This book is written in the form of the novel through asking question by mentor and answering them by mentee. It is short read but it took me a while to chew the concepts of profit making. Normaly I like to read business books as novels but in this instance it was dificult.
So this is my assessment of the book The Art of Profitability by Adrian Slywotzky according to my 8 criteria:
1. Related to practice - 3 stars
2. It prevails important - 3 stars
3. I agree with the read - 4 stars
4. not difficult to read (as for non English native) - 4 stars
5. Too long (more than 500 pages) - short and concise (150-200 pages) - 4 stars
6. Boring - every sentence is interesting - 3 stars
7. Learning opportunity - 4 stars
8. Dry and uninspired style of writing - Smooth style with humouristic and fun parts - 3 stars
Total 3.5 stars
Here are some highlights and excerpts from the book that I find worth remembering...
1 Customer Solution Profit.
▪ Once Factset identified a company as a potential customer for their information services, they’d send a team of two or three people to work there. They would spend two or three months, sometimes longer, learning everything they could about the customer--how they ran their business, how their systems worked (and didn’t work), and what they really cared about. Based on this genuine knowledge of the customer, Factset then developed customized information products and services tailored to the specific characteristics and economics of the account. Once they landed the account, they spent a ton of time integrating their product into the customer’s systems. During this process, Factset’s revenues were tiny and their costs were huge. If you looked at a monthly P&L for a particular account, you’d see they were losing a ton of money. Costs of $10,000 might be charged against revenues of $3,000.”
▪ But then things would begin to change. After three or four months, Factset’s products would be woven into the daily flow of the customer’s operations. Their software would be debugged and working fine. Now Factset didn’t need three people working fulltime on the account. One person could maintain the service, probably part-time. And as the word spread among the client’s employees about how powerful Factset’s data was and how effectively Factset’s service had been customized to their specific needs, they began taking more and more advantage of it. Factset’s monthly costs fell from $10K to $8K, while monthly revenues started to grow, from $3K to $5K to $12K.
▪ To succeed in business, you have to have a genuine, honest-to-goodness interest in profitability
▪ most of the executives were focused on things the division was already doing well, whose impact on profits seemed to be small--incremental quality improvements and modest production efficiencies--rather than the needs of their customers.
2 Pyramid Profit
▪ Here’s how it works at Mattel. You sell a Barbie doll for $20 to $30. But imitators can come in below you. So you build a firewall. You develop a $10 Barbie to seal off that space. It’s barely profitable, but it prevents other companies from establishing a connection with your customers. And even girls who start with the $10 Barbie usually move on to buy accessories and other dolls that make them profitable for Mattel. “But in order to achieve a real breakthrough, Mattel had to look in the other direction. Looking hard, they saw the opportunity for a $100 or $200 Barbie.”
▪ Forget about the little girl. Instead, think about her mother. She played with Barbies twenty or thirty years ago. She remembers those dolls with incredible fondness. And now she has money to spend. Maybe Mom will buy a designer Barbie--finely crafted, exquisite. Not a toy but a collector’s item, like the china teapots or African sculptures or rare postage stamps that enthusiasts will pay a great deal to own. Providing enormous satisfaction to the customer and enormous margins to Mattel.”
▪ Barbie wasn’t a product any longer, but a system, a carefully crafted, coordinated, and integrated system. A firewall of defensive product at the bottom of the pyramid and powerful profit-generators at the top.
▪ A true pyramid is a system in which the lower-priced products are manufactured and sold with so much efficiency that it’s virtually impossible for a competitor to steal market share by underpricing you. That’s why I call the lowest tier of the pyramid the firewall.
▪ The customers themselves form a hierarchy, with different expectations and different attitudes toward price. There are Mattel customers who absolutely won’t spend more than $10 for a no-frills doll. There are others who’ll pay top dollar for a unique product. The pyramid captures them both.
▪ General Motors, of course, invented the pyramid model back in the 1920s, under Alfred P. Sloan, with Chevrolet at the base and Cadillac at the apex
▪ Many businesses come in pieces. And all the pieces may not be equally profitable. In fact, in most cases, profitability is quite lumpy- sometimes high, sometimes low, sometimes non-existent.
▪ Think about Coca-Cola. One product, right? Yes--but several businesses. Coke has a grocery component, a restaurant component, a vending-machine component. Most of the profits flow from the restaurant and vending-machine sales
▪ Same product, several businesses. Whereas the Barbie pyramid is really based on several very different products targeted at basically distinct customer sets
3 Multi-Component Profit
▪ Now think about a hotel,” Zhao pressed on. It has lots of components. One is called ‘a single room for one night,’ another is called ‘a one-day meeting for twenty people,’ and yet another is called ‘a three-day convention for three thousand people.’ Think about the relative dollars compared to the relative costs. Same rooms, lots of ways to sell them
▪ think about a bookstore. It has a foot-traffic-in-the-store component, a book-group-member component, an online-website component, and a corporate purchasing component. Same books, lots of ways to sell them--each with its own profit picture
▪ Burton recognized that the bookstore itself could be a base for building several new high-profit components: the corporate business, the book-group business, the personal-service business. After several months of working with the booksellers association, he developed a program to dramatically intensify the bookstores’ outbound selling activities.
▪ He suggested having a couple of account managers call on corporate libraries and HR departments to promote the latest business books. Providing services to local book groups was next. And that was followed by promoting sales to high-purchase individuals.
It was obvious, in a way. After all, the booksellers already knew that their best customers bought nearly $500 worth of books a year. But they’d never realized that these people represented a separate component of their business that they could consciously, deliberately target and grow. A simple but powerful insight.
▪ The large box on the left,” he explained, “is your base business. The smaller boxes on the right are your component businesses
▪ “what’s the idea behind this profit model?” Steve thought a moment. “Different parts of a business can have wildly different profitability.”
▪ “The customer behaves very differently on different purchase occasions.”
▪ Different degrees of price sensitivity
4 Switchboard Profit
▪ So a switchboard is another word for packaging talent?” Steve asked. “No, no, no.
- The packaging concept was just the first step toward building a true switchboard. Packaging falls far short of creating the concentration of power that a switchboard requires.”
- Step two,” Zhao continued, “was to find a source of stories. In both TV and movies, good stories make the system go--they’re the core around which everything is built. Realizing this, Ovitz knew he needed a great source of stories. So he befriended the leading literary agent in New York at the time, a fellow named Mort Janklow ▪ So now, with a good flow of stories, Ovitz had leverage with the talent. And by organizing the talent, he had leverage with the studios. Ovitz could bring a great story to a hot actor and a hot director and then bring all three to a studio hungry for movie ideas. It was a brilliant idea--and like many brilliant ideas, obvious in retrospect
- There’s a step three?” - Even if you have a source of stories, along with the persuasiveness and skill needed to put together a package of talent, you’re only controlling two of the variables. There’s a third variable--number.” “Meaning what?” “Well, you could work your tail off putting packages together and still represent only three percent of the market.” Zhao smiled. “How interesting.” “I don’t know a lot about Hollywood,” Steve went on, “but I’m guessing there were probably ten or twelve good-sized studios at the time.” Zhao nodded. “Close enough.” “And probably several hundred stars, directors, and screenwriters hat mattered.” “Also close enough.” “So if you’re Michael Ovitz and you represent, say, a couple of dozen screen artists, the studios have lot of other options. They don’t have to deal with you if they don’t want to.” But if you represent a couple of hundred artists, the studios’ options start to narrow.”
“Does that apply only to the studios?” “No, that’s the beauty of it. The more critical mass you build, the higher your probability of putting together a package that works. That, in turn, means that a star, a writer, or a director will be better off being represented by you rather than any other agent, because the odds of being part of a winning combination are so much higher.” “So now the studios have to deal with you, and the stars want to deal with you.”
▪ “Let’s say a star gets five million dollars for a picture,” Steve began. “And let’s say there are two big stars per picture--Meryl Streep and Robert Redford in the 1980s, or Tom Cruise and Nicole Kidman in the ‘90s. Figure the director gets a million and a half, and the writer gets half a million. On the original Hollywood model, the agent represents one star and gets a ten percent fee. That’s $500 thousand. Here Ovitz represents a complete package and gets ten percent of $12 million, or $1.2 million. More than twice as much.” “Is that it?”
“Oh no, far from it.” Zhao sat up straight, staring at Steve. He just might have a great student on his hands. “By representing a team rather than an individual, he has far greater bargaining power. He could raise that twelve million to fifteen million, or more. After all, the studio has nowhere else to go if it wants to get its hands on the biggest stars.” “And therefore, the agent’s fee would rise to one and a half million dollars, three times greater than in the traditional model.” “And that’s it?” “No, there’s more. The biggest factor is that the probability of striking a deal goes way, way up. As the pool of talent you represent grows to two or three hundred, the chances of putting the ‘right’ talent together goes way up, and so does the probability that the studio has to deal with you. So your volume goes way up. The number of deals you can put together per unit of time will probably double or triple.” “Net result?”
“Profitability per unit of effort and unit of time is probably seven to ten times greater than in the traditional model.”
5 Time Profit
▪ Why couldn’t some company create a kind of telecom Switchboard by offering equipment, software, services--the whole nine yards--from every supplier, expertly mixed and matched for customized needs?”
▪ The profit would come from selling the equipment itself as well as from having inside knowledge of everybody’s products, not just those of a single supplier. And the company that moved first could really make it work by signing deals to represent all the best manufacturers, consultants, and software makers. Of course, you’d need top-flight experts to work with the customers, to make sure that the systems you put together were absolutely the best. And you’d have to invest the time in studying each customer’s business instead of trying to sell cookie-cutter solutions--a little like the Customer Solutions model. But the time invested up front could really pay off on the back end, with contracts to service and expand and upgrade the equipment continually.
▪ even weird numerical problems can usually be solved by using some information that’s generally available and a little common sense.”
▪ The key is to use the numbers to ask and answer critical questions.
▪ Intel invents a new chip and makes money by being the first to market?”
▪ “The main difference was that Intel usually had two to three years to profit from their innovations, while Waterstone’s had only six to nine months. So Terry asserted that they needed instant diffusion--a faster way to squeeze out the juice before everybody else learned the secret. She helped design a neat system to accomplish this.
▪ Two weeks before announcing a new product, Waterstone’s would send out a letter to two hundred clients letting them know it was on the way. A week in advance, they called them on the phone, saying, ‘Our new product will be available next Monday.’ “Thursday evening before the launch, they’d start a training session on the new product for everybody in the company--a crash course covering every detail. The class continued on Friday morning. Any unanswered questions raised by the participants had to be researched on Friday afternoon. Saturday morning they’d be at it again. They kept working through the weekend until the entire firm was ready to explain the new product in their sleep. “The client calls started coming in on Monday morning. By the end of the week, they’d have fifty or sixty inquiries. Within two weeks, the number would be up to a hundred.
6 Blockbuster Profit
▪ It’s inevitable that not every R&D project will hit the target. R&D is anti-profit when it has no clear target, the wrong target--for example, a market where customers won’t pay for what you’ve developed--or a trivial target, where the total profit return is a fraction of the total investment
▪ Gradually, it became clear to Marc and then to everyone in the organization that all of Agri-Chem’s profit was in a few blockbuster products. Yet the blockbusters were getting very little of the right kinds of R&D attention.
▪ “Marc changed that quickly, starting with the entire tenor of the project discussions. Projects of trivial value began to get no airtime. Soon they died of neglect. “By contrast, the potential big winners got a tremendous amount of workover, discussion, and debate. The attention focused on them was so forceful that the dialogue often spilled over into the hallways, into after-hours, into the agenda of other management meetings. Everyone got focused on the new key questions: How can we increase the feasibility level of the big projects? How can we accelerate their development? Can we parallel- process? Can we get more studies done to improve their positioning? What will it take to hit a home run?
▪ The Blockbuster model is a mind game. It takes huge confidence to aim high, to deliberately set out to build the next great blockbuster. When Marc got there, the dominant mood in the organization was We can’t. By his sixth year, the assumption was reversed to not only We can but to We probably will.”
▪ He insisted that each of his lead projects have at least one back-up compound, sometimes two. That way, if the lead failed, they would learn from it for the next one, rather than suffering a total write-off.”
7 Profit-Multiplier Model
▪ “So you take a character, or a story, or a skill, or any other asset, and iterate it, reuse it, and give it a different form.”
▪ lower R&D or development cost. You don’t have to reinvent the wheel every time you use it
▪ Most R&D projects don’t produce anything of value. If you could improve the odds
▪ Remember what I said about letting Einstein’s Dreams open your mind? That’s the point. And it relates not just to the Profit-Multiplier model but to all the profit models. Many people see only one way of making a profit--the one they grew up with, usually,
List of books:
▪ Asimov on Astronomy
▪ Einstein’s Dreams
8 Entrepreneurial Profit
▪ The most important thing about Jack is that he preaches frugality the way missionaries preach their faith: with zeal, passion, and absolute commitment. He creates a psychology of saving that is absolute and universal. And he makes himself into an example.”
▪ Jack also saves money by challenging the necessity for most trips. He likes to ask questions like, ‘Why can’t we make a deal using the phone and the fax machine?’ He’s only right forty percent of the time, but that’s enough to make a huge difference. The productivity hit is huge. It saves a lot of dollars, but, more important, it frees up thousands of fresh-for-fighting hours that his troops have available to apply to the tasks that matter.”
▪ He’s also a great believer in communication, but communication on the cheap. His typical off-site meeting is held at a high school gym. It starts early, ends late, and features a high-fiber agenda, each item focused on customers, or reducing costs, or selling more. He sets expectations very clearly.
▪ Jack wants rock bottom prices, but also creativity and new ideas for better ways of doing things. So he’s intense with suppliers, but he doesn’t beat them up. He persuades with passion, making suppliers understand how they’ll benefit if Jack can keep on growing twice as fast as the rest of his industry. And Jack’s habit of planning in advance and being hyper-organized saves the suppliers a tremendous amount of headaches and money. So for most of them, he’s a very tough yet very profitable customer.”
▪ He delays capital expenditures, and he asks hard questions about every major expense.” Zhao considered this. “The questions he asks are hard but always very well informed. And he doesn’t ask about major expenses only
▪ He holds contests among his people to test the frontiers of great performance.
▪ He throws parties to celebrate star performers.
▪ And he copies shamelessly from competitors.
▪ when he fails, he cuts back quickly.
▪ The hardest thing in business is to keep the entrepreneurial spirit alive and flourishing in the wake of continued success
9 Specialist Profit
▪ why they were so profitable:
- their betterknowledge of the customer’s system gave them a cost advantage indelivering their products and services
- They might have a price premium
- Reputation within the segment. As in, ‘These are theguys who really know our business.
- they’d have a shorter selling cycle-Therefore, higher average utilization in the business compared to the non-specialist
- They could attract better talent. Therefore, better quality, better cost, better ability to sell follow-on
Have we explained the entire fifteen percent differential? There must be something else:
- The specialists also tend to managepricing better by building menus. They know delivery costs so well that
- they can price á la carte and do it accurately. They never say ‘No’ to thecustomer, but they do tell the customer how much it will cost. Whetherit’s EDS, or Wallace, or Hewlett-Packard in its Global Account Management program, the menu of services and its pricing algorithms are critical to the difference between breakeven and fifteen percent
- “If you invent something--a solution to a problem--andyou are well known as a specialist, you can sell that same solution overand over, five, ten, fifteen times or more.”
- “And whatmight the margins on that be?”“Sixty to seventy percent?” “Why?”
- “Because most of the cost is in the development of the solution, the If you can replicate it and price to market, the operating cost can bequite low.”
- The specialist might come up with several solutions a year. Thegeneralist might develop one, or none.
- The specialist not only has something to replicate,but can test it sooner, and sell it sooner, because of connections into theindustry, into customer companies, into specific decision-makers
▪ copy of The Profit Zone
▪ Are there any other examples we’ve left out?
- Great antitrust lawyers, like the guys here at Storm & Fellows.
- Cardiologists and engineers. The best minds in law, medicine, the wholeworld of the professions.”
- ABB is the application of that principle toengineering on a very large scale. Any others?”
- “Professors in schools. Category-focused retailers. Specializedconstruction companies.”
▪ what are the common elements cutting through all of them?
- Number one, lower cost throughbetter knowledge.
- Number two, better price through reputation orthrough the unique design of their offering.
- Number three, shorterselling cycle.
- Number four, more rapid and universal penetrationbecause of the wired effect.
- Number five, windfall profits because of thereplication of high-value, high-margin answers throughout the”
▪ Add all these up, and the difference in profitability between generalist and specialist will be ten to fifteen points of margin. When generalists break even, specialists make fifteen percent. When generalists make ten percent, specialists can make twenty-five percent
▪ There are four levels to learning: Awareness. Awkwardness. Application. Assimilation.
10 Installed Base Profit
▪ Power “It has shifted.” “How?” “In the original sale, the buyer had it . . . lots of choices. In the after-sale, the seller has it because the buyer is locked into the seller’s consumables.”
▪ The seller can screw it up.” “How?” “Two ways.
- One is pricing too high. The buyer gets so upset that heswitches brands or drops the product altogether. The goose gets killed.”
- “The seller doesn’t work to make it easy for the customer to buy.”“How do you mean?”
“Early notice. Reminders. Multiple units per follow-on sale. Moving from passive receipt of installed-base profit to stimulating usage and growth
11 De Facto Standard Profit
▪ Think about Microsoft. Where does Microsoft make its money?”
- “In the upgrades.”
- “And in the applications.”
- - “Surprises cost money,” Steve went on. “They cause you to react,respond, scramble. The owners of the de facto standard can plan and can shape the next stage of the industry’s unfolding landscape, because it’s their business plan that drives it.”
- Your customers do your marketing for you andreduce your marketing expenses.”
▪ Well, last week the newspaper described a major accounting firm pulling out its Lotus products and replacing them with Microsoft’s, because of requests and pressure from customers who had standardized on Microsoft.” “And how much is that worth?”
▪ It saves you sales and marketing costs of twenty to thirty percent on that sale, because the customer does it for you.” “And what percentage of sales might this affect?” “Maybe a quarter or a fifth.” “For a total of . . .?” A quarter or a fifth of sales, at a savings of twenty to thirty percent, so a range of four percent at the low end to nearly eight percent at the high end.”
▪ ABC of Reading by Ezra Pound
12 Brand Profit
▪ But what about your homework assignment--to come up with examples of pure Brand Profit,
▪ 1994. It’s absolutely delicious. It’s about NUMMI, the Toyota-GM joint venture in Fremont, California. Same factory, same workers, same processes, two nameplates. The Toyota ameplate fetches pricing that is $300 per car higher than the GM nameplate
▪ Here’s another for you. The year was 1994. The context was the cutthroat PC business. In this world of selling boxes, some pretty careful research documented that a Compaq box--the exact same box as other PC makers produced--commanded a $200 price premium. Two hundred dollars.
▪ Ogilvy measured the impact on revenue and profit of sustained advertising investment, versus those companies who pulled back on their ad spend during a recession. Those who continued advertising during the recession increased revenues faster, and profits much faster, after the recession, compared to their rivals who cut back. What’s going on here?” Steve thought about it. “Cumulative impact
▪ So Brand Profit is partly a function of history.
▪ Share-determining segment - The SDS is the most important segment in the market. That’s the one where high share today translates into high share of the whole market tomorrow.”
“Example, please?” “Specialists in medicine are a great example. Cardiologists not only write a lot of prescriptions for heart medications, but they also influence what the general practitioners write. Another example is eighteen- to twenty-five-year-olds in tobacco. It’s an odious example, I know, but it’s very real. And there’s still another example from the building supply field--the one you’re immersed in right now.” Steve was ready. “Sure, architects,” he said. Their decisions and preferences for materials and design styles filter down to the contractors and ultimately to the do-it-yourself repair and remodeling markets.” “Exactly. And in all of these categories, spending a dollar on the SDS is worth more than spending five dollars on the average customer.”
13 Specialty Product Profit
▪ first learned about Specialty Product Profit in 1978. I worked with a dyestuff company in North Carolina. They used to make gobs of money. Pharma-type profits
▪ Here’s what I realized. The dyestuff business had been a specialty product business, just like the pharma business. Lots of little unique patented products that had huge margins. As long as there were plenty of new discoveries to be made, the system worked. The key question was what projects to work on, because some were far more valuable than others. But they were all profitable. “As I worked through the endless reams of product data, I found that ten years ago, more than eighty percent of their revenues came from those relatively unique patented, high-profit specialty products. Less than twenty percent came from commodity products.
▪ For them, the specialty product model would be viable for a considerable while.” “What was their ratio?” “When I started, it was seventy percent from specialty products and falling fast. They hadn’t been managing their pipeline. You could project that the ratio would be about fifty-five percent within three years because of patent expirations and new substitutes being introduced.
▪ what’s the difference between Specialty Product profit and Blockbuster profit? When you think of specialty products, think fine chemicals, think dyestuffs, think specialty papers, think specialty foods. Think niche. The key is finding a legitimate need or variation and addressing it. “When you think blockbuster, think pharmaceuticals, think Hollywood movies, think best-selling books, think pop music. Either the development costs are extremely high, so you need big hits to pay for them, or the demand is highly influenceable, so you need a brilliant, intensive marketing campaign. Or both. Pills and movies are the former, books and music the latter.”
14 Local Leadership Profit
▪ How many stores does Wal-Mart have?” As of the year 2000, it was actually around three thousand. What do you think the growth pattern was?” County by county. Here’s how it worked.” As he talked, Zhao quickly sketched a circle. Dots around the circumference. Then the dots filled in
▪ All told, about six percentage points extra to Wal-Mart’s bottom line
▪ Now, how far would Wal-Mart have gotten without the local leadership that fueled its profitability?” “They would have been a decade late,” Steve ventured. “No, they would never have gotten there. There wouldn’t have been enough financial fuel to support the expansion.”
15 Transaction Scale Profit
▪ So if I owned an ad agency, who would I go after? “The big accounts.” “But everybody wants the big accounts,” Zhao said, anticipating Steve’s next objection.
▪ But wait a minute,” Steve finally continued. “I just said that everybody’s trying to get all the business they can get, regardless of its profitability.” Zhao’s focus on Steve intensified. Still he said nothing. Steve went on:
- “But maybe you have to take risks to bias yourself towards the big business.
- Turn small business away to concentrate on the big accounts.”
- “Yes, risk-taking is one element. What are the others?” Zhao asked.
- “Skill. Persistence.”
- “Reference development.”
- To win, you’ve got to concentrate.”
- And there’s the open door syndrome.-You work for years to open the door to the kind of opportunity that matters--and then you don’t walk through it.
▪ Japanese managers have a saying. ‘When you point a finger at someone, always remember that three fingers are pointing back at you.
▪ . Don’t focus on Deborah, don’t focus on the doors you walked by already. Focus on the next three. Better still, focus on the next one.
▪ What did she do to get the big transactions?”
- “She paid attention to the potential million-dollar buyers.
- She askedherself, ‘How do these people want to be treated?’
- She didn’t overdo it.She was unobtrusive. But she was always around.
- She gave them
- She followed their needs.
- She built her rolodex.
- She noticedthe shoddy treatment plenty of other agents provided, and she offeredan alternative.
- She wasn’t as aggressive as her colleagues, which cost hersome sales early on. But it won her many more sales later. Much larger”
▪ You get to the big transactions through great relationships.
16. Value Chain Position Profit
▪ I often think about this line from Sun Tzu: ‘He who occupies the mountain pass can easily battle a thousand.’ Just as some moments in time are more critical than others, so too are some places more important than others.” Zhao began to point to different parts of the drawing as he continued:
- “Some places are much more critical than others. The high ground. Theriver ford. The mountain pass. The bridge. The isthmus. The channel- think of Gibraltar, Suez, the Bosphorus.
- “What’s true in geography is true in business. There are places on thelandscape, places in the value chain, that are ten times more valuablethan others in terms of profit, power, and control. These special places are the control points of the business landscape.
- “When earthquakes, tremors, floods, or other natural disasters occur,the location of these special places changes, making some vulnerable andothers blessed.
▪ Think about the examples of Value Chain Position Profit that you know--cases where there is an extremely lumpy distribution of power in the value chain, with enormous concentration of power and profitability in one place.”
- “Well, the obvious ones are Intel and Microsoft,” Steve replied.“Good. Profits in the PC box business are almost non-existent, but thetwo companies you name have been able to capture huge value as suppliers to the industry. Any others?
- Would yourather be a supplier to Wal-Mart or Wal-Mart itself? Would you rather be
Tom Clancy or Tom Clancy’s publisher?” “That’s easy. I’d rather be Wal-Mart. Or, for that matter, Home Depot or Toys R Us. But in publishing, I’d rather be Tom Clancy or Stephen King.”
Book: ▪ The Computerless Computer Company
17. Cycle Profit
▪ It’s one of the big problems we’ve been wrestling with. How the heck do we keep from going broke during the downturns? And then how do we gear up fast enough to take advantage of the upswings?”
▪ This is the mental picture most people have of a cyclical industry,” Unfortunately, it’s the wrong picture,” Zhao continued. “It focuses on volume, and it obscures the relationship between the cycle and profit. Let’s change that.”
What happens at D?” Zhao asked. “You lose money.”
“At C?”“Break even.”
“At B?”“Make money.”
“At A?”Steve chuckled. “Make an obscene amount of money.”
“Okay. So how does profit versus utilization look?”
▪ Now think about a great Cycle Profit company,” Zhao said. “Ummm. . . Toyota?” “Good choice. How do they do it?” Steve thought. He remembered a Wall Street Journal article on the company. “By driving down the breakeven point?” “You bet. How?” “They reduce costs, especially fixed costs.”
▪ book: Of Permanent Value by Andrew Kilpatrick.
18 After-Sale Profit
▪ Is buyer price sensitivity a constant? Is price sensitivity the same for all purchase occasions?” “No, I don’t think so,” was Steve’s knee-jerk response. “But I guess I’m not sure.” “Does it vary a little or a lot?” “At least a little.” “What about a handful of examples? Let’s say a cup of coffee, a television, a plane trip, a car.”
- “A cup of coffee--very low. That’s the basis ofStarbucks’ whole business. People will pay up to two or three dollars forthe stuff, even though the marginal cost is a dime.
- “With a television, it’s different,” Steve continued. “People pay moreattention to price. They’ll even go from store to store, looking to savetwenty or thirty dollars, for the satisfaction of having gotten the lowest
- “With a plane ride, the sensitivity is much higher. They’ll search hardfor bargains. They’ll make reservations months in advance.”
- “What’s going on there?” Zhao asked.“The ticket price is a big one, it’s a scary number, and everybodyknows that if you work hard at it you can get a big reward--you can save a hundred or two hundred dollars.” “So big ticket and high variability in the market.” “Yes.”
“What about cars?” “Cars are enormous. The biggest ticket of them all, except for houses. Big variability as well. Huge price sensitivity. Even the timid and the negotiation-averse will overcome their natural tendencies when they step into a car dealership. They’ll start to haggle.” “Unless?” “When will the car buyer agree to the asking price?” “They’ll pay if it’s the car they really want, and if they have to wait for it.”
“So, what general principles are at work?” Steve ticked them off. “Price sensitivity is highest when ticket price is high, variability is high, and there are lots of options.” “Conversely?”
“Price sensitivity is lowest when ticket price is low, variability is low, and there are few options.” Zhao gave a little bow. “Thank you. You’ve just described the basis of high profit in the After-Sale Profit model. There are lots of businesses where the action starts with a high-visibility, big-ticket sale. Computers, cars, copiers, industrial equipment.
“The purchase transaction occurs in the buyer’s maximum price sensitivity zone. Buyers will go to the wall to get the lowest price. Their zeal, their energy, their enthusiasm to hunt for the bargain drives the price down and the profit out.
“But then a funny thing happens. The initial transaction creates a new situation, a need for follow-up stuff that did not exist before. You didn’t need the service contract before you bought the elevator, or the PC, or the pickup truck. You didn’t need the replacement part or the accessories.
“But now you do. A whole new mini-market has been created, brought into being by the initial sale. “Now think about the characteristics of this mini-market. It’s stuff you gotta have, and the ticket prices are one-tenth or one-hundredth as high as the initial transaction. Much better characteristics than the initial sale.”
“Isn’t this just another variation on the Installed Base model?” “There are similarities,” Zhao agreed. “But who profits from the Installed Base model?” “The makers of the product, of course.” “Right. And who profits from selling the auto insurance policy, or the PC software, or the service plan on the appliance?” “Different people--the insurance company and the broker, the software maker, the appliance retailer.” “That’s the point,” Zhao nodded.
“So why don’t the hardware sellers collect on the follow-up stuff?” “Great question. For me, it is one of the enduring paradoxes of business. The big-ticket hardware folks invest the capital, take all the risks--which are huge--suffer the losses and the write-downs, and then let somebody else capture the business that has predictability, lower price sensitivity, higher margins, recurring revenue, and the opportunity to create an ongoing customer relationship, because the frequency of purchase is ten times greater than the frequency of the initial transaction. “So I don’t understand why the computer guys let others sell the follow-up memory, why the car guys let others sell the insurance and the extended warranty, and so on.
▪ “There’s a fundamental flaw in their business design--call it incomplete scope. It opens up a huge profit opportunity and customer relationship opportunity for others.” “What should they be doing instead?” Zhao asked. “They should be expanding their scope to include a full-court press on the after-sale stuff. They should also be customizing the after-sale stuff to the original sale product, so that the customer has a compelling reason to buy the after-sale items and services from them.” Zhao gave Steve a little thumbs-up gesture. “That’s it.” Steve continued, “They should be working hard to convert the After-Sale Profit model into an Installed Base Profit model.” “And meanwhile?” “Meanwhile, there are huge profit opportunities out there for the rest of us.” “How can that be?” Steve paused again. “Psychology?” he ventured.
“Say more.” “All the sex and prestige in the business is associated with getting the most market share, selling the most units of the big-ticket stuff.” “And . . .?”
▪ It’s a completely different business model!” he exclaimed. “You need different skills, different people, different systems, different databases. There’s also less psychic satisfaction, less glamor, and less visibility compared to the glamor of the original equipment business. As in ‘I sold ten auto insurance policies today.’ Big deal! Or ‘I sold ten elevator maintenance contracts today.’ Big deal! You don’t get great press notices or win trips to Hawaii for that.
19. New Product Profit
▪ People always confuse it with Time Profit or with Specialty Product Profit. Here’s the icon.” Zhao drew three strokes: a vertical, a horizontal, and an “S”.
▪ The profit explosion happens at the bottom, during the gold rush days,” Zhao explained. “Margins are fat and volume is skyrocketing. Multiply these two and you get a growing ocean of profitability. It’s the opposite of a no-profit zone--a super-profit zone. “New Product Profit is all about psychology. People get so caught up in the new product gold rush that they refuse to think forward three years, refuse to think clearly about what will happen on the other side of the parabola.”
▪ The Profit Parabola
▪ The total profit earned by all players in a market goes up, peaks, and comes down to zero.
▪ On the left side of the parabola he wrote, “Gold Rush.” On the top he printed, “Pike’s Peak.” On the right side, where the parabola’s down slope met the horizontal axis, he printed, “No Profit Zone.”
▪ The big problem,” Steve said thoughtfully, “is on the lefthand side, the up slope, the gold rush. Once you’re swept into that psychology, into the zone where even weak producers make money because customer demand is so strong, you can’t think clearly enough about how to manage strategically. Besides, everyone in the company is so busy making product that there’s zero time left over to see and manage the larger picture.”
▪ Once you admitted that to yourself, you could get down to business and manage the parabola strategically, which meant two simple rules.
- Overinvest, by a factor of three, on the lefthand side ofthe parabola, and underinvest, again by a factor of three, on therighthand side.
- “On the lefthand side, above all else, fight for mindshare. Be seen asthe leader in the new category in the mind of the customer. Merchandiseyour product mercilessly. Be everywhere. Build plants and do subcontracting deals as fast as you can. “And start measuring things that will give you clues that you’re approaching Pike’s Peak. Year-to-year and quarter-to-quarter growth Year-to-year and quarter-to-quarter price changes. Indices of customer excitement and customer boredom.” “And the objective of that is . . . ?” “The objective is to reverse the investment ratio about a year before hitting the peak. Not getting out of the market, mind you, just managing the business to maximize cash flow and to minimize the risk profile on the other side of the parabola. “George would start building flexible plants, rather than dedicated ones, for late-stage capacity. He looked hard for opportunities to sell dedicated plants to the inevitable latecomers who still wanted to get into the game. By selling plants, he felt that he was acting like a model corporate citizen, preventing an unnecessary capacity addition, delaying by nine months to a year the inevitable capacity overshoot point in the cycle and helping to keep prices firmer than they otherwise would have been. “Most important, George wanted to be in a great position on the day things started getting ugly. He could pull back on advertising, because everyone knew his product from his early grab-mindshare merchandising efforts. He could have less capacity than he really needed. He could serve the good customers--there always are some--and drop the bad customers. Most important, he’d be right there looking for the next wave, because he always wanted to be first and to be big on that one.”
- Fast arithmetic technique (Mt. Fuji)Re-read technique (Walton)
- Folder technique (Brands)
- Take-off-the-paradigm-filter technique (Paradigms)
- Front-end loading technique (Young)
- Re-read with questions and intent technique (Walton, Schultz)
20 Relative Market Share Profit
▪ Most important, RMS was prescriptive. It told you what you should do. Invest to win. Build a bigger lead. If you tried and failed, then cut your losses, or get out completely. “It was discovered in the 1960s and fully formulated in the early ‘70s. It reached its zenith in practice in the early 1980s with Jack Welch was its most aggressive, most persistent, most unsparing, and most thoughtful practitioner. “Bruce Henderson is the under-recognized innovator in the discipline--the Isaac Newton of strategy. But he wandered off into biology and Darwinism instead of completing what he started. That’s why he was eclipsed by Michael Porter. Porter filled in the rest of the picture and gave managers methods they could use. “But the whole intellectual underpinning of the thought system was Relative Market Share. Like gravity, it explained, it worked, you could measure it. You could make predictions based on it. No wonder it became the basis of classical strategy.”
▪ Why did RMS work?”
▪ What was the most important reason it worked?”
- “Economies of scale in manufacturing. The biggest factor in understanding cost in the classic period.”
- “Well, related to it, but different, was purchasing advantage. Thebiggest player could pay the lowest price.” “It varied from maybe thirty percent to as high as seventy percent. So it was a very big deal.”
- “The biggest player also had the advantage in marketing and They could afford to invest the most, and they had thelowest unit cost--that is, the lowest marketing cost or advertising cost per unit. A sort of economy of scale in marketing, not just in manufacturing.”
- The biggest player alsocould have the lowest overhead cost per unit and the lowest R&D costper unit, because they could spread these costs over greater volumes than any other competitor
▪ Okay. Back to the classic age. You talked about scale economies in manufacturing, purchasing clout, lower per-unit manufacturing costs, lower per-unit costs for overhead and R&D. And you talked about being a magnet for the best talent in R&D and in manufacturing. Anything else?”
- They also had thebiggest cash flow, so they could outspend rivals with ease and beat themin those arenas where being resource-rich mattered.”
- In the 1970s, GM’s profit volatility was lowest, Ford’swas moderate, and Chrysler’s was enormous. In bad years, GM made asmall profit, Ford broke even, and Chrysler lost a ton of money. “The leader had the least volatility!” “Right. And if risk is about more than just profit volatility--?” “The leader had the lowest risk by far. It could plan the market. It controlled the initiative. The others reacted. It was a great position to play from.”
▪ it is like Newton.” Steve was dredging up faint memories from a college science class. “The classic laws of physics still work, but they don’t work everywhere equally. At the frontiers, there are different types of forces and different rules and equations at work
▪ You see, Newton’s rule was simple--not that it didn’t take a genius to discover it. Gravity’s force was a function of mass over the distance squared. The classic rule of profit was equally simple. Profit was a function of RMS. The higher the RMS, the higher the profit. Today, profit can be a function of many things: time, location, offering, even local RMS.
“More than models and equations, profitability is a way of thinking. Physics tells us about physical energy. Profitability tells us about financial energy. No profit means no energy, no ability to play in the future, no ability to build the future. “Profitability is thinking differently, always asking: ‘How does the high profit happen?
▪ Ohno at Toyota always said, ‘Ask “Why?” five times. By the fifth time, you’ll start getting close to the real answer.’ “Profitability is the same. You have to ask ‘How does it happen?’ five times. By the fifth time, you’ll start getting close to the answer
21 Experience Curve Profit
▪ Direct labor costs are coming down a perfect seventy-five percent slope,” Steve began. “Meaning?” “With every doubling of cumulative manufacturing experience, costs are twenty-five percent lower.” Zhao watched and listened. “Raw material costs are not as good, but close. They’re coming down an eighty-five percent slope. It’s more or less the same for energy.” “Meaning?” “Costs fall fifteen percent with every doubling of cumulative experience.” “A well-run plant,” Zhao commented. “Yes, I would say so. Except . . Overhead costs are rising up a 140 percent slope.” “Meaning?” “With every doubling of cumulative experience, overhead costs are going up forty percent.” - With every doubling of experience, overhead costs are forty percent higher--completely out of control.”
Book: Value Migration
22 Low-Cost Business Design Profit
▪ focus is usually a great thing. Except that it probably wipes out your peripheral vision completely. It’s like wiping out your immune system.”
▪ focus plus peripheral vision equals one hundred percent. The more you have of one, the less you have of the other.
▪ So the experience curve danger is . . . ?” “It’s like having the microscope on maximum power. You lose your peripheral vision completely.”
“And what happens at the edge of the radar screen?” “Two things can happen, actually.
- The more traumatic one is whensomeone makes you irrelevant. Aluminum replaces steel in making beerand beverage cans. Plastic replaces aluminum when soda cans give way to bottles. And so on. The list is endless
- The other, less traumatic instance, the one that leads to a slow andpainful demise, is the invention of a completely new model that deliversthe same thing at a twenty or thirty percent lower cost. Examples? Southwest Air. Dell. Formosa Plastics. The incumbents are working meticulously and religiously to take cost out of the box, out of the current system, and someone comes along operating from outside the box and introduces the next system.”
“Not bad. Any other examples?” “Sure. Wal-Mart. Geico. Home Depot.”
Zhao was satisfied. “Your conclusions?”
“You might need two organizations.”
“Again?” Zhao chided. “That was your answer for After-Sale Profit.”
“I stand by my story. You might need two organizations. The experience-curve demons and the blank-sheet-of-paper gang. Think of it as maximizing your current hand while simultaneously buying a big insurance policy on the future.”
▪ about how the rules of success change. About how you have to change your business design every five years
▪ But what?”
“Well, I see a puzzle here. A business design used to have a pretty long life--ten years, twenty years, even thirty years of economic life.” Zhao nodded. “That’s right.”
“Today, it’s more likely to have a five- or six-year life.” “Yes.”
“And there’s so much friction inside organizations that it takes at least two or three years to change designs.”
▪ The equation doesn’t work!” Unless they could see it coming. Unless they could anticipate the change and start preparing for it. Unless they could give themselves a two-year runway to get the new business design off the ground. Unless they could start sooner rather than moving faster.” “Or do both
▪ You don’t skate to where the puck is - you skate to where the puck will be.
23 Digital Profit
▪ The book should have spent more time on the conventional ones, like deregulation, consolidation, fragmentation. They happen so often
▪ There’s the manic-depressive cycle for an organization--ten years up, ten years down. And recession, and the irrational expansion that precedes it.”
“Tell me more,” Zhao encouraged him. “Well, the memory of recession decays over time. And it decays fastest in Year 4 and Year 5 of the boom--when you need it most.”
▪ what’s the Digital Profit model?” Steve paused. “I don’t know whether there is such a thing,” he finally answered. “But I do know that shifting from conventional to digital has a huge impact on profitability. Huge and mysterious.” “Well, it works along so many different dimensions.
- First of all, goingdigital enables a business to create tenfold improvements in productivity. Tenfold!”“I couldn’t believe it,” Steve affirmed. “But here are some examples. Dell’s inventory turns went from six a year to sixty. Cemex’s response time on customer orders went from 180 minutes to twenty minutes. Oracle’s customer interaction cost went from $350 to twenty bucks. “But 10X productivity isn’t all of it--not by a mile. Digital allows you to literally reverse your business processes, from push to pull and from guess to know.”
- becoming digital lets a company’scustomers design the product or service they really want to buy. Think really Dell’s online configurator, or Herman Miller’s z-axis design system, or Mattel’s My Barbie. The seller creates a dynamic electronic menu, a “Choiceboard,” that lets customers design their own products, picking the exact mix of features they want
▪ It turns out that customers want to do a lot more than design their own products. Give them half a chance and they’ll shift their behavior from passive to active mode. They’ll look up product info, prices, order status, and the answers to technical service questions. They’ll schedule their own maintenance, download software, and so on. In fact, there are more than twenty different tasks like this that suppliers used to do that a digital business enables customers to do for themselves. Then a surprising thing happened. Steve started asking the questions. “The key issue is this: What is the relationship between profitability and information
▪ On a micro level or a macro level?
▪ at the macro level it’s huge for the simple reason that profitability is often a function of bad information
▪ But the question is, how much of profitability is a function of bad information?” Zhao paused, milking the moment for effect. He leaned closer to Steve and whispered conspiratorially, “Most of it
▪ the profit models that are similar to each other, but not quite the same.”
- Installed base, de facto standard, after-sale
- Time profit, new product profit, specialty product
- Relative market share, local leadership
- Blockbuster, transaction scale
- Multi-component, profit multiplier
- Experience curve, specialization