable fact-based retention tool.

Source: Caremark; Corporate Executive Board research; Sales Executive Council research.
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Tactic #3: Explicitly Communicate Differentiators That Matter
Facing retrenching customers that see little difference among brand promises
Customer Perception of Quality Variance Indexed to Product/Service Quality
Sales Experience

…winners will crystallize their most potent differentiators
Vodafone’s Framework for Surfacing Critical Differentiators

1.40

Current Customer Behavior
“Who has the best price?”

Desired Customer Behavior
“I want to buy from you.”

Customer Service

1.33

Effectiveness of Communication

1.13

Value to Price Ratio

1.09

Reputation for Execution

1.06

Current Customer Attitude/Perception
“I need the cheapest thing.”

Desired Customer Attitude/Perception
“I need the most valuable thing, and you have it.”

Product/Service Quality

1.00

Brand Promise

0.99

“What would have to be true?” Concentrate on the attributes of your proposition that could change the attitudes associated with desired behaviors.
Source: Vodafone; Market Research Executive Board research; Sales Executive Council research; Corporate Executive Board research.
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Tactic #3: Explicitly Communicate Differentiators That Matter

Differentiator Spotting
Volvo Sees Opportunities in Its Under-Valued Strengths
Framework for Exploring Potential Differentiators

Customers Already See Value

Low-Hanging Fruit

Customers Do Not See Value

Opportunity

Common Strength

Unique Strength

Volvo asks its sales and marketing teams: • What is the impact of our unique strengths on our customers’ economics? • Why don’t all customers appreciate that value?

Source: Corporate Visions, Inc. Power Positioning Workshop; Volvo Trucks North America; Sales Executive Council research; Market Research Executive Board research.
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Tactic #4: Focus on Commercial Innovation
Adjust How—Not What—You Sell in the Near Term to Boost Indispensability
Commercial Innovation “Exploration Map” and Examples

Sales Experience Innovation
How can we reduce customer effort/ cost relative to competitors?

Product Positioning Innovation

• Grainger’s sales team alters its reps’ pitch to teach customers about unappreciated inefficiencies in their own businesses. • Not coincidentally, Grainger has unique strengths in addressing those inefficiencies, enabling the firm to monetize its “teaching” commitment.

How can we improve our customers’ knowledge and capabilities through our buying process?

Customers

What privileged knowledge or capabilities do we have to help manage customers’ risks?

• Procter & Gamble changes the marketing communications supporting its Febreze brand from “a product for deodorizing” (an infrequent need) to “a finishing touch to a good cleaning job” (a frequent need). • The repositioning dramatically grows the product’s market size as the frequency of consideration expands.

How can we boost our customers’ capacity for buying our products and services?

How can we expand customer perceptions of our products and services to grow demand?

Source: Sales Executive Council research; Business Leaders Forum research.
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24

Tactic #5: Optimize Your Offering to Profitability
Clorox Forces Determination of “Good” and “Bad” SKUs
Clorox’s SKU Assessment Process

Process Stage

Selection of Strategic Driver
• Product decisions may have multiple competing strategic drivers.

Selection of Key Metrics

Categorization of Product Portfolio

Setting of Hurdle Rates
• Hurdle rates, which a SKU must meet to be considered “good,” are not employed. • SKU assessment produces multiple categories of nonprescriptive conclusion.

Assessment of SKUs
• SKUs are assessed using a dashboard of metrics. • Some business units may be unable to conduct the necessary analysis.

Conventional Approach • Strategic goals are frequently supplanted by the needs of the moment.

• SKUs are assessed on a • SKUs are grouped variety of performance for analysis according and profitability metrics. to multiple sets of characteristics. • Tracking numerous metrics for all SKUs • Hurdles for each of increases the difficulty of several metrics must be setting hurdles. set for each of several groups.

Clorox Approach

One Key Driver
Shareholder Return

Two Basic Metrics
Profit and Volume*

Two Product Types
Large Brand and Small Brand

Four Standard Hurdles
Two Profit, Two Volume

Two SKU Types
“Good” and “Bad”

* Defined in Project Acceleration Toolkit.
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Source: The Clorox Company; Supply Chain Executive Board research.

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Tactic #5: Optimize Your Offering to Profitability

SKU Skew
Clorox Sets Simple Parameters to Identify “Good” and “Bad” SKUs
SKU Assessment Process Selection of Strategic Driver One Key Driver
Shareholder Return

Selection of Key Metrics Two Basic Metrics
Profit and Volume

Categorization of Product Portfolio Two Product Types
Large Brand and Small Brand

Setting of Hurdle Rates Four Standard Hurdles
Two Profit, Two Volume

Assessment of SKUs Two SKU Types
“Good” and “Bad”

Two Profit Hurdles
Key Metrics • Inventory Holding • Remnant Costs • Marketing Expenses • R&D Costs

Two Volume Hurdles
Volume

“Good” SKU Definition

Large Brand Small Brand
SKUs

A “good” SKU is one that meets either the relevant profit hurdle, volume hurdle, or both.

Average per-SKU costs are assessed for four key metrics.

Volume hurdles are set based on actual per-SKU performance.

Avoid Perfection
“It’s more important to have your hurdle rates than to worry about getting them exactly right. It’s better to make a few educated choices and act on them consistently than to struggle with accurately evaluating every single possible factor for a single, one-time rationalization.” Kevin Pegels Director of Supply Chain Planning The Clorox Company

* All numbers illustrative.
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Source: The Clorox Company; Supply Chain Executive Board research.

26

Road Map for Today’s Presentation

The Crisis So Far

What Is Happening with Demand

What the Best Companies Will Do

How We Can Help

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27

Here to Help
Our Resources Are at the Ready to Help You and Your Teams
Economic Downturn Support
https://www.mlc.executiveboard.com/Members/DecisionSupportCenters/EconomicDownturn/Manage.aspx

Use ideas from the best companies to manage risks, talent, customers, and planning. Monitor the most recent economic indicators across key markets. Learn about the dynamics driving the downturn and their implications.

Source: Marketing Leadership Council research.
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