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Break the Rules the Way Zappos and Amazon Do

What would you think of a business that identifies cost reduction opportunities but purposely does not follow through with the cuts? Or another that actually chooses to build excess capacity? Not long for this world, you might figure. Or perhaps they're luxury chains that can pass on their inefficiencies to customers who are used to paying a premium.

Well, both guesses are off. Consider the following examples. The first is Zappos, which was recently acquired at a premium by Amazon (AMZN), which happens to be our second example. Both companies seem to make a point of ignoring the "make it lean" dictum of the hour, and both are thriving, not in spite of these "inefficiencies" but because of them. What may look like costly mistakes are in both cases deliberate choices made by people who know how to manage their operations for the new retail environment.

Another bromide that's being put to rest is that "… it's all about product and good value." Well, lots of stores provide good value. In fact, good value has long since ceased to qualify as a differentiator; it's just the price of entry today. Successful retailers like Zappos and Amazon understand that offering a great product at a great price no longer suffices. To gain and keep customers, you have to provide them with a unique and addictive experience.

With Zappos, that experience is superior customer service, delivering on this promise of guaranteed long-term satisfaction. It's the unquestioned knowledge in the consumer's mind that she or he can for any reason, for a one-year period, with consummate ease and without shipping costs, return any purchase to get a full refund. And Amazon has turned its mammoth selection and super-rapid delivery into a unique experience. In these, and in the case of other leading retailers and manufacturers we've studied, the ability to manage for a changing reality is the element that will determine success or failure.

Controlling the Value Chain

We found, in fact, that retail success depended on three strategic operating principles. The first is the necessity of providing an experience that uniquely connects consumers with the brand/retailer in such a compelling way that they become mentally addicted—think of Starbuck's (SBUX), Apple (AAPL), or Lululemon (LULU). The second is the ability to carry out preemptive distribution of the product or service, the ability to reach consumers when, where, how, and how often they want, and ahead of the competition. The last is a business model that offers complete control of the value chain, from raw materials and creation through sales and consumption.

In fact, value chain management provides the foundation for everything else. Without maximum control of this entire process, the business cannot provide the level of experience or the ability to be everywhere, all the time ("preemptive distribution") necessary to succeed. From Zara's ability to get new fashion must-haves out onto the street every few weeks to Ralph Lauren's (RL) or Apple's own retail store—and their totally controlled "mini-shops" in, respectively, Bloomingdale's (M) and Best Buy (BBY)—retail success depends on the controlled management of the entire value-chain process.

Most important, the winners understand this process as a never-ending loop that begins with the consumer, pauses at consumption, and then starts all over again. And the brand or retailer must control the three stages of the value chain that directly "touch" and affect consumers' purchases: first, the beginning of the cycle when defining the kind of value that will speak to their expectations and desires; second, the innovative development of the product, marketing, and experience strategies; and finally, the delivery of the value, including its addictive experience where it connects with consumers at point of sale.

Regardless of the size and nature of the business, it must use three elements to make up the core of its management strategy:

1. Collaboration. From the chalkboards for consumer feedback in Lululemon stores to Whole Food's (WFMI) engagement with small producers, to the breaking down of silos between Estee Lauder's (EL) multiple brands, value-chain control requires leveraging human and strategic assets across the entire system.

2. Decision-making. It isn't just Mango and the fast-fashion companies that have short decision-making times. Specialty brands such as Victoria's Secret (LTD), department stores like Kohl's, and such wholesale brands as The North Face are finding that a rapid turnaround allows for a higher degree of responsiveness to what consumers want, where and when they want it, and how often.

3. Efficiency. By combining across-the-chain collaboration with decisive action, retailers can move products from the drawing board to the customer in fast, flexible, and cost-efficient ways. Here, "cost-efficient" most decidedly does not mean starving your system, but rather using built-in redundancy to cope with volatility at both the supply and demand ends. Paradoxically, because of the flexibility it allows, this very redundancy helps eliminate the problem of excess inventory. The great example of this strategy was Amazon's building distribution centers near UPS (UPS) shipping hubs.

When businesses bring all three of these elements together, the result is a huge competitive advantage.

After looking at retailers from a wide variety of segments, we found that the management model we're offering—stressing collaboration over "ownership," decisiveness over self-protection, and a value chain driven by consumer demand—exists in all of the winners. What's more, those companies that did not survive the recession were among those that a group of independent observers had rated weakest in these elements. We cannot guarantee that our approach will lead to success, but ignoring it will almost certainly lead to failure.

Michael Dart is head of private equity at Kurt Salmon. Robin Lewis is chief executive of The Robin Report, for senior executives in the retail industry. Dart and Lewis are co-authors of The New Rules of Retail (Palgrave Macmillan, 2010).

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