Which is where CPI Services comes in. For this customer, Oliva explains, CPI Services could design a plan in which it assumes, say, 60% of the risk, and the customer assumes the other 40%. Or CPI Services could assume 100% of the risk but put the customer's premium payments in a fund that accrues dividends. Then, if the customer goes for a predetermined amount of time with no losses, CPI Services would pay out the dividends--in other words, give the customer some of its money back.
Another type of plan CPI Services could set up would involve assuming a customer's past liabilities to free up funds. Consider a hospital that has self-insured for the past 15 years. The hospital would have to maintain a substantial "loss fund"--actuaries hired by the hospital would calculate how large--to cover lawsuits it has already lost but still must pay damages for and to protect against future lawsuits it may or may not lose. But now, strapped by the current upheaval in the health-care industry, the hospital wants to free up the money in that fund. CPI Services could step in and design a plan to assume the past liabilities and help the hospital transfer its funds to more needy areas of the balance sheet. The premium the hospital would pay CPI Services would be significantly less than the amount it had previously been paying into the loss fund.
To offer such customized risk-management plans, CPI Services must become intimate with the businesses it covers. To accomplish that, the three partners plan to do two things: work with the customer as well as the broker ("We want to get into the loop directly between them," says Sanchez) and invest up to $400,000 in software and hardware. The software, which is being developed by Seattle-based Milliman & Robertson, an insurance-consulting and actuarial firm, will allow CPI Services to tailor each policy starting from a standard plan and then deviating from it based on the customer's individual traits, such as its historical losses.
Without the software, analyzing each company separately would be not only prohibitively costly but also an administrative nightmare. The program that Milliman & Robertson ultimately builds, says Joy Schwartzman, a principal at the consulting firm, "will provide CPI Services with a consistent foundation." That way its various underwriters won't have to use nonobjective factors to evaluate clients, which can lead to errors and wildly divergent conclusions about customers' risks. "It's extremely important to us, since we're creating a plan around the customer, that they get exactly what was negotiated on the first try," says Oliva.
The software, which according to Schwartzman will be a customized program most likely based on a Lotus-type spreadsheet, will take months to develop. That's because there's so much information to accumulate. Milliman & Robertson will need to collect, for example, average liabilities for each of the industries CPI Services wants to serve, as well as other industry information like average profit margins and company valuations. After creating a database, the consultants will develop statistical models for CPI Services to use in assessing a company's risks. One of the models, says Schwartzman, will allow CPI Services to compare industry averages with an individual company's historical losses and quickly determine what that company's liabilities might be.
Of course, because CPI Services is so new, there is no hard evidence that its strategy will work. But Sanchez's projections show the company collecting about $60 million in premiums the first year. The real figures, says Sanchez, won't be in for another three to five years--and by then, he says, CPI Services should begin turning a profit. His prediction? A margin of 10%. Oliva echoes Sanchez's optimism about mass customizing a service like insurance. "We formed our company on the premise that we would be demand driven," says Oliva. "We wanted to close the gap between what customers need and what insurance companies have offered."
George Homan, CEO of ChemStation, didn't need to turn his company around (revenues had been growing by about 20% a year, and debt had been steadily dropping) or to carve out a market niche. What he did need to do was figure out how to decrease his expenditures when the recession of the early 1980s put a squeeze on profits.
When Homan incorporated the company, in 1983, it made sense to deliver each order of industrial detergent in its own 55-gallon drum. But as the price of plastic, gasoline, and drivers escalated, Homan found himself laying out more cash for packaging and shipping than for making the soap itself. He considered cutting costs by buying raw materials in huge quantities, but that would have created a new problem: the vats of finished soap would have taken up tons of space and also would have gone to waste if a mixture fell out of favor with customers.
So Homan decided to take a radical step: institute an entirely new delivery system--one centered on permanent, reusable containers. ChemStation would deliver a concentrated version of the soap in smaller containers, thus enabling it to ship more orders per truck and to combine delivery routes. The customer would then add the water on-site to reconstitute the product.
In the process of installing the permanent tanks, Homan learned something very interesting about his customers: because of variances in the environment, similar detergents weren't working equally well even for customers within the same industry. He realized then that if he wanted to give his customers the best value, he'd have to develop detergents geared to their individual cleaning needs. Making that happen, though, would require more than just changing formulas. He would have to make a serious commitment to technology to make up in efficiency what he'd be losing in not manufacturing in bulk. And he'd have to turn his salespeople into information machines.
Though Homan never called his strategy "mass customization," that's exactly what it was. It works this way: Initially, the salespeople take the lead. They ask potential customers about their cleaning tasks, making sure to find out things like whether the soap will be used in an area with a lot of people and how much the customer wants to spend. The information is fed--either over the salespeople's modem-equipped laptops or by the chemists who transcribe it from the salespeople's handwritten notes--into the Tank Management System, ChemStation's proprietary database.
