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Profit Pools and Core CompetenceDarral G ClarkeProfessor of ManagementThe Marriott SchoolBrigham Young University6/15/20241Darral G.Clarke for BM 499Profit Pools and Core CompetenProfit Pools:A Fresh Look at StrategyOrit Gadiesh and James L.GilbertHarvard Business ReviewMay-June 19986/15/20242Darral G.Clarke for BM 499Profit Pools:A Fresh Look at THE PC INDUSTRYS PROFIT POOLnValue chain focusnAxesnVerticaloperating marginnHorizontalshare of industry data40%30201000100%share of industry revenuemicroprocessorsother componentspersonal computerssoftwareperipheralsservicesThe value chain for the PC industry includes six key activities;the profitability of the activities varies widely.Manufacturers compete in the largest but least-profitable segment of the chain.6/15/20243Darral G.Clarke for BM 499THE PC INDUSTRYS PROFIT POOLVThe Profit Pool LensnThe profit pool is the total profit earned in an industry at all points along the industrys value chainnSegment profitability may vary by customer group,product category,geographic market,or distribution channelnProfit concentration may be very different than revenue concentrationnShape of the profit pool reflects the competitive dynamics of a businessInteractions of companies and customersCompetitive strategies of competitorsnProduct pools are not stagnant6/15/20244Darral G.Clarke for BM 499The Profit Pool LensThe profitTHE U.S.AUTO INDUSTRYS PROFIT POOL100%operating marginsource:Harvard Business Review,May-June 1998auto rental25%1510500share of industry revenueauto manufacturingnew car dealersused car dealersauto loansauto insuranceaftermarket parts20leasingwarrantygasolineservice repairThe automotive industry encompasses many value-chain activities.The way that profits and revenues are distributed among these activities varies greatly.The most profitable areas of the car business are not the ones that generate the biggest revenues.6/15/20245Darral G.Clarke for BM 499THE U.S.AUTO INDUSTRYS PROFIProfit Pools:Company ExamplesCompaniesAutomakersU-HaulElevators(OTIS)Harley DavidsonPolaroidCore BusinessAuto manufacturingTruck RentalElevator ManufacturingMotorcyclesInstant Photography CamerasSources of Highest ROIAuto leasing,insurancePacking materials,storageServiceAccessories(consumer products),leasing,service,restaurantsFilm6/15/20246Darral G.Clarke for BM 499Profit Pools:Company ExampleManagerial ImplicationsnFocus on growth and market share can lead a company to focus on unprofitable segments of an industrynTodays deep revenue revenue pool may be tomorrows dry hole.nThe goal should be to focus on profitable opportunitiesnIndustry should be considered more broadly than traditional definitionnAutomobile industry includesComponent manufacture and supplyNew car assembly and deliveryNew car warrantee and serviceNew car financing and insuranceUsed car sales and service6/15/20247Darral G.Clarke for BM 499Managerial ImplicationsFocus oTurbulent industriesnProfit pools are especially important and useful in industries undergoing deregulation and/or technological changenSuch changes can open new profit pool opportunities and drain old onesnChoke points may change or be eliminatednOpportunities for either forward or vertical integration may emergenCurrent vertical integration may be disintermediated6/15/20248Darral G.Clarke for BM 499Turbulent industriesProfit pooCreating and managing a profit poolnProfit pool analysis may indicate new opportunities or threatsnImperativesnBe open to a new perspective on your business and industrynDeveloping new strategy may require overturning elements of the current strategynBe open to reevaluate the role played by current competitorsnBe vigilant to identify possibility that new entrants may seek to enter your industry with radical strategies 6/15/20249Darral G.Clarke for BM 499Creating and managing a profitLooking Ahead:Profit Pools and the Five ForcesnProfit pools are computed by multiplying the size of the revenue by the unit profit marginnEssentially an accounting process-no theorynMost valuable in situations in which external conditions are essential stable and/or unimportantn(Often dominated by internal data alone)nThe five forces tells us(which will study next)nthe underlying determinants that determine both the revenue size and the unit profit marginnThe profit drivers which allow us to forecast the direction of change6/15/202410Darral G.Clarke for BM 499Looking Ahead:Profit Pools anMarakon RunnersThomas A.StewartFortuneSept.28,19986/15/202411Darral G.Clarke for BM 499Marakon RunnersThomas A.StewaMarakon Associatess Approach to Corporate StrategynConsultants to many large corporationsnCoca Cola,HP,GM,CitiCorp,etc.nClients have returns 3.1%higher than industry peer groupnGoal is to increase shareholder value through analysis of economic profitnDeep drilling in business data to measure value creationProduct segmentsCustomer segments6/15/202412Darral G.Clarke for BM 499Marakon Associatess Approach How Strategy HappensnLearning where value is creatednWaterfall charts by product and customer segmentsnEvaluating strategynIndustry average profit per unitnCompanys profit vs industry averagenManaging valuenCurrent strategynChange product focusnChange customer focus6/15/202413Darral G.Clarke for BM 499How Strategy HappensLearning wLearning where value is createdProduct segmentsCustomer segmentsProfit/loss($per unit)Volume(units)Volume(units)06/15/202414Darral G.Clarke for BM 499Learning where value is createEvaluating StrategyCompany profit per unitIndustry-average profit per unit6/15/202415Darral G.Clarke for BM 499Evaluating StrategyCompany proManaging for valueCurrentstrategyChangeproductfocusChange CustomerfocusValue6/15/202416Darral G.Clarke for BM 499Managing for valueCurrentChangApplication to our casesnRetail industry(Wal*Mart)nSoft drink industry(Coca-Cola and PepsiCo)nSteel(Nucor)and aluminum cans(CC&S)nHi tech(Intel,Cisco,and Dell)nVideo games(Nintendo)nWeb businesses(eBay and Yahoo!)6/15/202417Darral G.Clarke for BM 499Application to our casesRetailThe Core Competence of the CorporationPrahalad,C.K.and Gary HamelHarvard Business Review,May-June 19906/15/202418Darral G.Clarke for BM 499The Core Competence of the CorCore CompetencenA Firm is made up of resourcesnpeople,patents,brand names,plant&equipment,processes,etcnA competence is the ability to employ diverse skills and resources to perform tasks and activities.nA core competence is a broadly based and/or a broadly applied fundamental capability.6/15/202419Darral G.Clarke for BM 499Core CompetenceA Firm is made Competence and TechnologynCompetence is not the same as technologynCompetence requiresntechnologiesnsocial organizationncollective learning6/15/202420Darral G.Clarke for BM 499Competence and TechnologyCompeCore competence questions:nWhat are we really good at?nHow can we build upon it?nWhat do we need to be good at?6/15/202421Darral G.Clarke for BM 499Core competence questions:WhatCharacteristics of Effective CompetenciesnDurability:Technical equipment can be short lived.Reputation or knowledge may depreciate more slowly.nTransparency:The more complex the source of competence,the harder it is to imitate it.nTransferability:The availability of resources to competitors.nReplicability:A competitors internal ability to replicate a competence using available resources.6/15/202422Darral G.Clarke for BM 499Characteristics of Effective CChoosing CompetenciesnHow central is this competence to our success in the market?nHow long could we preserve our competitiveness in this business without this particular competence?nWhat future opportunities would be foreclosed if we were to lose this particular competence?6/15/202423Darral G.Clarke for BM 499Choosing CompetenciesHow centrCore Competence and Core Products6/15/202424Darral G.Clarke for BM 499Core Competence and Core ProduA Hierarchy of Competencies6/15/202425Darral G.Clarke for BM 499A Hierarchy of Competencies8/9Building Strategy from CapabilitiesStrategyCapabilitiesResources1.Identify resources,appraiserelative strengths and weaknesses.Leverage use of resources2.Identify capabilities.What do we domore effectively than competitors?Identify resource inputs to capabilities.3.Appraise rent-generating potential resources and capabilities in terms of:sustainable advantage,inappropriability4.Select strategy that best exploits the firms resources and capabilities rela-tive to external opportunities.5.Identify resourcegaps that need to befilled.Invest in replenishing,augmenting,and up-grading the firmsresource base.CompetitiveAdvantageSource:Robert M.Grant,“The Resource-Based Theory of Competitive Advantage,”California Management Review,Spring,1991,page 151.6/15/202426Darral G.Clarke for BM 499Building Strategy from CapabilHow to map your industrys profit poolOrit Gadiesh and James L.GilbertHarvard Business ReviewMay-June 19986/15/202427Darral G.Clarke for BM 499How to map your industrys proA straight forward exercise with complicationsnConcept is straight forwardnDefine value chain activitiesnDetermine their size and profitabilitynApplication of concept is complicatednFinancial data doesnt correspond to value chain activitiesnCompany data is aggregated across businessesnProducts,customer purchases,channel volumes rarely match up with boundaries of an activitynConsiderable creativity is required6/15/202428Darral G.Clarke for BM 499A straight forward exercise wiFour step processnDefine the poolnDetermine the size of the poolnDetermine the distribution of profitsnReconcile the estimates6/15/202429Darral G.Clarke for BM 499Four step processDefine the poFour step processDefine the poolDetermine the size of the poolDetermine profit distributionReconcile the estimatesTask:determine which value-chain activity influence profits now and in the futureDevelop a baseline estimate of cumulative profits generated by all profit pool activitiesDevelop estimate of the profits generated by each activityCompare the outputs of steps 2&3GuidelinesTake a broad view of the value chain(beyond traditional industry definition)Seek a rough but accurate estimateShift between aggregation and disaggregation in your analysisIf numbers dont add up,Check assumption and calculationsExamine industry from three perspective:own,other players,customersTake easiest route:go where the data areDo own economics first,then large pure players,large mixed,smallerCollect additional dataDont disaggregate more than necessaryTake at least two viewpoints:company level and product levelUse proxy measures where necessaryResolve inconsistenciesdont ignore themOutputProfit pool listEstimate of total pool profits,(range)Point estimate of profits for each value chain activityFinal estimates of activity and total pool profits6/15/202430Darral G.Clarke for BM 499Four step processDefine the poWhat is“profit”anyway?nCan be thought of in three ways(all of which may be relevant for profit pool analysis)nAccounting profitnReturn on investmentEconomic value added=after-tax operating profits cost of all invested capitalnCash-flowEarnings before taking fixed-asset and capital costs into account6/15/202431Darral G.Clarke for BM 499What is“profit”anyway?Can beExample:Credit cards at RegionBankAcquisitionFundingServicing$80 value of a subscriber$279 average annual revenues per subscriber$60 annual payment to servicer per subscriber-$64 cost of acquiring a subscriber-$235 average annual costs per subscriber$50 average annual cost to servicer$16 acquisition profit per subscriber$44 annual funding profit per subscriber$10 annual servicing profit per subscriber$3.20 annual acquisition profit per subscriber amortized over 5 year average lifeX260 million subscribersX260X260$800 million profit$11.4 billion profit$2.6 billion profit6/15/202432Darral G.Clarke for BM 499Example:Credit cards at RegioRegionBanks Profit Pool Map100%acquisition funding servicingShare of industry revenue20%Operating margin6/15/202433Darral G.Clarke for BM 499RegionBanks Profit Pool Map10RegionBanks Profit Pool MosaicBanksShare of industry profitsacquisition funding servicingShare of activity profits100%100%BanksBanks6/15/202434Darral G.Clarke for BM 499RegionBanks Profit Pool Mosai
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