The Art of Profitability

A review by Andrew Forward, of Adrian Slywotzky's book on business profit models

Here are questions to help get you started when you review your business's profit models

To succeed in business, you have to have a truly genuine interest in profitability. Most people don't.

Customer Solution Profit

Once you identify a potential customer send in a team of 2 or 3 people to work there. Learn everything you can about the customer - how they run their business, how their systems worked (and didn't work), and what they really cared about. then develop customized products and services tailored to the specific characteristics and economics of that account.

During this initial process revenues are tiny and costs are huge. Once your product is fully integrated you need a lot fewer resources to maintain the service - perhaps just one person, part time.

Invest time and energy in learning all there is to know about your customers. Then use that knowledge to create specific solutions for them. Lost money for a short time, make money for a long time.

Pyramid Profit

Can only be applied in a few situations.

Here's how it works, with an example from Mattel. You sell a Barbie doll for $20. Now, others could sell for cheaper - so you introduce a $10 barbie. It is barely profitable but helps prevent others from entering the market.

Mattel then introduced a $100 or $200 barbie for the mothers that had barbies 20 / 30 years ago. They remember those great dolls from years ago and now have the money to buy the real expensive ones.

The product is no longer just a product, but a system. You have the the firewall defensive product at the bottom of the pyramid and powerful profit-generators at the top.

The pyramid has to be more than just a collection of products at different price points. A true pyramid is a system so that (a) cheap products are so efficient that competitors will have a hard time competing on price (i.e. the firewall) and (b) the nature of the customer set (they themselves are a pyramid).

Be sure to keep your lowe-price product really strong so competitors cannot grab the market.

Multi-Component Profit

Think Coca-Cola. One product, several businesses. Grocery, restaurant, vending machine. Most of of the profit stems from restaurant and vending machine sales. Different from pyramid in that customers buy from all price points, not just one.

Always ask "What is our next vending machine?"

Different parts of the business can have different profitability. Customers behave very differently on different purchase occasions (different degree of price sensitivity).

Switchboard Profit

An example from Hollywood.

  1. Packaging related talent together such as actions, directors and screen-writers
  2. Find a source of great stories
  3. Attain critical mass

By representing a team as opposed to individuals you get greater barginning power, and volume is way up.

Time Profit

An example from the financial sector.

  1. Come up with a great little innovation
  2. Eventually get copied within 10 - 12 month
  3. A lot of revenue before imitation starts

An approach to capitalize on this stay-ahead-of-the-game business was to:

The problem with innocation is tedium (i.e. tedious things). What separates winners and losers in innovation is who masters drudgery. The creative process starts with a brilliant idea. Then you determine if the idea will work and if it is worth doing from a business standpoint. Both these activities are exhilarating. Then the real work rolls in whereby you have to reduce the idea to practice, you have to hold lots of meetings and it takes hard work to make it.

Blockbuster Profit

R&D; can result in both high-profit and anti-profit products. So, how can you tell the difference?

An anti-profit has no clear target, or has the wrong target. Perhaps the market has customers that will not pay for your product, or it's a trivial marekt where profits represent a fraction of the investment.

So, trivial projects receive trivial face time with management and die of neglect. Big winners get a lot of time resulting in discussions and debate even outside of the status meetings. Blockbuster profit is a mind game that takes a lot of confidence to aim high, to deliberately set out to build the next blockbuster.

An approach to managing for blockbusters is to develop a fake portfoloio of the top 15 blockbuster opportunities that you see in your market.

Front-end loading is a opposite of cramming. Maximize your breadth of knowledge in the beginning rather than at the end

Front-end loading builds a struture of knowledge that is incomplete but powerful. As you gain more insight and add to your very strong foundation making it easier to discover and be involved with a blockbuster idea.

Profit-Multiplier Model

Take 1 thing, and make money from it 5 or 6 times. That thing could be a character (like Mickey)

You can profit from lower R&D; and improve the probability of success as it has already been successful elsewhere.

Many people only see 1 way to make a profit, reality is much more complicated.

Entrepreneurial Profit

Be an entrepreneur

We cannot afford to operate any other way.

Specialist Profit

Wilbert's strategy for learning is:

Knowledge of customer's system gives cost advantage in delivering their products / services. You have a shorter selling cycle, price premium, higher utilization all due to your reputation. You can attract better talent which helps improve quality, cost, and the ability to sell follow-on business.

You can manage pricing better by building menus, you know delivery costs so you can accurately price a la price. You never say "No", but you do say how much something will cost.

When you invent something you can sell the same solution over and over which results in:

  1. Lower cost, better knowledge
  2. Better price through unique design or reputation
  3. Shorter selling cycle
  4. More rapid / universal penetration due to wired effect
  5. Windfall profits, replication of high value, high margin, answers throughout market place

There are 4 levels of learning Awareness, Awkwardness, Application and Assimilation.

Installed Base Profit

Think cameras, razor blades, and printers. There are two profit buckets, hardware and consumables. Prior to the initial purchase the buyer has the power with a lot of choice. After the purchase the seller has the power as the customer is locked into a solution.

Seller must make it easy to buy

De Facto Standard Profit

Think Microsoft. You are able to "plan" the industry. You have lower marketing costs - customer base does it for you (to some extent).

Brand Profit

Learn most about how profit is made by studying profitable companies. Figure out their business model and think how they might apply elsewhere. Visit their stores, try their products, test their services and talk with their customers.

Share Determining Segment (SDS) is the most important segment in the market where high share today translates into high shares in the entire market tomorrow.

Architects for example include contractors who influence the do-it yourselfers. Spending $5 on SDS is much more efficient than $5 on average customers.

Specialty Product Profit

Similar to blockbuster except the market is a niche.

Local Leadership Profit

Dominate local market, free advertising with high density of stores, better able to negotiate with supplies and premium price for foot traffic.

Walmart's approach was to draw a circle around a city and penetrate that area from outside in.

Transaction Scale Profit

Bigger transactions yield bigger profits. The cost per unit rises more slowly than the revenue per unit. This model can be applied to brokerage-type and transportation-type businesses.

One approach is to turn away small business to concentrate on big business. It takes skill, persistence and reference development to succeed. Be weary of missed opportunities, do not concentrate on others, or your past misses, just on the next one.

Value Chain Position Profit

There are strategic points of power along the supply-chain. For example, I would rather be Walmart than a supplier to Walmart; I would rather be Tom Clancy than his publisher.

There are no pre-existing control points, but they are set relative to the value added at the each point and the connection that a supplier has to its customers. You can profit from predictability - the company that owns the control point can set the pace and direction of the entire supply-chain.

Cycle Profit

In cyclic businesses, it is important not to get too tied up looking at sales volume - because it obscures the relationship between cycles and profit.

One approach is to drive down your break even point by reducing costs, especially fixed costs. When others lose money, you break even; when others break even, you make money; when others make money, you make a lot of money.

Another approach is to be an avid student and master of pricing within your cycle and maintain a tiny lead and lag difference from market pricing. This slightly higher pricing but always comparable strategy translates into a lot of profit.

Profit requires sellers, prices, project managers and inventors.

After-Sale Profit

Buyer price sensitivity is not constant.

Price sensitivity highest when
  • Ticket price is high
  • Variability is high
  • Lots of options
Price sensitivity lowest when
  • Ticket price is low
  • Variability is low
  • few options

Prior to buying that big-ticket item, you simply did not need a lot of things like

These minimarket stuff are about 1/10 to 1/100 the price of the original big-ticket item.

The different between After-Sale and Install Base profit is that Install Base profits the seller of the original item, whereas After-Sale can profit anyone selling within that mini-market.

Although after-sale products enjoy higher margins it can be difficult for hardware focussed companies to expand the scope of thier business to include more after-sale stuff. The end goal should be to turn your after-sale profit into install base profit.

Psychologically there is a lot less glamour to selling after-sale items - yipee, I sold 10 service contracts today does not have the same ring as selling a car, or big appliance. Which is too bad - because the margins on the service contract are a lot higher.

There is a ton of money lost somewhere in the zone between a great idea and brilliant application. It is the billiant application that counts.

When studying a business talk to the clients. And be sure not to ask, "What do I need to know?", and start asking "What am I afraid to find out?".

New Product Profit

New products experience a profit explosion at the beginning. Not only are marins high, but sales volumes are skyrocketting.

When caught the whirlwind of a new product, be sure to look past the next year and think forward 3 years.

A theory is that the total profit earned by all players in a market goes up, peaks, and comes down to zero. Think of radios, TVs, VCRs, Walkmans, desktops, laptops, servers, sedans, minivans, SUVs, faxes, fax-printers, fax-print-copiers.

The problem is the gold rush. Once you are swept into that psychology (where even weak produces make money) you cannot think clearly enough to manage strategically.

To deal with this problem

  1. Admit reality (parabola was real)
  2. Overinvest by a factor of 3 on the way up
  3. Underinvest (also fact of 3) on the way down

Fight for mindshare. Be seen as the leader in the new category. Merchandise your product mercilessly. Be everywhere. Start measuring things that will give you clues that you are approaching the peak. Year-to-year and quarter-to-quarter growth rates, price changes. Indicies of customer excitment and boredome. The objective is to reverse the investment ratio out of the market.

Once things get ugly, you can successful pull back because of your early mindshare. You can start service just the good customers (and drop the bad ones). You can use your effort to look for that next big wave.

  Time Profit New Product Profit Specialty Product Profit
Cycle 24 months 60 months 120 months
Skill Speed Shift resources Select
Metaphor Race-car driving Surfing Sismography
Motto "When you see #2 in your rearview mirror, step on the gas" "Get off the last wave first, catch the next wave first" "Find the richest old fields - the place where customers need, technical feasability, and lack of competition intersect"
Examples computer chips, consumer electronics, financial products cars, copiers specialty chemicals, pharmaceuticals

Relative Market Share Profit

It is presciptive. Invest to win. Build a bigger lead. If you tried and failed, then cut your losses, or get our completely.

The strategy works because of the economics of scale in manufacturing, purchasing advantage (biggest player pays the lowest price). The biggest player also has a marketing and advertising advantage - they can afford to invest the most, and had the lowest marketing cost per unit. The biggest attracts the best, the best have the better equipement, labs and budgets - a self reinforcing upward spiral as success drove more success.

The leader has the lowest risk. It can plan the market, whereas the others react to it.

RMS is still important, but it the where and how. Just like Newton. The classic laws of physics still work, but they don't work everywhere equally.

Profit used to a function of RMS - the higher the RMS, the higher the profits. Today, profit can be a function of time, location, offering and even local RMS.

Ask "Why?" five time, afterwhich you will be close to the answer.

Experience Curve Profit

It is all about using your experience in an industry to bring down costs. It is relevant to companies where cost of goods is high (say 70%). Being big also helps, as you can spread your overhead costs over more units sold. Same with advertising, sales and marketing costs.

Overlaps with Relative Market Share in that bigger companies have an advantage, but the reasons for the advantage are different. For Experience Curce, it is about learning rate and for RMS it is about scale.

A danger with experience is that you become too focused on studying and cutting costs and lose sight of other opportunities or threats. Someone may make you irrelevant - aluminum replaces steel to make soda pop cans; plastic replaces aluminum in soda pop bottles. Someone invents a completely new model that delivers the same thing at 20 - 30% lower cost - Dell computers, Ryan Air, Wal-Mart.

To deal with these issues, you may need two organizations: one to manage the experience curve, the other think blank-sheet-of-paper. This should maximize you current process while buying insurance on future processes.

Low-Cost Business Design Profit

Does not need huge market share to be hugely profitable - as long as it continues to be dramatically lower-cost

Value Migration believes that the rules of success change. You have to change your business design every 5 years. This requires companies become great at anticipating the next change - improving their reaction times and having better instincts.

Digital Profit

Allows businesses to create tenfold improvements in productivity. Allows you to reverse your business processes, from push to pull, guess to know. Being digital allows customers to customize the product to their liking. Digital puts a lot more power in the hands of customers to look up product info, prices, order status, and FAQs.

From a process standpoint, more information is available real-time. You can see problems sooner, take corrective action sooner, redeploy resources sooner.

Without a fundamentally sound business design, the digital effect is worthless.

Below is a list of similar profit models (cousins) that you have just read about.