Main Takeaway: The Art of Profitability

By Adrian Slywotzky

In this show you will learn EVERY node of profitability, and how your business may

leverage these profit drivers!

CARE About Profit

To succeed in business, you have to have a genuine interest in profitability. And most people don't.

To study successful businesses you have to visit their stores, factories, offices - try their products, test their services, spend time at their websites. Most important you've got to talk with

their customers, live with them, get to know their needs, wants, problems by spending time with them, seeing what

they do, what works for them & what doesn't. What annoys them & what makes their lives easy or productive or fun.

You'll learn more from 1 hour with a customer then 50 research studies.

Innumeracy LessonYou can figure out all the answers with some basic information, calculations, and

common sense.• How many people really ask the right questions about a business plan, a new

product launch, a major investment, a marketing campaign, an HR program?• Many people in business aren't used to thinking this way. You can usually work

out less than 7 calculations that will blow up an impressive but fatally-flawed business plan.

• Being able to take measure of the world is one of the most crucial skills we can develop.

Always do the arithmetic. It's the strongest ally, truth detector, opportunity detector.

4 levels to learning : awareness, awkwardness, application, assimilation.Always ask "why?" 5 times. By the 5th time you'll start getting close to the real

answer.

Customer Solution Profit

Study customers, create a custom solution set with multiple services. Develop the relationship.

Invest time and energy in learning all there is to know about your customers. Then use that knowledge to create specific solutions for them. Lose money for a

short time. Make money for a long time.Potential applications: Anything, except where there is no relationship-building. Where does it NOT work?

Example: Factset

Once Factset identified a company as a potential customer, they'd send a team of 2-3 people to work there for a few months, learning

everything they could about the customer, how their systems worked (& didn't work), what they really cared about. Based on this

genuine knowledge, they'd develop customized 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, revenues were tiny and costs were huge. But after 3-4 months, they were woven into the daily flow of customer's

operations. Software debugged and working fine. Now one person could maintain account, part-time. More people in company use it.

Costs fall, revenues grow.

Pyramid ProfitCompany caters to different levels of price sensitivity. Offer a range of

services from low price / high volume to higher price and lower volume.

The base of the pyramid consists of low-priced high-volume products, while the apex is made up of high-priced low-volume products. The bulk

of profitability is concentrated at the top of the product pyramid, but the base plays a strategic role -- often through a "firewall" brand -- in

protecting the profitability at the top.

At Mattel: Barbie = $20-$30. But imitators can come in below you, so you build a firewall, a $10 Barbie. Barely profitable but prevents other companies from establishing a connection with your customers. And even girls who start with the $10 Barbie move on to buy accessories.

Then made a $100-$200 Barbie for nostalgic collectors.

Pyramid Profit Cont.

Has to be more than just a collection of products at different price points.

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. A firewall.

The customers themselves form a hierarchy, with different expectations and attitudes towards price. The

pyramid is made to capture them all.

Multi-Component Profit

Same product, several businesses. Offer a range of services that includes higher margin specialty items and loss leading, high demand

services. Caters to customers that consolidate on fewer suppliers.

Multiple products and/or sales channels, and only some of these represent the bulk of profitability. To maximize sales in the high-

profitability components, it's necessary to have full presence in the less-profitable components as well.

Different parts of a business can have wildly different profitability. The customer behaves very differently on different purchase

occasions. Different degrees of price sensitivity.

Example: Multi Component

Coke per ounce: .02 in grocery store, .06 in vending machine, .12 in restaurant

Hotel: single room for 1 night, one-day meeting for 20 people, three-day convention for 3000

people.Bookstore: foot-traffic component, ecommerce component, book-club component, corporate-

purchasing component.

Switchboard Profit

Multiple sellers communicating with multiple buyers via a power broker associated with the service provider. The more buyers and

sellers that join the switchboard, the larger the margin commanded by the service provider.

Can't do it with a small niche: once you have 15-20% of market, an upward spiral kicks in. Perceived probabilities go way up, and all

deals start flowing your direction.

More profitable because agent's cut of so many players in one deal. Also, by representing a team rather than individual, far better

bargaining power.

Examples: EBAY, Wilson & Sonsini (Silicon Valley startups), Michael Ovits (Hollywood deals)

Time ProfitTakes advantage of innovation, newness, uniqueness, to gain time limited

competitive advantage. Requires strong early sales effort to maximize high margin revenue. Profit margins quickly erode as competition catches-up. Needs instant diffusion: a faster way to squeeze out the juice before everyone else learns the

secret.

What separates winners and losers in innovation is who masters the drudgery. The creative process usually starts with a brilliant idea. Next you determine

whether, if the brilliant idea worked, it would be worth doing from a business standpoint. That's exhilarating and most stimulating part, but it's also the easiest. Then comes the real work: reducing the idea to practice. That's the drudgery part, and the part where people need the most pressure and encouragement. People

go into pits as they try to turn that idea into products that can be manufactured.

Examples: Intel (CPUs), Apple (iPod)

Blockbuster Profit

Similar to Time Profit with Revenue realized is so powerful and fast that in a quick swoop the model pays for often high service

development and marketing costs. Big winners get tremendous amount of workover, discussion,

debate, attention.

Get everyone focused on new key questions: How can we increase the feasibility level of the big projects? Can we parallel-process? can we get more studies done to improve their positioning? What will it

take to hit a home run? Get everyone developing it as excited as possible. Go into total risk-management mode to remove as much

uncertainty as possible.

Examples: Movie Studios, Book Publishers, Drug Makers

Profit-Multiplier Model

Taking one skill and making money from it 5 or 6 times. Take any asset, iterate it, reuse it, give it a different form.

Better profit from lower development cost. Don't have to reinvent the wheel every time you use it.

Improves the odds of success for the development you've already done. Leverage brand to multiply the value of one

service by selling loosely related services under the same branding.

Example: Disney sells one service (movies) and then leverages brand to sell toys, clothing, dvds, theme park attractions, etc.

Entrepreneurial ProfitTotally aligns an organization behind rational, common sense, profit-seeking

activity, rather than all the extraneous nonsense that only large organizations can afford or tolerate. A simple mindset that says, "We can't

afford to operate any other way.”

Creativity and new ideas for better ways of doing things. Delays expenses. Asks hard and well-informed questions about every expense. Copies

shamelessly from competitors. Holds contests among employees to test frontiers of great performance. Throws parties to celebrate star performers.

Experiments a lot. When it fails, he cuts back quickly. When it works, he pours it on.

Some employees can't handle the pressure. The ones who stay are excited and engaged. Hierarchical design with multiple subsidiaries to maintain

startup-like customer responsiveness, energy and efficiency.

Specialist ProfitSpecialists are several times more profitable than the generalist.

Characterized by lower cost, higher quality, stronger reputation, shorter selling cycles, and

better price realization.

Lower cost through better knowledge. Better price through reputation or unique design of offering. Shorter selling cycle. More rapid & universal

penetration because of wired effect. Windfall profits because of high-value high-margin answers throughout the marketplace.

The difference in profitability between generalist and specialist will be 10-15 points of margin. When generalists break even, specialists make 15%. When

generalists make 10%, specialists make 25%.

Example: Southwest (one jet type)

Installed Base ProfitInitial product sales or profits are slim and profit is realized on follow-up products

and services.Two buckets:

(1) hardware. 2-5% profit. new demand. bigger price sensitivity. customer has power.

(2) consumables. 10-15% profit. continuing demand. less price sensitivity. seller has power.

Seller can fuck up by making price too high so customer switches brands. Or if sellers doesn't work to make it easy for customer to buy: early notice, reminders, multiple units per follow-up sale, turning passive receipt into stimulating usage and growth.

Take some aspect of your business where customers are returning naturally and stimulate it more - market aggressively.

Examples: All suppliers of laser printers and video game players.

De Facto Standard Profit

The more players who buy that enter in the system, the more valuable the network.

Being the standards gets you plannability - less surprise. (Surprises cost money by causing you

to react, respond, scramble.)

Your customers do your marketing for you.Examples: Microsoft, Apache, SAP, and eBay

Brand Profit

The company expends significant marketing investment in order to build awareness and is reinforced by customer experience. You know

Brand is working when a consumer says, "I only drink Coke" even-though blind tests show

consumers are often unable to distinguish the difference between Coke and its competitors.

Examples: Coke, Crest, Singapore Airlines, Acura

Specialty Product Profit

Similar to brand profit but companies use above standard materials and design to generate higher margins until competitors start to imitate.

Lots of little unique patented products with huge margins. 10 years ago, 80% of profits came from those. Now 80% of profits are from

commodity stuff. The profit model shifted from specialty product to cost-and-cycle management. Key is to develop new niche products.

Difference from Blockbuster is that this is niche: specialty foods, specialty papers, etc. Finding a legitimate need or variation and

addressing it.

Examples: Apple (computers), Ben and Jerry’s (ice cream), Prada (shoes), Tumi (bags)

Local Leadership Profit

Many businesses and their company economies are totally local. Risk occurs when these companies fail

to recognize they are a local business model.

Purchasing costs are lower, capture most better traffic locations, recruiting and advertising work

better. Every store is like a billboard. Slightly higher pricing. Fill a county.

Examples: Walmart, Starbucks

Transaction Scale Profit Real estate woman who only sells $1M+ houses. Paid attention only to that market. What kind of people. Studied for 7 years. You get to the big

transactions through great relationships.

But you can't get to the big transactions just by wanting to: you have to take risks to bias yourself toward the big business. Turn small business

away to concentrate on the big accounts. Needs skill, persistence, reference development.

Revenue increases proportionately with transaction volume but materials, construction, and or distribution costs do not.

Examples: Microsoft (Office software), Morgan Stanley (finance deals)

Value Chain Position Profit"He who occupies the mountain pass can easily battle a thousand." What's true in geography is true in business. There are places in the value chain that are 10 times

more valuable than others in terms of profit, power, control. When earthquakes or floods happen, the location of these special places changes, making some

vulnerable and others blessed.

Note pre-existing control points. (There are none: they're conditional depending on the circumstances: relative value added, trajectory. MS + Intel vs PC makers. Wal-Mart vs suppliers. Creation of scarcity. Capturing bottleneck. Connection to

the customer: a better connection than the other value-chain players have. Profit from predictability. The company that owns the control point sets the pace. Its

business plan defines the future. The others react, always a step behind.)

Example: Cingular (partners with Motorola, Sony, insurer to sell Walkman mobile phone)

Cycle Profit

Industries characterized by distinct and powerful cycle. The company can not control the cycle, but it works to maximize its position within the cycles grip. As capacity tightens the companies lead price increases, as capacity

loosens, its lag price declines.Drive down the breakeven point. Reduce fixed costs.

When others lose money, they break even. When others break even, they profit.

Permanently ahead.

Example: Travel industry (adjust rates seasonally)

After-Sale ProfitPrice sensitivity changes for different purchase occasions. Low sensitivity on coffee is what made Starbucks ($2-$3 for a 10-cent cup). For a TV it's high:

people price-shop relentlessly. Airfare and cars: the highest.

Price sensitivity is lowest when ticket price is low and there are few options. The action starts with the high-visibility big-ticket sale. Computers, cars,

equipment. Buyers go to the wall to get the lowest price. Their zeal drives the profit out.

But 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, PC, pickup truck. Didn't need the replacement parts or accessories. A whole new minimarket created by the initial sale. Ticket prices

are tiny. Frequency of purchase is greater.

After-Sale Profit

Big-ticket companies should customize the after-sale stuff to the original sale product, so the customer has a compelling reason to

buy the after-sale items and services from them. Work hard to turn the after-sale profit model into the installed base profit

model.

But selling this after-sale stuff is so unglamorous that many less are shooting for it : you can quietly sell service contracts and

insurance for a lot of profit. Needs a very different organization focused only on that.

Example: General Electric (nuclear power plant services, auto loans, insurance)

New Product ProfitProfit explosion happens at the beginning, during the gold-rush days. Margins are fat and volume is skyrocketing. Multiply these two and you get a growing ocean

of profitability.The Profit Parabola _/\_ "The total profit earned by all players in a market goes

up, peaks, and comes back down to zero."Theory supported by: radios, tvs, vcrs, walkmans, desktops, laptops, servers,

sedans, minivans, suvs, faxes, fax-printers, fax-printer-copiers.

Time Profit: 2-year cycle, speed, race car, "when you see #2 in the rear-view mirror, step on the gas". Chips, electronics.

New Profit Product: 4-year cycle, shift resources, surfing, "get off the last wave first, get on the new wave first". Cars, copiers.

Specialty Product Profit: 10-year cycle, select, seismography, "find the richest fields: the place where customer need, technical feasibility, and lack of

competition intersect"

Relative Market Share ProfitCompanies with high market share tend to be more profitable. Large

companies have price advantages due to manufacturing experiences and volume economies from better supplier relationships. Invest to win. Build

a bigger lead. If you try and fail, cut your losses or get out completely. (Jack Welch was its most thoughtful practitioner.)

Economics of scale. Purchasing advantage. Marketing & advertising. Because lowest overhead per-unit, spread costs over greater volumes

than any other competitor. Attract the best talent in the industry. Biggest cash flow, so can outspend rivals. Leader has least volatility, lowest risk.

Controlled initiative while others react.

Used to think profit was just Relative Market Share, but it's function of many things: time, location, offering, local Relative Market Share.

Experience Curve Profit

Experience in serving the market and strong financial management drives down the transactional cost. (Basically just continuing to

optimize…)

Danger is focusing on this too much and losing peripheral vision. (Focus + Peripheral Vision = 100%. The less you have of one, the

more you have of the other.)

At the edge of the radar screen is where new things come to make you irrelevant, or the invention of a new model that delivers the same thing at a 20-30% lower cost, like Southwest Airlines, Dell

Computer, Nucor steel, Wal-Mart, Geico, Home Depot. Incumbents are busy managing costs, and someone comes along to introduce

the next system. See next point...

Low-Cost Business Design ProfitThe company thrives on reducing the cost per unit through cumulative experience. You might need two organizations: the experience-curve

incumbent and the blank-sheet-of-paper gang. Maximizing your current hand while simultaneously buying a big insurance

policy on the future.

The low-cost business design doesn't need huge market share to be hugely profitable. It is hugely profitable as long as it continues

to be dramatically lower-cost.

Value Migration: how you have to change your business design every 5 years. (Though it takes 2-3 years to change!) So you need to see it coming, start

preparing for it. Give yourself a 2-year runway to get the new business design off the ground. Start sooner.

Move faster. Anticipate.

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