Do You Know Where The Real Profit Pools Are?
By V Rory Jones,
a management consultant,
San Francisco, California, U.S.A.
http://www.biassociates.com
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Your guide to exploiting Profit Pools and delivering
superior shareholder value
Ever had that feeling you've got a great business, but that its' not delivering
the results it really deserves? More likely than not, you do have a great
business - it is simply that its strengths are not being directed towards
the right opportunities, or that those opportunities are not being well
exploited.
This discussion outlines a new approach to market strategy - an orientation
around 'cash-based' Profit Pools. In it, we outline what the right opportunities
are, how to find them, and how to exploit them. In summary, we see that:
1) Most businesses have a poor understanding of the nature of existing
and prospect Profit Pools
a. GAAP distorts the profit picture: With large non-cash and tax adjustments,
working capital changes, allocations etc.
b. The right information is simply not available: No profit views by customer,
channel, offering, or geography; grossly insufficient granularity, poorly
allocated expenses and very limited competitor and partner information
c. The right skills are not at right place: Separated skills in Finance
and Marketing; Profit Pool strategies need a blend
d. Management is not explicitly focusing on Profit Pools
2) A Profit Pool driven market strategy has a dramatic impact to a business'
intrinsic value
No other aspect of business strategy has a greater impact on business
value than market strategy, and no other approach to market strategy boosts
Economic Profit over time (business value) than one oriented around Profit
Pools?
The path forward starts first with getting a Profit Pool view of the existing
business, and then to getting that view for new markets and crafting an
attack centered on market cash profit potential1.
1. What are Profit Pools?
A Profit Pool is a part of a market that offers some sort of economic
return to participant players. A good Profit Pool offers a large amount
of cash-based profit (we'll discuss the focus on cash later) over a certain
amount of time into the future. A less attractive Profit Pool simply offers
a smaller profit opportunity, while an unattractive Profit Pool offers
net losses to its participants.
Simple enough in concept, though quite elusive to properly characterize
and exploit.
The non-production printer market provides a simple illustration of a
Profit Pool view. The offering comprises three parts; the printer machine
(two types; ink and laser), supplies, and some level of service. In addition,
customers are relatively distinguishable; in terms of size (Fortune 500,
mid-size and SOHO), and in terms of industry.
Well, the most attractive market Profit Pool is the SOHO customer, in
certain professional and retailing sectors, that buys ink printers. Interestingly,
it is not that SOHO customers have the greatest demand for ink printers,
because they don't.
They are the most attractive Profit Pool because their lifetime profit
contribution is the greatest of all other market Profit Pools. It turns
out that SOHO customers do not have the purchasing departments that can
efficiently analyze the per-page costs of ink, and use competitive bidding
to achieve a more reasonable price. In addition to paying a far higher
price, many types of SOHO customer (professional and retailers in particular)
have a very high per-machine page throughput. Over time, the profit from
a SOHO ink customer in these areas far outstrips others.
Conversely, a relatively unattractive Profit Pool is well illustrated
by Fortune 500 laser printer customers. The laser printer's price point
may be higher (largely driven by its production cost), and the volume
of printers sold may be higher also, but the supplies prices have been
negotiated down significantly by sophisticated buyers, and the per-machine
throughputs are relatively low.
If you were investing in this market, where would you focus your incremental
funds? Why is it that the existing players in the market do not seem to
see which sectors deserve the highest priority for growth investments?
Types of Profit Pool
There are three types of Profit Pool when considering a move in the market.
As in Figure 1, the first and most readily accessible Profit Pool is that
already addressed by the business (marked as "Existing"). Here, Profit
Pools are segments of the market already served by the business.
The second type (marked as "New and Charted") is an increment to the existing
business. Here, the business is looking at taking the existing game ("offering"
or "business model") into a new market/segment ("customer set"); or alternatively,
expanding its servicing of an existing market/segment with a new offering/business
model. Notably, in this type of Profit Pool the move to new markets/segments
or offerings/business models has already been charted by others; competitors
already exist there.
Finally, the third type of Profit Pool (marked as "New and Uncharted")
refers to a move into uncharted areas. Little is known or established
before entering these new areas; either there is low familiarity with
customer needs, or the offering/business model has not been tried before,
or both.
Existing Profit Pools
While it might be reasonably expected that a business is already extracting
all the profit that it can from the market, it turns out that this is
not the case at all. Existing Profit Pools are actually a surprisingly
rich source of improved performance and profitability.
In fact, we have found that most businesses have a very limited knowledge
of their own performance in extracting cash-profits from markets. There
appear to be four factors driving this (see detail in panel over):
1) GAAP distorts the real profit picture
2) The right information is simply not available
not enough granularity, and very limited view by customer,
channel, offering, or geography
poor/inaccurate expense allocations
limited competitor and partner information
3) The right skills are not at the right place
4) Management is not explicitly focusing on Profit Pools
These four forces come together with devastating effect. Were it enough
that the lack of visibility caused businesses to not focus on the good
Profit Pools - that would be one thing - but the reality is that they
also causes the business to serve areas where the Profit Pools are actually
negative!
In our work, we observe this unfortunate situation with boring regularity.
The value-creating effort being expended at one end of the business is
actually being destroyed with cash-based losses - at the same end of the
business, simply by serving the wrong part of the market.
One last note on Existing Profit Pools. The indications of internal cash-profitability
discussed above are a proxy for, though not a substitute for an understanding
of market profitability. A solid understanding of competitor, partner
and customer economics, now and into the future, is essential to properly
see where all the opportunities and trade-offs are, and to predict the
behaviors of other market players and customers. This is explored in Section
3.
New Profit Pools
Naturally, one of the most powerful ways to increase shareholder value,
indeed the entire business' value to all stakeholders, is to grow future
cash-based profitability.
With this in mind, business must also search for growth in high cash-margin
revenues, in addition to improving existing business performance. They
need to be very careful, however, to ensure that they only grow in positive
Profit Pools - the more positive, the better. Growth in Profit Pools where
cash profitability is negative, results in a destruction of business value;
negating all the efforts made in that Profit Pool, but also stealing the
results of efforts in positive Profit Pools. Such 'bad' growth is very
common (and actually the base motivation for this paper).
Now, obtaining an understanding of New Profit Pools is mostly an exercise
of looking externally, at competitors and others.
New Charted Profit Pools
By definition, charted Profit Pools have already been penetrated by participating
players, and as such there is both information out there on their attractiveness
(including current and future economics), and the market has an existing
structure with working commercial models.
The first attribute, that there is existing information, makes it easier
to identify and understand the nature of specific Profit Pools. It also
allows a high level of risk mitigation - since new market entrants (should)
know more on what they are getting to.
New market entrants need to get information and estimate the economics
of existing players and that of un-penetrated parts of the market, now
and into the future. Information needs include; economics of competitor
and channel business models, market unit demand, customer value proposition
and other factors - existing, and future. Only with this can the nature
of those Profit Pools be understood and effectively leveraged in market
strategy formulation.
It is worth adding that this external information is surprising available.
Our experience shows that GAAP statements, pricing information, customer
and channel sources, and public sources (including legal surveillance)
are good enough to build a picture to manage by. Obviously, the information
is not perfect and, of course, not as good as internal information.
We take the view that it is incumbent on management to get this information,
and process it, as it underpins all thoughtful decisions at the strategic
level. To the extent that information is not perfect, it does allow decisions
to be informed - rather than uninformed - and it allows risk to be mitigated.
Knowing specific risk areas, their magnitude, and the development of contingencies
is a primary responsibility of managers - as agents of shareholders.
Further, in our work we continuously encounter situations where the absence
of readily available information, or its proper processing, resulted in
the destruction of vast amounts of shareholder value. This includes poorly
invested cash, ongoing losses, etc.; far in excess of what it would have
taken to develop insights before the investment and there is opportunity
cost; the capital investment could have been made into Profit Pools that
would have delivered solid returns.
The second attribute of Charted Profit Pools, that there is an existing
commercial model in the market, results in less scope for new entrants
to define market structure to their terms and strengths. In addition,
the presence of an existing competitor set will undoubtedly make the market
difficult to break into - and first-mover rewards have already gone.
New Uncharted Profit Pools
Uncharted Profit Pools have only rudimentary market information available
(high-level ethnography and addressable market -type information), and
there is no commercial model in use. This situation is a mirror reflection
of Charted Profit Pools; risk due to the lack of information is high,
while the limited opportunity to define the market, its offering and structure
dramatically increases potential returns; as does the opportunity to be
first mover.
With that said, it is still critical that managers considering a move
into Uncharted Profit Pools gather the same type of information as in
Charted Profit Pools to estimate their nature (including unit demand,
potential customer value proposition, economics of potential business
models, and etc.). Obviously, there is greater uncertainty over this information,
making it much more important to understand the probabilities of outcomes
and develop well considered contingencies and their associated triggers.
Profit Pool Attractiveness and the Business Model
A business model is the formula a business creates and uses to create
value in product (or service) markets, and translate that value into cash
flow to the capital markets (share and debt holders). It comprises the
following (among others):
1) The configuration of internal operations - including manufacturing
structure, the organization, etc.
2) The 'commercial model' - that is the structure of the transaction(s)
with the customer and others, including pricing structure, bundling, etc.
Naturally, one business model is different from another - such that one
player's profitability is also different from another's. This affects
the total profit available in a Profit Pool, which may alter if shares
were different or change.
This issue must be recognized by strategists, and the probabilities and
impacts of differing business models need to be incorporated in future
plans and contingencies (and investment-return assessments). In most situations
the impact is relatively small in comparison with the order of magnitude
differences between Profit Pools.
However, there are instances where business model variances do have a
non-trivial impact - such as Dell's introduction of a new operations configuration
into the PC market; one that effectively gives them several points in
profit margin above all competitors. Right now, the PC's overall Profit
Pool is much more attractive than it would be if one or more other players
copied Dell's model; in that scenario, profits would dip and PCs would
not be as attractive an opportunity. Dell investors appear to be betting
this will not happen.
A second interesting perspective on business models and understanding
Profit Pools lies in a value chain view. Here, strategists need to look
at Profit Pools across the flow by the offering to the end customer. This
is important as they have an opportunity to alter the commercial model
or other factors to cause a re-distribution of the overall Profit Pool
across the value chain.
These and other issues and perspectives add a layer of complexity into
the market strategy equation that allows the savvy manager to gain advantage.
Strength in increasing shareholder value tends to circle back to add to
competitive strength in product markets.
2. Why care about Profit Pools?
In short, no other aspect of business strategy has a greater impact on
business value than market strategy, and no other approach to market strategy
boosts Economic Profit, and thus business value, than one that is oriented
around Profit Pools. It works like this:
We must start with the premise that the intrinsic value of a business
(not its market value; which is subject to volatility arising from macro-economic
and other near-term factors) is the present value of all future cash flow
it is expected to generate (as first set out by Alfred Rappaport in 1981).
This notion is almost universally accepted today; the cash generated by
a business in each year going into the future is discounted to its value
today, and simply summed.
Figure 2 - compiled based on a composite of the economics of many businesses
- illustrates the relative impact of key business economic factors on
cash flow (in this case, Economic Profit; which includes a charge for
the assets in use). As can be clearly seen from the chart, the most powerful
drivers of cash flow are what we call 'top-line' factors - unit sales
and price.
Market strategy governs the performance of these top-line factors more
than any other aspect of business strategy. As shown in Figure 3, market
strategy is a plan (needs to be continuously updated) that states with
great specificity and appropriate detail; what parts of the market will
the business participate in, and, how will it compete in those market
areas?
Such decisions have a direct bearing on the business' ability to both
grow profitably, and to compete. Success at competing has a direct impact
to share, thus unit sales, and price, thus also profitability. In addition,
success with profitable growth will only come if the targeted markets
offer both increased penetration and/or expansion, and the opportunity
for profitable commerce.
Now, a market strategy deliberately focused on deep, positive Profit Pools
provides the maximum potential for a great positive impact to cash flow
over time. Conversely, a lack of focus results in participation a non-trivial
amount of 'shallow' - some even net loss-making - Profit Pools, resulting
in less than optimal overall cash-flow.
It is worth reiterating cautionary comments at this point. Markets with
the largest revenue opportunity do not necessarily offer the best long-term
profit opportunity. In fact, we frequently find the reverse is true; with
many players in the large revenue markets, profitability has declined,
and smaller markets become more attractive.
Take the example of the lubricant market; the profit opportunity in high-volume
combustion engine segments is outstripped by that targeted - but well
branded - WD-40 driven segment. This phenomenon is not unique. Most industries
are replete with examples of defensible segments being pealed off and
exploited. This does not mean that large markets tend to be unattractive
- as many are clearly attractive; it simply makes it incumbent on managers
to seriously consider specialist and similar markets, and how they play
in them.
Caring about 'Existing' Profit Pools
We find most businesses orient investments (capital, market spend and
human resources) around today's revenue performance. Considerable emphasis
in placed on historic revenue performance, though some weight is given
to positioning issues, such as share, top 'x' positioning and the like.
One such example is in Figure 4 (this client example has been disguised;
suffice to say that it represented a range of product and service offerings
to business customers):
The orientation towards investing in large revenue markets (the yellow
bar represents the client's revenues) is clear and obvious. This is a
relatively common approach; almost applying the 80:20 rule; where 20%
of offerings generate 80% of today's revenue - and so (mistakenly) deserve
80% of investments.
However, the alternative view of the business is to look at Existing Profit
Pools from an internal viewpoint. What we found is shown in Figure 5.
The insight revealed in this cash view of invested capital was that 40%
of assets were actually driving losses. In fact, of the five offerings
favored for investment resources, only one represented an attractive Profit
Pool opportunity.
The view in Figure 5 is limited; though it is a first step to fine tuning
the business and delivering superior returns. In particular, the view
is single year (rather than future-oriented), internal-only (i.e. not
looking at the market's Profit Pool opportunity), and is limited since
it looks at the business only by offering; and not addressing the same
information by customer, channel and geography.
With this information, and information on inter-dependencies between the
various offers and markets, management is in a far better position to
make informed decisions on where to invest to grow profitably, and where
to 'manage' businesses to, at a minimum, limit loss.
Caring about New Profit Pools
As mentioned above, one of the most powerful ways to increase shareholder
value, indeed the entire business' value to all stakeholders, is to grow
revenues that have attractive future cash-based margins. Again, care is
needed to avoid the reverse.
As we have seen, GAAP-based profit measures (e.g. Gross and Operating
Profit) are not only inaccurate - they are misleading. They mask offerings,
or customers, or channels that are actually negative in cash-based profitability,
since not all charges are incorporated. They also improperly allocate
M&S, R&D and G&A - distorting the picture of relative attractiveness between
opportunities - and they include many of the accountant's adjustments,
such as non-cash depreciation and other charges.
Managers that are truly focused on maximizing shareholder value, must
look at market opportunities through a clean cash-profit lens, and expend
the needed effort to understand the true nature of market Profit Pools;
this will dramatically mitigate the risk of investments by being better
informed, and by understanding the situation and having contingencies
and triggers for corrective action.
A quick ROI on the effort needed to get a good picture of the nature of
market Profit Pools will almost always show that the effort is easily
paid back, when considering the magnitude of all that is riding on a market
entry.
Finally, in the case of considering new markets/segments that are as yet
uncharted, managers are facing the risk of opportunity cost, in addition
to that of as potential failure. Such an entry is really the creation
of market/segment. If that process is not done right, such as in building
the offer or business model, much of the potential value of that market
could be lost.
3. What to do? How do we exploit Profit Pools?
Profit Pools offer an opportunity to get your cash-generation machine
(your business) humming at an optimal rate. To make it work, however,
the business' leaders must first embrace the focus on intrinsic shareholder
value through cash-flow growth, and commit to the Profit Pool approach
to market strategy.
In terms of practical steps, that means prioritizing parts of the market
with the most attractive Profit Pools (even if they aren't great revenue
sources), and competing with a business model that can extract high and
sustained levels of profit, while capturing share (see Figure 3).
We encourage business leaders to address three sets of issue, as set out
in Figure 6, in their efforts to adopt a Profit Pool driven market strategy:
Understand your own ACTUAL PERFORMANCE
The first step is to get visibility of your own business' profitability.
This means an accurate and granular view of cash-based profits - by offering,
customers, channels and geographies - using existing segmentation schemes.
As discussed above, this means that managers need to cut through GAAP.
This is an important step, besides getting visibility, it re-orients management's
psyche around value-creating measures. To illustrate the importance of
these, Figure 7 shows the impact of using cash-based measures, versus
typical GAAP measures (note that GAAP measures have been corrected here
to eliminate expense allocation inaccuracies, and adjusted to increase
granularity).
Note how the use of Gross or Operating Profit would mislead management
in two critical ways. First, the parts of the business on the right (in
this case we are looking at offerings) are actually unprofitable as a
result of tax, financing and other charges - where as GAAP measures paint
them as positive contributors. The second issue is the prioritization
the GAAP measures would have you work to; many of the offerings on the
right have attractive Gross or Operating Profit profiles, and may actually
be grown by managers - unaware that their growth actually destroys cash
generation and value.
With this profitability picture in hand, the next step is to identify
cross-relationships and inter-dependencies between each area of business.
There is a temptation in business to be simplistic and simply 'lop-off'
those offerings, customers, channels or geographies under the line on
the right side of the chart. This is a very dangerous point in the exercise
as management has only half the picture; both the customer and the business
itself (through bundling, etc.) are typically greatly inter-twined.
So, management needs to understand these inter-relationships well. The
objective of this exercise is not to cut out parts of the market, but
to improve performance. We can do this by identifying loss-making businesses
and finding ways to get them to profitability (or letting them shrink).
We can also do this by directing growth investments to Profit Pools that
are known to deliver positive results.
With that said, actions should not be taken in either area without first
obtaining a strategic view of the various markets.
Get a STRATEGIC VIEW of Markets
A strategic view is one that provides insights to the two issues addressed
in Figure 3; where should the business compete - and, how should it compete
in target areas?
To deliver this, an assessment of the attractiveness of markets areas
(in this case, Profit Pools) is needed, as is an outline of the various
competitive 'plays' or positionings that have been adopted (and un-adopted
but viable).
For existing and charted markets, much of this type of information is
the same, and obtainable in similar ways and from similar sources. In
the case of uncharted markets, additional techniques are needed as, in
many ways, the market is as yet undefined.
For existing and charted markets
An understanding of existing and new markets has to start with segmentation.
Segmentation is a crucial activity, as it is the basis upon which all
targeting and competitive activities will be based. Segmentation is a
very high-value activity. Unfortunately, it is not easy to come up with
a powerful segmentation scheme from the start, and it is an iterative
process.
We find that market analysis should begin with existing or known segmentation
schemes along the four 'dimensions' (offering, customers, channels and
geographies), subsequently finding new and more useful schemes at a later
date. Such other schemes must be crafted with two criteria in mind for
segmentation; to be both measurable and actionable.
For example, we might start an analysis of the beverage market, in the
customer 'dimension,' looking at all the usual suspects - age, ethnicity,
income - and then come to notice that there is another scheme that reflects
highly useful behavioral attributes; such as heavy users tend to be highly
brand loyal. This is a critical insight, and loyalty drives premium prices
and reduces certain competitive-related expenses. We can then find ways
to measure and target heavy users; perhaps fine-tuning traditional measures
(age, ethnicity, income), or identifying new ones (retail outlet type,
etc.).
With our segmentation scheme settled, we have an object on which to develop
a strategic view. We need to understand the various sizes of these segments,
their future sizes, and future profitability. In this respect, the model
outlined in Figure 8 is very useful:
As can be seen, there are a number of elements of understanding (in yellow)
that are needed. We will touch on three key ones here; though it is notable
that many factors are inter-related, and drive each other (Figure 8 is
somewhat simplistic, though it covers the bases):
Expected future demand: In the absence of any substitute solutions for
the customer (a big assumption that needs to be investigated), an understanding
of future demand is critical for estimating market unit sales, and highly
influential for assessing competitive intensity (which tends to get worse
in low-growth markets).
Competitive intensity: In competitively intense markets, pricing tends
to be low, driving down returns and the attractiveness of Profit Pools.
We can forecast competitive intensity through an understanding of factors
such as the barriers to enter and exit a market, the ability to build
a position that can be well defended (such as a strong brand, which customers
appreciate in offerings that need trust - such as banks), or the liquidity
of the market itself (liquid markets are relatively intensively competitive.
Price and offer merits (Customer Value Proposition): Price is often a
function of business economics (for what returns is the business willing
to deliver the offer) and Customer Value Proposition (which, in turn,
entails a solid understanding of customer economics - particularly important
to business customers). Though, competitive intensity plays a role, also.
Out of this analysis comes an assessment of the market's current and potential
revenue, shown in Figure 9:
In this example, there is clearly an opportunity in certain areas to increase
penetration and drive growth. However, we need to map in the insights
we gained on future cash based profitability for the entire market - including
competitors - based on existing offerings and business models. This we
can see for the current year in Figure 10.
In this view we can see what the profit potential is for the year in the
entire market. It is a very insightful picture for managers to have, as
they can see what turf is worth fighting for.
To create this, we have developed an understanding of competitor economics
at a relatively granular level. This is achieved by starting with GAAP
statements, and gathering competitor information from a variety of sources:
1) Customers and channel partners
2) Financial reports
3) Company statements and press release
4) Direct observation (factories, etc)
5) Analyst reports (capital and product markets)
Now, even this is not enough. Markets come and go, and it is critical
to overlay a forecast of profitability. Continuing with this example we
have the present value the total potential profit in each part of the
market (Figure 11):
This perspective captures the growth and disappearance of markets over
time. It accounts for low penetration in certain areas, and uses reasonable
judgment to assess a reasonable amount of growth. It also captures the
relative magnitude of the potential in each market.
A short study of this chart and it becomes clear where management needs
to be investing, and where it needs to be 'managing' poor performance.
Naturally, forecasts are never highly accurate. However, there is an order-of-magnitude
certainty that is usually very high indeed, for purposes of comparing
market opportunities.
There are four principals for forecasting in the formulation of market
strategy:
1) Developing market forecasts allows much better management decisions
than uninformed decision (oddly enough, many managers today rarely think
through issues of future profitability and total potential) 2) Awareness
of uncertainty, and its degree, facilitates improved contingencies and
remedial action (the greater the uncertainty, the more alternative paths
need to be thought through)
3) Order of magnitude is often enough (other factors come to play in selecting
markets to target, such as organizational strengths, etc., and we have
found that order of magnitude assessments are good enough for input to
such decisions)
4) When viewed in hindsight, most market forecasts are highly accurate,
for purposes of strategy and investments (we have found that organizations
have a surprising amount of the core information needed to conduct market
forecasts, and that when completed, the rationale and key 'way-point'
used in the forecast have been enough to stand the test of time)
Figure 12 is an example of a forecast done for an anti-depressant over
15 years ago. In it, basic information was used to create an order of
magnitude forecast of unit sales; such as continued patient penetration,
availability of new technologies, etc..
This and many other forecasts have stood the test of time - certainly
enough for management to weigh alternative investment strategies.
For uncharted markets
Without doubt, uncharted markets are more difficult to address than charted
ones. Similar to the artist's white canvas issue; uncharted markets demand
vision.
With that said, vision is not enough. Business acumen is needed to avoid
getting into a 'Pool' that will never deliver a return to investors, and
to avoid taking a good opportunity and creating a market business model
that will also never deliver a return to investors. The three stepped
approach in Figure 13 is very effective in understanding uncharted opportunities.
The first step is to develop a picture for each of the likely market outcomes.
This starts with collecting baseline ideas from leaders, market specialists
and observers, engineers and others. This is readily synthesized in a
war-gaming exercise, where the market scenarios are worked out together
with potential business models.
Such an exercise is very high-value; war-gaming pits the various interests
against each other together within the limits of realistic frameworks
to map how markets will evolve. Such efforts need to be then be quantified
in the second step to understand the economics of each scenario and business
model.
In this step, the use of ranges and order of magnitude information is
very useful. The target is, as in the efforts in 'existing' and 'charted'
markets, to get down to an outline of what the time-adjusted market 'Profit
Pool' looks like from an order of magnitude perspective.
Interestingly, this technique also uncovers a great deal of other useful
management information, such as what the options are at any one point
in market evolution, what decisions can be postponed, etc..
The last step is essential; without it, the path forward is very high-risk.
The approach forward has been built on a certain number of assumptions
- usually of the sort where customer behavior is assumed based on one
'driver' or other. In the third step, such drivers need to be tested.
Such testing can range from putting various proto-types into the market
under differing business models, to isolating specific customer drivers
and finding creative ways to address their validity.
One thing is for sure, in undefined markets, asking the customer what
they want is useful as input, though they rarely have the vision to directly
tell you what the offering should look like in the end-game - and less
likely to define a business model formula that is optimal for your business.
Define a path that EXPLOITS OPPORTUNITIES
In formulating the path forward, it is useful to consider the alternative
generic market strategies and their typical risk/reward profiles and associated
likelihood for success.
Generic Strategies
The two areas that market strategy addresses, where to compete, and how
to play in those targeted areas, are reflected at a high-level in Figure
14. An existing business has the opportunity to move in one or both directions,
and in doing so it can simply follow others, or it can do something new.
At a general level, there are a limited number of strategy types that
are available. Each is discussed separately:
The Incrementalists: This strategy involves extending the offering to
the business' existing customer set, or altering the business model (changing
the terms of the transaction). By definition, the Incrementalist is a
strategy that moves the business into competition with existing players.
As such it does not offer as great an opportunity to capture the benefits
of a first mover (which include a high probability of a dominating share
position, and a superior pricing level based on a stronger brand or other
position). See Figure 15 for an illustration of the typical share achievements
of new market entrants - based on a composite of performances within several
very different markets.
As a result, the Incrementalists are unlikely to get very good returns,
while risking the chance of investing a great deal to enter the market.
The Risk-Taking Incrementalist has the additional burden of making headway
in markets where there is no existing presence to build off; having to
develop customer relationships from scratch. Having to develop both new
customer sets and new offerings where there is already an existing base
of competitors is very unlikely to result in success - or economic rewards.
The Exploiter / Follower / Stone Stepper: Expanding an existing offering
/ business model into new market areas (the 'Exploiter') does offer the
opportunity for high-returns and low risk IF that offer / business model
is truly powerful. However, expanding an 'also-ran' offering / business
model into new market area (the 'Follower') will only deliver the relatively
low sort of returns that can be expected in the Incrementalist strategy.
The ('Stone Stepper') enters a new market area with the business' existing
offering / business model. The purpose is to use such a move as a bridgehead
into another market as a Pioneer (described below); the risk / return
profile is very unpredictable.
The Disruptor: Taking a new offering / business model into an existing
market has demonstrated itself to be a very effective market strategy.
Here, the game is redefined, and a formula that improves both the customer
value proposition and margins will deliver very attractive economic returns.
First mover rewards are available to Disruptors.
Notably, since the customer market already exists, there is considerable
existing knowledge available. This information and familiarity needs to
be fully exploited to mitigate risk, and craft a business model that will
actually deliver superior returns. The Disruptor strategy offers a very
good risk/return profile - provided the strategy is formulated with an
eye to Profit Pools and related techniques.
The Pioneer: Opening up a new market is one of the most high risk moves
that can be made, particularly with a new offering or business model,
and often reserved for venture capital. However, the first mover rewards
are the highest of all when the right formula is found.
The risk level in the Disruptor and Pioneer strategies is high; making
them particularly in need for the risk-mitigation information efforts
discussed. Furthermore, those same efforts will also reap rich rewards
as they are also directed at defining high-return business models.
Strategy Formulation
In short, with the information base gathered, formulating strategy is
a very situation specific exercise. The most useful approach is hypothesis
based; that is, designing a set of viable strategic options, and evaluating
them for business / shareholder value creation. The higher the risk, the
greater the need to more fully understand potential evolution paths, and
the greater the need to have solid contingency plans.
Such hypothesized strategic options set out which markets to target, and
how to play. They also detail the offer, the business model, and the path
forward.
In each of these considerations, the business' value can only have a chance
of achieving its potential if it is focused on the most attractive Profit
Pools.
About The Author:
| Mr. Jones is a management consultant
with extensive experience analyzing markets and crafting strategies
that deliver superior financial returns. He began his career as
an engineer with Thomson Consumer Electronics. Subsequently, turning
to consulting, he joined PricewaterhouseCoopers, where he was a
Partner in the strategy consulting practice, and he is now at Business
Intelligence Associates - a consultancy he co-founded. He earned
an engineering BSc from City University, London, and an MBA from
University of Chicago. http://www.biassociates.com
|
Article Source: thePhantomWriters
Article Submission Service
Published - July 2008
|
