Profit Pools and Core
Competence
Darral G Clarke
Professor of Management
The Marriott School
Brigham Young University
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Profit Pools: A Fresh Look at
Strategy
Orit Gadiesh and James L.
Gilbert
Harvard Business Review
May-June 1998
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THE PC INDUSTRY’S PROFIT POOL
Value chain focus
Axes
Vertical—operating margin
Horizontal—share of industry data
40%
30
20
10
0
0 100%
share of industry revenue
microprocessors
other components personal computers
software
peripherals
services
The 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.
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The Profit Pool Lens
The profit pool is the total profit earned in an
industry at all points along the industry’s value
chain
Segment profitability may vary by customer group,
product category, geographic market, or distribution
channel
Profit concentration may be very different than
revenue concentration
Shape of the profit pool reflects the competitive
dynamics of a business
• Interactions of companies and customers
• Competitive strategies of competitors
Product pools are not stagnant
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THE . AUTO INDUSTRY’S PROFIT POOL
100%
o
p
e
ra
ti
n
g
m
a
rg
in
source: Harvard Business Review, May-June 1998
auto rental
25%
15
10
5
0
0
share of industry revenue
auto manufacturing
new car dealers used car dealers
auto loans
auto insurance
aftermarket parts
20
leasing
warranty
gasoline
service repair
The 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.
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Profit Pools: Company
Examples
Companies
Automakers
U-Haul
Elevators
(OTIS)
Harley
Davidson
Polaroid
Core Business
Auto manufacturing
Truck Rental
Elevator Manufacturing
Motorcycles
Instant Photography
Cameras
Sources of Highest ROI
Auto leasing, insurance
Packing materials, storage
Service
Accessories (consumer
products), leasing, service,
restaurants
Film
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Managerial Implications
Focus on growth and market share can lead a company to
focus on unprofitable segments of an industry
Today’s deep revenue revenue pool may be tomorrow’s dry
hole.
The goal should be to focus on profitable opportunities
Industry should be considered more broadly than
traditional definition
Automobile industry includes
• Component manufacture and supply
• New car assembly and delivery
• New car warrantee and service
• New car financing and insurance
• Used car sales and service
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Turbulent industries
Profit pools are especially important and
useful in industries undergoing
deregulation and/or technological change
Such changes can open new profit pool
opportunities and drain old ones
Choke points may change or be eliminated
Opportunities for either forward or
vertical integration may emerge
Current vertical integration may be
disintermediated
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Creating and managing a
profit pool
Profit pool analysis may indicate new
opportunities or threats
Imperatives
Be open to a new perspective on your business and
industry
Developing new strategy may require overturning
elements of the current strategy
Be open to reevaluate the role played by current
competitors
Be vigilant to identify possibility that new entrants may
seek to enter your industry with radical strategies
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Looking Ahead: Profit Pools
and the Five Forces
Profit pools are computed by multiplying the size
of the revenue by the unit profit margin
Essentially an accounting process-- no theory
Most valuable in situations in which external conditions
are essential stable and/or unimportant
(Often dominated by internal data alone)
The five forces tells us (which will study next)
the underlying determinants that determine both the
revenue size and the unit profit margin
The profit drivers which allow us to forecast the
direction of change
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Marakon Runners
Thomas A. Stewart
Fortune
Sept. 28, 1998
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Marakon Associates’s Approach to
Corporate Strategy
Consultants to many large corporations
Coca Cola, HP, GM, CitiCorp, etc.
Clients have returns % higher than
industry peer group
Goal is to increase shareholder value
through analysis of economic profit
Deep drilling in business data to measure
value creation
• Product segments
• Customer segments
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How Strategy Happens
Learning where value is created
Waterfall charts by product and customer
segments
Evaluating strategy
Industry average profit per unit
Company’s profit vs industry average
Managing value
Current strategy
Change product focus
Change customer focus
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Learning where value is created
Product segments Customer segments
P
ro
fi
t/
lo
ss
(
$
p
e
r
u
n
it
)
Volume (units) Volume (units)
0
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Evaluating Strategy
Company profit per unit
In
d
u
st
ry
-a
v
e
ra
g
e
p
ro
fi
t
p
e
r
u
n
it
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Managing for value
Current
strategy
Change
product
focus
Change
Customer
focus
V
a
lu
e
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Application to our cases
Retail industry (Wal*Mart)
Soft drink industry (Coca-Cola and
PepsiCo)
Steel (Nucor) and aluminum cans (CC&S)
Hi tech (Intel, Cisco, and Dell)
Video games (Nintendo)
Web businesses (eBay and Yahoo!)
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The Core Competence of the
Corporation
Prahalad, C. K. and Gary
Hamel
Harvard Business Review,
May-June 1990
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Core Competence
A Firm is made up of resources
people, patents, brand names, plant
&equipment, processes, etc
A competence is the ability to employ
diverse skills and resources to perform
tasks and activities.
A core competence is a broadly based
and/or a broadly applied fundamental
capability.
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Competence and Technology
Competence is not the same as
technology
Competence requires
technologies
social organization
collective learning
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Core competence questions:
What are we really good at?
How can we build upon it?
What do we need to be good at?
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Characteristics of Effective
Competencies
Durability: Technical equipment can be short
lived. Reputation or knowledge may depreciate
more slowly.
Transparency: The more complex the source of
competence, the harder it is to imitate it.
Transferability: The availability of resources to
competitors.
Replicability: A competitor’s internal ability to
replicate a competence using available
resources.
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Choosing Competencies
How central is this competence to our
success in the market?
How long could we preserve our
competitiveness in this business without
this particular competence?
What future opportunities would be
foreclosed if we were to lose this
particular competence?
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Core Competence and Core
Products
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A Hierarchy of Competencies
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Building Strategy from
Capabilities
Strategy
Capabilities
Resources1. Identify resources, appraiserelative strengths and weaknesses.
Leverage use of resources
2. Identify capabilities. What do we do
more effectively than competitors?
Identify resource inputs to capabilities.
3. Appraise rent-generating potential
resources and capabilities in terms of:
sustainable advantage, inappropriability
4. Select strategy that best exploits the
firm’s resources and capabilities rela-
tive to external opportunities.
5. Identify resource
gaps that need to be
filled.
Invest in replenishing,
augmenting, and up-
grading the firm’s
resource base.
Competitive
Advantage
Source: Robert M. Grant, “The Resource-
Based Theory of Competitive Advantage,”
California Management Review, Spring,
1991, page 151.
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How to map your industry’s
profit pool
Orit Gadiesh and James L. Gilbert
Harvard Business Review
May-June 1998
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A straight forward exercise
with complications
Concept is straight forward
Define value chain activities
Determine their size and profitability
Application of concept is complicated
Financial data doesn’t correspond to value chain
activities
Company data is aggregated across businesses
Products, customer purchases, channel volumes rarely
match up with boundaries of an activity
Considerable creativity is required
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Four step process
Define the pool
Determine the size of the pool
Determine the distribution of profits
Reconcile the estimates
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Four step process
Define the pool Determine the
size of the pool
Determine profit
distribution
Reconcile the
estimates
Task: determine which
value-chain activity
influence profits now
and in the future
Develop a baseline
estimate of cumulative
profits generated by all
profit pool activities
Develop estimate of the
profits generated by
each activity
Compare the outputs of
steps 2 & 3
Guidelines
Take a broad view of the
value chain(beyond
traditional industry
definition)
Seek a rough but
accurate estimate
Shift between
aggregation and
disaggregation in your
analysis
If numbers don’t add
up,Check assumption
and calculations
Examine industry from
three perspective: own,
other players, customers
Take easiest route: go
where the data are
Do own economics first,
then large pure players,
large mixed, smaller
Collect additional data
Don’t disaggregate more
than necessary
Take at least two
viewpoints: company
level and product level
Use proxy measures
where necessary
Resolve inconsistencies—
don’t ignore them
Output
Profit pool list
Estimate of total pool
profits, (range)
Point estimate of profits
for each value chain
activity
Final estimates of
activity and total pool
profits
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What is “profit” anyway?
Can be thought of in three ways (all of
which may be relevant for profit pool
analysis)
Accounting profit
Return on investment
• Economic value added= after-tax operating profits –
cost of all invested capital
Cash-flow
• Earnings before taking fixed-asset and capital costs
into account
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Example: Credit cards at
RegionBank
Acquisition Funding Servicing
$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
$ annual acquisition profit
per subscriber amortized over 5
year average life
X260 million subscribers X260 X260
$800 million profit $ billion profit $ billion profit
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RegionBank’s Profit Pool Map
100%acquisition funding servicing
Share of industry revenue
20%
O
p
e
ra
ti
n
g
m
a
rg
in
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RegionBank’s Profit Pool Mosaic
Banks
Share of industry profits
acquisition funding servicing
S
h
a
re
o
f
a
ct
iv
it
y
p
ro
fi
ts
100%
100%
Banks
Banks
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