PROFITABILITY:
SURVIVING AND THRIVING IN A LAND OF GIANTS
Ken Wong
Key Number 1: The Right Priority and the REAL Enemy
MARGIN-SUCKING
MAGGOTS
Chasing the WRONG Customers
In the WRONG Way
For the WRONG Reason
2
Profit: The Scorecard
Price
Unit
Margins
Net
Income
Return On
Investment
Divided
By
Assets
Managed
Minus
Cost
Times
Unit
Volumes
Market
Share
Times
Market
Size
3
A Comparison of Profit Levers
A 1%
change in...
Creates a change in
operating profit of ...
Price
11.1%
Variable Cost
Fixed Cost
Volume
7.8%
2.3%
3.3%
(Average economics of 2,463 businesses in Compustat)
Nothing destroys profits FASTER than cutting price
• The Tradeoffs Are Significant
– Every 1% price cuts requires you to either cut variable costs by
1.34% OR acquire enough new customers to raise volume by 3.4%
• Price cuts often lead to an erosion of quality
– Price cuts that have an immediate financial impact focus on
“shovel-ready” sources of cost reduction that makes
differentiation impossible
– You cannot “automate” a relationship
– Efficiency programs take time to implement
• There rarely is enough volume available to offset the cost of
acquisition
5
Yes….but
CUSTOMERS ALWAYS WANT LOWER PRICES
DO WE GIVE THEM THOSE PRICES?
HOW DO WE SUSTAIN PROFITABILITY IF WE DO?
Value is the RATIO of Quality-to-Price
• Four Ways to Enhance Value
1. MAINTAIN QUALITY – REDUCE PRICE
2.
REDUCE QUALITY A "LITTLE" – REDUCE PRICE A "LOT"
3.
INCREASE QUALITY – MAINTAIN PRICE
4.
RAISE QUALITY A "LOT" – RAISE PRICE A "LITTLE"
Why We Prefer "Quality-based Value Gains"
• Longer strategic window of opportunity/advantage
• Greater economic efficiency
Some Evidence
% chg 3 years post-recovery
(SALES; EBITDA)
13.0
12.2
9.4
9.0
7.9
6.6%
6.2%
6.3
6.2
4.4
PREVENTION
(cut PRICES then
cut COSTS to fiance)
PROMOTION
(spent heavily)
PRAGMATIC
PROGRESSIVE
(cut costs THEN
(reallocated costs to
reallocated cost to support new value prop)
Price &/or Promotion)
SOURCE: "Roaring Out of Recession" (Gulati & Nohria, HBR 4/2010)
The Giant’s Advantage
And how they’ll use it in the future
Economies of Scale - It Can Be a "Good Thing…"
Unit cost
100
50
The
Small
Firm's
LOSS
25
The Large Firm's PROFIT
12.50
1
2
4
8
Vol
11
…Or Even Greater When Used Properly
MORE
SCALE
Via experience effects,
economies of scale,
market power, etc…
LOWER
COSTS
LOWER
PRICES
Via business
planning
12
How Great Businesses Use Scale
MORE
SCALE
Via experience effects,
economies of scale,
market power, etc…
LOWER
COSTS
BETTER
QUALITY
Via business
planning
13
The Productivity Cycle - Basic Form
Via sales and
marketing
HIGHER
SALES
SUPERIOR
VALUE
MORE
SCALE
Via experience effects,
economies of scale,
market power, etc…
Via execution and
implementation
LOWER
COSTS
LOWER
PRICES
AND/OR
BETTER
QUALITY
Via business
planning
14
The Giant’s Traditional Game Is Changing
• Price is Not the Best Way to Add Value
– Short strategic window
– Inefficiency relative to quality enhancement
15
What Should We Expect?
1. More Automation, Information Technology, Mobile Commerce
– Scale underlies the giant’s advantage: people are not scalable
2. Giants will seek to compete on QUALITY OVER PRICE
– Limits to Scale: Eventually scale effects bottom out
– Market Diversity: Scale Requires Standardization
– Profit Impact of Quality-driven value is superior
– High-value accounts are less price-sensitive
3. There will be a BLURRING OF INDUSTRY BOUNDARIES
– Competition for BASIC services will come from internet-based
competitors, traditional banks, affiliated banks (eg Rogers,
Loblaws) and other established brands whose cost advantage is
not scale-based
How to Respond
The Ultimate Strategic Challenge
1. Find a way to raise quality WITHOUT raising costs
OR
2. Find a way to reduce costs WITHOUT destroying quality
18
Priority One
Know Your Business Arena
19
Are You Focused on the Right "Business Arena"?
THE VIAGRA RULE
• People DO NOT buy products or services, they buy solutions to
problems
• Customer willingness to pay a premium price increases
– With the importance of the problem being solved
– The complexity of the work
– The number of alternative suppliers
• DO NOT TELL PEOPLE WHAT YOU DO - TELL THEM WHY THEY
SHOULD CARE
20
Priority
Align Operations With Your Arena
21
The Disney Rule
• The Reality of A Trip To Disney
– Expensive
– Long lines
– Junk Food
– Expensive Food
• Our Response:
“Let’s Go Back!!!”
To Sell on Value, Know Your Costs… and the Value They Create
Total Costs
Add "Good" Costs
Reduce "Bad"
Costs
Increase
"Value"
Reduce
"Waste"
Higher Prices
and Sales
Lower
Costs
Higher Profits
23
Priority Three
Be Bigger Than You Are
24
What is Different in These Pictures?
FILTER
FILTER
STAND
STAND
CARAFE
BASE
- On/off
FILTER
STAND
CARAFE
BASE
- On/off
- Timer
CARAFE
BASE
- On/off
- Timer
- Flavour controls
25
How Common Components and Modules Create Value
Unit cost
100
ADDED
PROFIT
FOR
MODEL A
MODEL
A
ADDED PROFITMODELB
FOR MODEL B
ADDED PROFIT FORMODEL
MODELCC
COST IF COMMON COMPONETS USED IN MODELS A + B + C
MODEL A
SALES
Vol
MODEL B SALES
MODEL C SALES
COMBINED SALES OF A + B + C
26
Five Sources of Interrelationship Between Businesses
1. Procurement
–
Common purchased inputs
2. Technological
–
–
–
–
Common product technology
Common process technology
One product incorporated into the other (component)
Use of products requires a common interface (E.g. stereo equipment)
3. Infrastructure
–
–
Common capital
Common staff functions
4. Production
–
–
–
–
–
Common location of raw materials (logistics)
Common fabrication process
Common assembly process
Common testing/quality control procedures
Common factory support needs
5. Marketing
–
–
–
Common buyers
Common channels of distribution
Common geographic markets
27
Priority
Focus on the “Right Customers”
28
The Profitability of Selling to Transactional Customers
Profit
contributed by:
Profit
Base profit
Cost of new
customer
Time
Source: Bain and Company (Frederick Reicheld)
29
The Value of Customer Loyalty
Profit
contributed by:
Price premium
Referrals
Profit
Lower costs
Increased volume
Base profit
Cost of new
customer
0
1
2
3
4
5
6
7
Year
Source: Bain and Company (Frederick Reicheld)
30
Profit Impact of a One-Percent Increase in Customer Loyalty
Volume
3.3%
Cost
7.8%
Price
11.1%
19
Advertising agency
17
Bank branch deposits
17
Publishing
17
Auto/Home insurance
16
Auto service
15
Credit cards
9
Industrial distribution
7
Software
0
4
8
12
16
20
Percentage Increase in Profits per Customer
Source: Bain and Company (Frederick Reicheld)
31
Priority
Know What Matters Most
32
What Matters Most
• The “Service Profit Chain“
– Profits grow from satisfied customers who receive value due to
satisfied and loyal employees who had proper training,
coaching, and support
COMPANY
Internal
Marketing
EMPLOYEES
External
Marketing
Interactive Marketing
CUSTOMERS
33
EXECUTION
THE EXECUTION OF THE
MARGIN-SUCKING
MAGGOTS