Toyota and Dell both did it for a while but then stopped. American Express, Cisco, GE, Tesco, Trader Joe’s and Godrej, among others, all kept at it, and have continued to reap the benefits. “It” refers to the adoption of an “outside in” strategy that calls on companies to start with their market when they design their strategy, rather than limit themselves by asking what they can do with existing resources. According to Wharton marketing professor George Day, firms that adopt an “inside-out” approach are handicapped in keeping up with their customers and ahead of their competitors. Day and Christine Moorman from the Fuqua School of Business at Duke University describe their approach in a new book called Strategy from the Outside In: Profiting from Customer Value.

Knowledge at Wharton interviewed Day about the challenges companies face in implementing “outside in” strategy, especially during a recession; what benefits companies can realize by adopting this approach, and which companies have done this well and which haven’t, among other topics. In the accompanying video, he discusses his book’s contribution to the ongoing debate over marketing strategy, and relates how McDonald’s used an “outside-in” approach to turn around its business.

An edited transcript of the conversation follows. 

Knowledge at Wharton: Can you briefly describe ‘outside in’ strategy as opposed to ‘inside out’ strategy?

George Day: Companies that have adopted an ‘outside in’ strategy are those with a focus on creating and keeping customers by delivering superior customer value. They do that by standing in the customer’s shoes and viewing everything the company does through the customer’s eyes. Think of customer value as the lens on the strategy.

‘Inside out’ thinking, on the other hand, begins by asking, ‘What are we good at? What are our capabilities and products? How can we use our resources more efficiently?’ It’s a resource-based view of the firm that is inherently limiting because it means the company is slow to respond to major changes in the market. In our book, we look at a number of companies that began with an ‘outside in’ lens but then became myopic, falling into ‘inside out’ hubris — companies like Toyota and Dell, which I can talk more about later.

Strategies are especially stressed during a recession, when companies must align their cost base with rapidly shrinking revenues in order to protect earnings. The management team focuses almost entirely on internal processes — improving productivity, downsizing and so forth. This response is appropriate when your goal is to drive short-run earnings. But if it becomes the predominant point of view on strategy, you are highly vulnerable to shifts in the market, new technologies, new channels or the entrance of new competitors, so an ‘inside out’ myopia ends up making you vulnerable.

American Express is an example of a company that didn’t fall into that trap. It was able to sustain an ‘outside in’ approach during the recession when a lot of companies were trying to manage earnings by cutting back everything that moved, including core R&D and new product launches. Amex and others said, ‘We are going to take an earnings hit anyway, and the last place we want to cut back is innovation. So we will continuously invest in learning about our customer and use this as an opportunity to gain an advantage by improving our value proposition.’ Indeed, research going back 30 years suggests that the best time to gain market share is during recessionary upheavals.

Knowledge at Wharton: Your book cites the British supermarket chain Tesco as an example of a company that has profited from an ‘outside in’ strategy. Can you give us more detail about Tesco?

Day: Tesco started moving to this strategy in 1995 when it began to look at everything it did from the perspective of customers. Every question that came up about operations, human resources, finance and retailing was answered through the lens of whether the firm’s target customers would see value — in the form of better prices for staple items, for example, or shorter lines or even cleaner restrooms.

The company also focused on making the customer an asset by doing things like stocking its stores with products that reflected the tastes of shoppers in a particular area. In one case, shoppers who bought diapers at a Tesco store received coupons by mail not only for baby wipes and toys, but also for beer. Tesco’s analysis had shown that new fathers bought more beer at retail because the arrival of a newborn tended to curb their pub hours. Another example of Tesco’s emphasis on the customer: When the company entered the U.S. market in 2007, members of its UK staff lived with 60 American families to learn about their habits and preferences. They discovered, for example, that Americans like to buy prepared meals at a grocery store more often than Europeans.

Finally, Tesco was quick to recognize an opportunity in the market for retail financial services in the UK, especially after customers became increasingly distrustful of big banks that accepted bailouts during the recent financial crisis. Taking advantage of its huge transactional database, Tesco started offering credit cards and then moved up to bank accounts and mortgages. They have now become a significant player in financial products — all because they know much more about their customers than the banks do. The U.K. banking industry is wary of Tesco’s retail banking operations because banks typically don’t invest a lot of money in understanding their individual clients or tailoring offerings to specific markets. Tesco does that really well with its 14 million customers.

Knowledge at Wharton: I always thought the purpose of a company was to create shareholder value. Now you are saying it is to create and keep customers. I know that if done well, this obviously helps to increase profits, which then increases shareholder value. But it does suggest a slightly different emphasis. Do you expect any pushback on this?

Day: We are, in fact, suggesting a dramatically different emphasis, but we are suggesting it as more of a rebalancing. If you focus totally on shareholder value, that leads you to a short-term perspective. By the way, we want to maximize long-run shareholder value; it’s just a question of how to get there. We would like to go the route of saying that the customer is the source of the value, and then deliver a better value proposition. The market will reward that. So we see shareholder value as an outcome rather than the primary focus.

Knowledge at Wharton: A lot of companies say they focus on customers and drive strategy from the perspective of the market — i.e., from the ‘outside in.’ But in the book, you say that this is “shockingly uncommon.” Why is it so uncommon if it sounds, in some ways, like such an obvious approach?

Day: Good question. Why do companies become inward looking? Many that at one time had been ‘outside in’ become ‘inside out’ mainly because they get positive reinforcement in the short run. If you focus on improving efficiency, you get results — for a while. That’s what happens in a recession. A second reason: Strategy theorists argue that resources exist to be used and the task of managers is to improve and fully exploit then. This is certainly a worthwhile aim but, on its own, it is an inherently limiting and unbalanced approach.

We talk a lot about Amazon as a paragon of ‘outside in’ thinking. It started with an online bookstore, then went beyond books and asked, ‘What do our customers really want?’ They are now a big provider of cloud computing and web services for their channel partners, and of course there is the Kindle. So [Amazon CEO Jeff] Bezos would say, ‘Hey, rather than ask what are we good at, ask who our customers are and what they need. We will figure out how to give it to them.’ By shifting the focus so significantly, you open up a much broader array of opportunities.

Toyota is an example of a company that began to focus on the wrong metrics. It became obsessed, not with what the customer needed, but with beating General Motors and becoming big. The company became too internally focused, tried to grow way too fast and lost sight of quality. It became too much of a ‘how fast can we drive this growth” approach. As we know, they ran into quality problems.

Knowledge at Wharton: What sorts of pressures are top executives, including CEOs, under that may keep them from focusing on an ‘outside in’ strategy?

Day: Without strong leadership, internal concerns are likely to take precedence. Executives have to worry about next year’s budget; they have to get their products made; they have to outsource and so forth. These issues are crucial and must be dealt with, but if they take precedence, you lose perspective.

Such attitudes have been especially manifest in the last two years. A lot of companies were worrying about survival. And yet by simply hunkering down, cutting R&D, slowing innovation and no longer experimenting, these companies are putting their survival at risk even more. Markets these days are so volatile that you must keep experimenting. Downsizing adds to the defensive mentality. If everyone in your industry is acting the same way, then you will be okay; if everyone is defensive and is cutting back, you will be protected. But if one company says, ‘You know, we are going to aggressively use this as a chance to gain market share,’ and starts to invest more in innovation, then it will be ready to go when the market turns around. There is a lot of evidence that ‘outside in’ companies do outperform ‘inside out’ companies.

Knowledge at Wharton: Does an ‘outside in’ strategy rely more on gathering and analyzing data than an ‘inside out’ strategy?

Day: It’s a question of insight. We don’t talk about data. We talk about market insights — understanding the changing needs of customers and drawing out actionable ideas. You have to be out there living with them. An effective CMO [chief marketing officer] and CEO will make sure the whole management team is immersed in the market as opposed to talking to each other in the C-suite. They will be gathering deep insights into competitors.

We have never seen good companies get bogged down in the MBA affliction called “analysis paralysis” because they know what they are looking for. Yes, companies are still swamped in a data tsunami. But they are much more adaptive. They are doing more experimentation and finding out what works. Everyone is scrambling, but the ‘outside in’ companies have an edge.

Knowledge at Wharton: Can you give us some examples of successful approaches?

Day: Procter & Gamble has for years required every one of its executives to visit customers three times a year. Another company is India-based Godrej — a conglomerate that is involved in industries ranging from appliances and consumer goods to health care and security. India has 26 states representing 26 different markets. Each member of the C-suite owns a state, right down to the company’s secretary, and has to be out there in that state four to five times a year to understand what is happening with customers, competitors and channels. This means that every state, in effect, has its own advocate.

Knowledge at Wharton: How do you measure how well you have implemented an ‘outside in’ strategy? How does one prove that it is working?

Day: Your channels may be your best litmus test. First and foremost, are you continually being surprised by bad results, or the entrance of a new competitor, or a new product category opening up that you weren’t even aware was on the horizon? The reason ‘outside in’ performs so well is that it is much more active as opposed to reactive. An example is Dell, which was a great ‘outside in’ adherent early on. It really understood its corporate market. Going way back to the early days of Dell in the 1970s, Michael Dell had a visceral connection with his market. He saw the need for competitively priced, reliable equipment based on the Wintel [Windows/Intel] platform. Because Dell didn’t have much proprietary technology of its own, the company invested heavily in supply chain management. They understood that what their big corporate customers wanted was individually configured computers that could be delivered to dozens, if not hundreds, of sites.

The second litmus test is, do you know who your customers are and what value you are delivering to them? Again, Dell is an example, this time of a company that didn’t adapt. As Dell began to get more serious competition from Asia, and as other people figured out what made Dell’s supply chain so effective, Dell started to lose its price edge. The company had to continue to go down the price curve but it no longer had much of a cost advantage. So Dell did two things. First, it cut back on customer support and service, which meant their customer satisfaction ratings at one point plummeted. Second, they were so focused on streamlining the supply chain — investing in [quality control program] Six Sigma, supply chain coordination efficiencies, etc. — that they focused inwardly way too much.

Then, three to four years ago, a big shift occurred with the flattening out of the corporate PC market and the arrival of PCs and laptops being purchased from Apple stores, Best Buy and other retail outlets — all places that offer companies a closer connection to their customer. Dell had made a conscious decision not to have a retail presence. Also, it lost contact with this growing market of individuals and small businesses that wanted a more personalized laptop experience, which Dell simply couldn’t deliver on. Finally, Dell’s supply chain was more difficult to manage once consumers started demanding various color combinations and different configuration choices.

The third litmus test is, what is the role of marketing in this organization? Is the marketing function viewed as credible? Are market insights and foresight driving the results of the organization? At Cisco, for example, CEO John Chambers saw his company through the eyes of his customers. He was getting a lot of feedback from them about the arrival of Voice over Internet Protocol (VoIP) — which wasn’t good news for Cisco because this new technology would make some of the company’s products obsolete. But Chambers realized he had to meet the needs of his customers, so in 2003, Cisco purchased a VoIP business in what has turned out to be an extremely profitable acquisition.   

Knowledge at Wharton: How has the Internet and the rise of social networking changed the ways companies market their goods and services, and how do these new online tools favor your ‘outside in’ strategy?

Day: In the last decade, we have seen a tremendous proliferation in the number of channels: Markets are splintering and companies can reach finer and finer segments with tailored offerings. They have much more pricing flexibility. Every cell phone has thousands of different pricing plans. You layer social media and social networking on top of that, and you can then enter into an increasingly direct dialogue with your customers.

So many more media are available as ways to reach customers. The net effect is that it is much more difficult to navigate through this complex market environment. In order to prosper, you have to look at the world from the ‘outside in’ — constantly experimenting to learn how your market will respond to various initiatives. This is not about prediction. Prediction says we will forecast in advance where things will go. Today’s marketplace is much too dynamic. It’s necessary to see patterns sooner and respond to them adaptively.

Knowledge at Wharton: What is the role of the CMO in all of this?

Day: There are four customer value imperatives that we identify in our book — ranging from ‘innovate new value for customers’ to ‘capitalize on the brand as an asset.’ These are the collective responsibility of the C-suite because the C-suite is the direct driver of economic profit and shareholder value. The CEO is first among equals. But if you have everyone accountable, who has direct day-to-day responsibility? In an increasing number of organizations, but not a majority, that job belongs to the CMO.

We talk about the CMO as someone who has earned that responsibility. An increasing number of CMOS are top line leaders. They own the value proposition and they position the business for the future. The rest of the C-suite says, ‘That’s your domain.’ But in many companies, the CMO has not earned the respect and the responsibility. In many medium-sized organizations, the CMO tends to be in a sales support function rather than assuming responsibility for the brand, for finding organic growth opportunities.

The people we have seen who have been successful in the CMO role are those who build up credibility with the CEO and the rest of the C-suite by really knowing the job and being a passionate advocate for customer value. At the same time, they build a strong team in R&D and sales who back them up with solid insights into the market.

Knowledge at Wharton: The subtitle of your book is Profiting from Customer Value. Can you talk a little more about who this customer is?

Day: In many markets, the distinction is made between consumers — you and me, the final buyer — and customers, which would be channels and channel intermediaries. We chose not to worry about that distinction but to go with the more generic term “customers,” which includes both. It can refer to anyone who is making a choice based upon comparative value propositions.

The customer buys the expectation of benefits. They are going to patronize the company that delivers the best package of benefits at the most reasonable total cost. Trader Joe’s is a case in point. It is very imaginative in the ways it meets customers’ needs. For example, it works hard to create the image of a small community-related store rather than a vast impersonal chain. So the staff runs around in Hawaiian shirts, they are very friendly and they chat about products in the store that they have tried. The stores also listen to customers’ complaints about store items that they have bought and liked in the past but that are no longer stocked. If enough people complain about a product’s absence, the store will bring it back in. Finally, Trader Joe’s sends out a newsletter to customers with recipes, tips and news, and they make it fun to read.

In B2B markets, customers win by getting better solutions and by absorbing less risk. A successful company will offer solutions that help the customer make money. GE Wind Power is an example. GE entered this industry in 2003 after buying the remnants of the Enron wind power business. It was a small operation but it gave GE the chance to learn about, and gain insight into, the wind power market. The biggest market at the time was Germany, mainly because the German government provided very substantial subsidies. The market back then was very fragmented, and the belief was that you had to have different sizes of wind power turbines to meet different property specifications. At one point, Siemens offered eight or nine different sizes tailored to a specific location.

The industry had essentially lost sight of the market. Companies never looked at the world through the customer lens and figured out that reliability —  the percentage of time the machinery is working — and efficiency — the ability to convert the wind into energy — were the real keys to making money. So GE Wind Power invested in understanding customer requirements, and based on that, decided to challenge the whole industry model. They built only one size of wind turbine, but they made it extremely reliable. Plus the company used its existing expertise in jet engine turbines to make the most efficient rotors anybody has.

The key story here is that GE’s insights into their customers gave them a strong sense of where to put their R&D dollars. Subsequent to that, they offered a service guarantee that their turbines would be working 98% of the time. 

An ‘outside in’ strategy means looking at the world as a positive sum game. A lot of the strategy literature, especially the competitive forces approach, is all about intensity of competition. The world is seen as a zero sum game, i.e., “If the customer has more power, we lose.” That’s not a good mindset. It doesn’t help. You need to go into a collaborative conversation with the customer.