business modelling
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Understanding & Improving our Understanding & Improving our Business ModelBusiness Model
Key advantages ofKey advantages ofBusiness ModellingBusiness Modelling
• Focuses the definition of competitive Focuses the definition of competitive advantage on the Customer’s current & advantage on the Customer’s current & emerging prioritiesemerging priorities
• Directly links the drivers of competitive Directly links the drivers of competitive advantage to advantage to quantitativequantitative measures of measures of business performancebusiness performance
• Provides a generic framework to utilise Provides a generic framework to utilise when looking for future sources of when looking for future sources of competitive advantagecompetitive advantage
Helps us see competitive advantage more clearly
Background to the FrameworkBackground to the Framework
1960’s 1970’s 1980’s 1990’s +
““The rising tide lifts The rising tide lifts all boats”all boats”
Organisation EconomicsOrganisation Economics• Post WWII, demand out-Post WWII, demand out-
stripped supplystripped supply• Regulation, global trade Regulation, global trade
management management (protectionism) created (protectionism) created relatively stable relatively stable industriesindustries
• ““If you build it they will If you build it they will come” euphoria come” euphoria supplanted by a need for supplanted by a need for more rigorous thinkingmore rigorous thinking
• Approaches to strategy Approaches to strategy focussed on improving focussed on improving organisation structure & organisation structure & command-control command-control functionsfunctions
Business Modelling FrameworkBusiness Modelling Framework
““Scale & market share Scale & market share drive value growth”drive value growth”
Relative Supply EconomicsRelative Supply Economics• Supply and demand Supply and demand
becomes more balancedbecomes more balanced• Approaches to business Approaches to business
strategy focussed on the strategy focussed on the identification and building identification and building of structural advantageof structural advantage
• Exemplified by Exemplified by Experience curve and Experience curve and Porter’s Five Forces Porter’s Five Forces modelmodel
• Economies of scale, High Economies of scale, High market share = high market share = high profitabilityprofitability
““Become lean and Become lean and mean”mean”
Efficiency EconomicsEfficiency Economics• Global competition, lower Global competition, lower
trade barriers, de-trade barriers, de-regulations allows regulations allows capacity to exceed supplycapacity to exceed supply
• Corporate raiders and Corporate raiders and more active shareholders more active shareholders drive trend to downsizing, drive trend to downsizing, restructuring, re-restructuring, re-engineeringengineering
• Focus on core Focus on core competencies, “Stick to competencies, “Stick to the knitting”the knitting”
““Better business Better business design drives design drives profitable growth”profitable growth”
Customer EconomicsCustomer Economics• Customer needs and Customer needs and
priorities changing priorities changing rapidlyrapidly
• Information flowing more Information flowing more freely; Internet freely; Internet exacerbating situationexacerbating situation
• Markets converging, Markets converging, channels compressing, channels compressing, products to solutionsproducts to solutions
• Structural advantages Structural advantages and barriers to entry and barriers to entry becoming less easy to becoming less easy to protectprotect
Source :- Slywotzky & Morrison, The Profit Zone
What makes a better Business Model?What makes a better Business Model?
TRADITIONALTRADITIONAL• More Customers / VolumeMore Customers / Volume
• What new products can I sell What new products can I sell to increase sales and profit?to increase sales and profit?
• Where are the opportunities in Where are the opportunities in my industry to get bigger & my industry to get bigger & more efficient?more efficient?
• How do I create barriers to How do I create barriers to protect my market share?protect my market share?
BUSINESS MODELLINGBUSINESS MODELLING• More Profitable & faster More Profitable & faster
growing Customersgrowing Customers• What are my customers key What are my customers key
priorities & how can I meet priorities & how can I meet them better ?them better ?
• When I look at all the money a When I look at all the money a customer spends along the customer spends along the value chain - where’s the profit value chain - where’s the profit zone?zone?
• What mechanisms are available What mechanisms are available to keep me in the profit zone?to keep me in the profit zone?
Business Modelling tries to focus Business Modelling tries to focus on a small number of key questionson a small number of key questions• Defining the important customers?Defining the important customers?
– Who are the most profitable customers?Who are the most profitable customers?– What are their priorities / business drivers?What are their priorities / business drivers?– How are these priorities changing?How are these priorities changing?
• How do we capture the value we create in How do we capture the value we create in the form of profit?the form of profit?
• How do we protect our profit stream? How do we protect our profit stream? • How do we deliver value to these How do we deliver value to these
customers? (operating systems)customers? (operating systems)
Business Modelling FrameworkBusiness Modelling Framework
Definition of Key TermsDefinition of Key TermsBusiness Modelling FrameworkBusiness Modelling Framework
Dimension Key Issue Key Questions
Strategic Dimensions
Customer SelectionWhich customers I we chose to
deal with? (or focus on)
To which customers can I add real value? Which customers will allow me to profit?
Which customers do I want to serve?
Fundamental Assumptions about Customer Priorities
What is my fundamental assumption about what the
customer values?
What are our customers' priorities? How do we assume they will change in the future?
Profit Model / Value Capture
How do I make a Profit?
How do I provide additional value to the customer that enables me to extract a price
(or volume) premium over others in the market?
Differentiation / Strategic Control
How do I protect my profit stream?
What is my unique value proposition? Why should customers buy from me ahead of the competition? How do I conterbalance
customer or competitor power?
Scope of ActivitiesHow do I define the limitations
of our business?
Do we confine ourselves to certain products, markets or customers? What won't we make or where won't we go?
Source :- Slywotzky & Morrison, The Profit Zone
S’holder Value US$239.6 BillionSales US$90 BillionValue to Sales 2.7 x
Customer SolutionsFinancingManufactured Products & Services
Customer solutionsCustomer relationshipsCEO marketing6-Sigma Quality
Multi-component product, service,solution, and financing“Sell the whole solution”
Customers value suppliers who can deliver lower total systems costs byproviding a complete solution in areasoutside their core competencies
ConsumersManufacturersSenior Executives
1997
S’holder Value US$13.1 BillionSales US$26 BillionValue to Sales 0.5 x
Manufactured Products
BrandMarket Leaders“Be No. 1 or No 2 or exit”
Product sales“sell the box”
Customers value high quality, economical products,delivered reliably
ConsumersManufacturersEngineers
1981
OUTCOMES
SCOPE
DIFFERENTIATION / STRATEGIC CONTROL
PROFIT MODEL / VALUE CAPTURE
FUNDAMENTAL ASSUMPTIONS ABOUTCUSTOMER PRIORITIES
CUSTOMER SELECTION
Example - General ElectricExample - General ElectricBusiness Modelling FrameworkBusiness Modelling Framework
DIMENSIONS
Source :- Slywotzky & Morrison, The Profit Zone
Customer Solution ProfitCustomer Solution Profit• Know the customerKnow the customer
• Create a solution (that Create a solution (that reduces total customer reduces total customer system costs)system costs)
• Build the relationshipBuild the relationship
• May incur early lossesMay incur early losses
• But significant profits followBut significant profits follow• ExampleExample
ABB (can build & finance a power station ABB (can build & finance a power station not just supply the generators)not just supply the generators)GE (provides financing, maintenance & GE (provides financing, maintenance & scheduling services as well as selling scheduling services as well as selling locomotives)locomotives)
The Profit Zone
Product
ProductServices Options Financing
Sell the Box, or ...
Sell the Solution
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Time
Pro
fit
Source :- Slywotzky & Morrison, The Profit Zone
Total System EconomicsTotal System EconomicsExample : - Printing CompanyExample : - Printing Company
• This company sold mainly Point of Sale Material to big This company sold mainly Point of Sale Material to big consumer marketing companies (e.g. Coke, Frito Lay, etc.)consumer marketing companies (e.g. Coke, Frito Lay, etc.)
• Business was competitive based upon cost per item.Business was competitive based upon cost per item.• The printer investigated their customer’s real cost of putting The printer investigated their customer’s real cost of putting
POS Material in the market and found that for the average POS POS Material in the market and found that for the average POS Promotion, 40% of the printed materials never made it to a store Promotion, 40% of the printed materials never made it to a store to be displayed due to inefficient customer distribution systems to be displayed due to inefficient customer distribution systems and poor tracking.and poor tracking.
• The printer changed his business model - he now organises The printer changed his business model - he now organises distribution to the store himself and charges the customer on a distribution to the store himself and charges the customer on a cost per item displayed instead of a cost per item printed.cost per item displayed instead of a cost per item printed.
• Needless to say his new model is far more profitable.Needless to say his new model is far more profitable.
Source :- Slywotzky & Morrison, The Profit Zone
Total System EconomicsTotal System EconomicsExample : - Printing CompanyExample : - Printing Company
• Expense of UsageExpense of Usage• Cost of MaintenanceCost of Maintenance• Associated LabourAssociated Labour• Cost of DistributionCost of Distribution• Cost of InventoryCost of Inventory• Cost of Defects / Cost of Defects /
Returns / FailureReturns / Failure• Costs of inflexibilityCosts of inflexibility• InefficienciesInefficiencies
Big Box :• Cost of Distribution / installation• Cost of having no POS material in
the store when the promo starts• Lost Sales at store• Cost of storing / disposing of
unused POS Material
Little Box :Cost of
Printing POS Material
Processor ChipsChip setsValue Chain Management
Speed of Product DevelopmentConsumer BrandCompatibility
Chip ManufactureBrand Premium
Customers value leading edge technology with broad consumer acceptance and guaranteed compatibility
PC OEMsConsumers
1997
Memory Chips andsolutions
SCOPE
TechnologyDIFFERENTIATION / STRATEGIC CONTROL
Chip manufactureLicensing
PROFIT MODEL / VALUE CAPTURE
Customers value leading edgetechnology delivered with high quality,low cost manufacturing systems
FUNDAMENTAL ASSUMPTIONS ABOUTCUSTOMER PRIORITIES
Industrial Equipment Manufacturers
CUSTOMER SELECTION
1981
Example - IntelExample - IntelBusiness Modelling FrameworkBusiness Modelling Framework
DIMENSIONS
Source :- Slywotzky & Morrison, The Profit Zone
““Two steps ahead” ProfitTwo steps ahead” Profit
• First mover generates First mover generates excess returns before excess returns before imitators begin to erode imitators begin to erode marginsmargins
• Create and maintain a Create and maintain a lead time over the next lead time over the next competitor and a competitor and a constant stream of new constant stream of new products products
• ExampleExampleIntelIntel (focuses on being two years (focuses on being two years ahead of nearest rival’s product ahead of nearest rival’s product developments)developments)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Q2 Q4 Q6 Q8 Quarters Post Launch
$ p
er
Un
it
TheProfitZone
Cost
Price
Source :- Slywotzky & Morrison, The Profit Zone
Brand ProfitBrand Profit• Brand company expends Brand company expends
considerable marketing considerable marketing investment in building investment in building awareness, recognition & awareness, recognition & credibilitycredibility
• These “intangibles” are These “intangibles” are reinforced by customer reinforced by customer experienceexperience
• The Brand achieves a The Brand achieves a significant price premium in significant price premium in the marketplacethe marketplace
• ExamplesExamplesNike, Coca-ColaNike, Coca-Cola
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Market BrandPrice Price
Pri
ce
pe
r U
nit
Source :- Slywotzky & Morrison, The Profit Zone
Value Chain Position ProfitValue Chain Position Profit
• Profit concentrates Profit concentrates itself in certain parts itself in certain parts of the value chainof the value chain
• Profit comes from Profit comes from – participating in the participating in the
more profitable value more profitable value chain segments ORchain segments OR
– capturing downstream capturing downstream margin by leveraging margin by leveraging value chain power value chain power
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
0 25% 50% 75% 100%Share of Industry Revenue
Op
era
tin
g M
arg
in0
10
%2
0%
30
%4
0%
Source :- Slywotzky & Morrison, The Profit Zone
OtherComponents
Microprocessors
PersonalComputers
Software
ServicesPeripherals
Example : The way Ford looks at it’s Value ChainExample : The way Ford looks at it’s Value Chain
0 25% 50% 75% 100%Share of Industry Revenue
Op
erat
ing
Mar
gin
05%
10%
15%
20%
Auto Manufacturing
Used Car Dealers
AutoInsurance
Service / Repair
Auto R
ental
After-marketParts
Leasing
AutoLoans
Warranty
Gasoline
New CarDealers
Notes about using the Generic Notes about using the Generic Profit ModelsProfit Models
• The models serve two purposesThe models serve two purposes– They help us understand the drivers of our current They help us understand the drivers of our current
profitabilityprofitability– They present us with alternative ways to look for future They present us with alternative ways to look for future
profitabilityprofitability
• The models illustrate where the The models illustrate where the keykey sources of sources of profit are, they don’t suggest that this is where profit are, they don’t suggest that this is where allall sales / profits should come fromsales / profits should come from
• There are few “pure” examples of any model - There are few “pure” examples of any model - most successful business use a combination of most successful business use a combination of modelsmodels
How do I assess the power of my How do I assess the power of my business model?business model?
• HypothesisHypothesisThe most powerful business models The most powerful business models deliver greater shareholder value deliver greater shareholder value
• A number of quantitative & qualitative A number of quantitative & qualitative factors are considered important ...factors are considered important ...
– Return on Sales (EBIT Margin)Return on Sales (EBIT Margin)– Profit Growth Profit Growth – Asset Efficiency (Assets / Sales) Asset Efficiency (Assets / Sales) the inverse of Asset Turnsthe inverse of Asset Turns
– The Degree of Strategic ControlThe Degree of Strategic Control
How do I assess the power of my How do I assess the power of my business model?business model?
Returnon Sales 1
40%
0%
ProfitGrowth 2
30%
0%
AssetEfficiency 1
0.1
1.0
Degree ofStrategic Control 3
10
0
ShareholderValue
to Sales 4
10X
0X
1. 1999 Actual levels have been used2. Compound annual EBITA growth 1995 to 19993. A rating based upon the strength of differentiation / sustainability4. Shareholder Value divided by Sales is used, however any valid measure of the leverage you have in shareholder value creation would suffice e.g. EV Multiple, PE Multiple, Market to Book, etc.
Intel 38%
Intel 24%
Intel 0.7
Intel 9
Intel 6x
What is a Strategic Control Point ?What is a Strategic Control Point ?
• A Strategic Control point is a mechanism A Strategic Control point is a mechanism that helps protect the profits flowing from that helps protect the profits flowing from a business model against the corrosive a business model against the corrosive effects of competition and customer powereffects of competition and customer power
• A business model without a strategic A business model without a strategic control point is like a ship with a hole in its control point is like a ship with a hole in its hull - it will sink much sooner !hull - it will sink much sooner !
• Strategic Control Point keep you in the Strategic Control Point keep you in the profit zone longerprofit zone longer
Examples of Strategic Control Examples of Strategic Control PointsPoints
Business models that have strong ...Business models that have strong ...• Brand, Copyright, PatentsBrand, Copyright, Patents• Control of Distribution / the Value ChainControl of Distribution / the Value Chain• Two year lead in product developmentTwo year lead in product development• Commodity with 10% - 20% cost Commodity with 10% - 20% cost
advantageadvantage
Assessing the strength of your Assessing the strength of your Strategic Control Point(s)Strategic Control Point(s)
• Strength is often different in different industriesStrength is often different in different industries(e.g. Brand is almost irrelevant in OE Automotive but extremely (e.g. Brand is almost irrelevant in OE Automotive but extremely relevant in carbonated beverages)relevant in carbonated beverages)
• Strength is relative to the countervailing strength Strength is relative to the countervailing strength of your competitors & customersof your competitors & customers
• It is also relative to it’s reach It is also relative to it’s reach (e.g. if your patent protected product only has application in a (e.g. if your patent protected product only has application in a very small segment of the market)very small segment of the market)
• Strength is cumulative i.e. if you have more than Strength is cumulative i.e. if you have more than one Strategic Control Point you can add their one Strategic Control Point you can add their scores togetherscores together
The TemplateThe TemplatePossession Reach
Strength vs. Competitors /
CustomersIndex Value
Do you Posses it? (Yes=1, No=0)
What %age of your Sales does it
apply to?
Countervailing strength of
Competitors / Customers
Index value for my industry
Extended Value
A B C D AxBxCxD
Commodity with cost disadvantage 1 0.0
Commodity with cost parity 2 0.0
Commodity with 10% to 20% cost advantage
3 0.0
One Year lead in Product development 4 0.0
Two Year lead in Product development 5 0.0
Strong Brand, Copyright or Patent protection
6 0.0
Own the Customer Relationship 7 0.0
String of super-dominant positions 8 0.0
Control the Value Chain / Distribution 9 0.0
Own the Industry Standard 10 0.0
0.0Total Strategic Control Rating
Strategic Control Point
ExamplesExamplesINTEL GE
Possession ReachStrength vs.
Competitors / Customers
Index Value
Do you Posses it? (Yes=1, No=0)
What %age of your Sales does it
apply to?
Countervailing strength of
Competitors / Customers
Index value for my industry
Extended Value
A B C D AxBxCxD
Commodity with cost disadvantage 1 0.0
Commodity with cost parity 2 0.0
Commodity with 10% to 20% cost advantage
1 100% 70% 3 2.1
One Year lead in Product development 4 0.0
Two Year lead in Product development 5 0.0
Strong Brand, Copyright or Patent protection
6 0.0
Own the Customer Relationship 1 100% 70% 7 4.9
String of super-dominant positions 8 0.0
Control the Value Chain / Distribution 9 0.0
Own the Industry Standard 10 0.0
7.0Total Strategic Control Rating
Strategic Control Point
Possession ReachStrength vs.
Competitors / Customers
Index Value
Do you Posses it? (Yes=1, No=0)
What %age of your Sales does it
apply to?
Countervailing strength of
Competitors / Customers
Index value for my industry
Extended Value
A B C D AxBxCxD
Commodity with cost disadvantage 1 0.0
Commodity with cost parity 2 0.0
Commodity with 10% to 20% cost advantage
3 0.0
One Year lead in Product development 4 0.0
Two Year lead in Product development 1 60% 40% 5 1.2
Strong Brand, Copyright or Patent protection
1 100% 70% 6 4.2
Own the Customer Relationship 7 0.0
String of super-dominant positions 8 0.0
Control the Value Chain / Distribution 1 80% 50% 9 3.6
Own the Industry Standard 10 0.0
9.0Total Strategic Control Rating
Strategic Control Point
End of Section 1End of Section 1
Do we understand what Business Do we understand what Business Design is all about ?Design is all about ?
Going DownstreamGoing Downstream
• Going downstream involves assessing the Going downstream involves assessing the potential application of three generic profit potential application of three generic profit models …models …– Customer Solution ProfitCustomer Solution Profit– After sale / installed base profitAfter sale / installed base profit– Value chain position profitValue chain position profit
Customer Solution ProfitCustomer Solution Profit• Know the customerKnow the customer
• Create a solution (that Create a solution (that reduces total customer reduces total customer system costs)system costs)
• Build the relationshipBuild the relationship
• May incur early lossesMay incur early losses
• But significant profits followBut significant profits follow• ExampleExample
ABB (can build & finance a power station ABB (can build & finance a power station not just supply the generators)not just supply the generators)GE (provides financing, maintenance & GE (provides financing, maintenance & scheduling services as well as selling scheduling services as well as selling locomotives)locomotives)
The Profit Zone
Product
ProductServices Options Financing
Sell the Box, or ...
Sell the Solution
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Time
Pro
fit
Source :- Slywotzky & Morrison, The Profit Zone
After-Sale / Installed Base After-Sale / Installed Base ProfitProfit
• Profit on the Initial sale is Profit on the Initial sale is secondary to profits from secondary to profits from follow-on products & servicesfollow-on products & services
• In the installed base model - In the installed base model - having the base gives you having the base gives you proprietary rights to the proprietary rights to the follow-on follow-on
• In the after-sales model you In the after-sales model you focus on follow-on sales of focus on follow-on sales of yours & others base productsyours & others base products
• ExampleExampleGillette (Razor sales secondary to blade Gillette (Razor sales secondary to blade follow on sales)follow on sales)
The Profit Zone
ProductMaintenance Consumables Accessories
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Hardware Consumables /Base Product Follow-on Products
Pro
fit
Ma
rgin
After-Sales Model
Installed Base Model
Source :- Slywotzky & Morrison, The Profit Zone
Value Chain Position ProfitValue Chain Position Profit
• Profit concentrates Profit concentrates itself in certain parts itself in certain parts of the value chainof the value chain
• Profit comes from Profit comes from – participating in the participating in the
more profitable value more profitable value chain segments ORchain segments OR
– capturing downstream capturing downstream margin by leveraging margin by leveraging value chain power value chain power
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
0 25% 50% 75% 100%Share of Industry Revenue
Op
era
tin
g M
arg
in0
5%
10
%1
5%
20
%
Source :- Slywotzky & Morrison, The Profit Zone
Auto Manufacturing
Used Car Dealers
AutoInsurance
Service / Repair
Auto R
entalAfter-
marketParts
Leasing
AutoLoans
Warranty
Gasoline
New CarDealers
Tools to assist in the processTools to assist in the process
• Total System Economics Total System Economics (Little Box / Big Box)(Little Box / Big Box)
• Value Chain AnalysisValue Chain Analysis
• Downstream Potential Tool Downstream Potential Tool (HBR Article)(HBR Article)
Total System EconomicsTotal System Economics
• Expense of UsageExpense of Usage• Cost of MaintenanceCost of Maintenance• Associated LabourAssociated Labour• Cost of DistributionCost of Distribution• Cost of InventoryCost of Inventory• Cost of Defects / Cost of Defects /
Returns / FailureReturns / Failure• Costs of inflexibilityCosts of inflexibility• InefficienciesInefficiencies
Big Box :The Customer’s Total Economics
Little Box :Our Product
Sales
Reducing the Customer’s Total System Economics (Big Box) creates opportunities to increase our product sales (Little Box)
Total System EconomicsTotal System EconomicsExample : - Printing CompanyExample : - Printing Company
• This company sold mainly Point of Sale Material to big This company sold mainly Point of Sale Material to big consumer marketing companies (e.g. Coke, Frito Lay, etc.)consumer marketing companies (e.g. Coke, Frito Lay, etc.)
• Business was competitive based upon cost per item.Business was competitive based upon cost per item.• The printer investigated their customer’s real cost of putting The printer investigated their customer’s real cost of putting
POS Material in the market and found that for the average POS POS Material in the market and found that for the average POS Promotion, 40% of the printed materials never made it to a store Promotion, 40% of the printed materials never made it to a store to be displayed due to inefficient customer distribution systems to be displayed due to inefficient customer distribution systems and poor tracking.and poor tracking.
• The printer changed his business model - he now organises The printer changed his business model - he now organises distribution to the store himself and charges the customer on a distribution to the store himself and charges the customer on a cost per item displayed instead of a cost per item printed.cost per item displayed instead of a cost per item printed.
• Needless to say his new model is far more profitable.Needless to say his new model is far more profitable.
Total System EconomicsTotal System EconomicsExample : - Printing CompanyExample : - Printing Company
• Expense of UsageExpense of Usage• Cost of MaintenanceCost of Maintenance• Associated LabourAssociated Labour• Cost of DistributionCost of Distribution• Cost of InventoryCost of Inventory• Cost of Defects / Cost of Defects /
Returns / FailureReturns / Failure• Costs of inflexibilityCosts of inflexibility• InefficienciesInefficiencies
Big Box :• Cost of Distribution / installation• Cost of having no POS material in
the store when the promo starts• Lost Sales at store• Cost of storing / disposing of
unused POS Material
Little Box :Cost of
Printing POS Material
Similar Exercise :-Similar Exercise :-What is most important to my What is most important to my customers? customers? (Customer Priorities)(Customer Priorities)
• What are the top three priorities for my What are the top three priorities for my customer’s business?customer’s business?
• Try to answer this question …Try to answer this question …– Imagine that you’re the CEO of your five most Imagine that you’re the CEO of your five most
important customersimportant customers• What would your overall objectives be?What would your overall objectives be?• What major concerns would you have?What major concerns would you have?• How could a supplier help you towards your How could a supplier help you towards your
goals?goals?
Value Chain AnalysisValue Chain AnalysisCan we draw this picture for the relevant Can we draw this picture for the relevant Customer Activities ?Customer Activities ?
0 25% 50% 75% 100%Share of Industry Revenue
Op
era
tin
g M
arg
in0
5%
10
%1
5%
20
%
Auto Manufacturing Used Car
Dealers
AutoInsurance
Service / Repair
Auto R
ental
After-marketParts
Leasing
AutoLoans
Warranty
Gasoline
New CarDealers
• What are the relevant What are the relevant segments ?segments ?(Total cost of a brake job ?)(Total cost of a brake job ?)
• How do we get the How do we get the data ?data ?
Downstream Potential ToolDownstream Potential Tool
• Attractiveness of Downstream BusinessAttractiveness of Downstream Business– Ratio of Installed base to New ProductsRatio of Installed base to New Products– Product Life Cycle Spend vs. Initial Product CostProduct Life Cycle Spend vs. Initial Product Cost– Difference between downstream margin & product marginDifference between downstream margin & product margin
• Importance of Customer RelationshipsImportance of Customer Relationships– Magnitude of Product differentiationMagnitude of Product differentiation– Market share of top 5 CustomersMarket share of top 5 Customers– Share of total profit earned from Top 20% of CustomersShare of total profit earned from Top 20% of Customers
• Power of the Distribution ChannelPower of the Distribution Channel– Distribution & selling expense as a percentage of product PriceDistribution & selling expense as a percentage of product Price– Channel Concentration - Market Share of Top 5 DistributorsChannel Concentration - Market Share of Top 5 Distributors– Degree of Channel Innovation or multiplicationDegree of Channel Innovation or multiplication
How to Scope out the Downstream OpportunityHow to Scope out the Downstream Opportunity
Ratio ofInstalled Base
to New Product Sales
2 x
20 x
Ratio ofLife CycleSpend to
Our ProductCost
1 x
5 x
Significant Patent
30%
60%
10%
50%
DifferenceBetween
D’stream Margin & Our Product
Margin
-10%
+10%
10%
50%
20%
30%
Stable &Monolithic
Dynamic &Multiplying
Unattractiveor Unimportant
Focus on Traditional
Mfg Strategies
Potentiallytroublesome
Monitor &Experiment
Attractive&
Imperative
Magnitude Of DownstremProduct-basedDifferentiation
MarketShare of
Top 5Customers
Share of TotalProfit earned
from the top 20%of Customers
Distribution &Selling Costs
as a Percentageof Product Price
ChannelConcentration
Share of Top 5
Distributors
Degree ofChannel
Multiplication
StrongBrand
Technology orPerformance
Lead
20% CostAdvantage
Commodity
Attractiveness of Downstream Business
Importance of Customer Relationships
Power of theDistribution Channel
Appendix AAppendix A
Generic Profit ModelsGeneric Profit Models
Notes about using the Generic Notes about using the Generic Profit ModelsProfit Models
• The models serve two purposesThe models serve two purposes– They help us understand the drivers of our current They help us understand the drivers of our current
profitabilityprofitability– They present us with alternative ways to look for future They present us with alternative ways to look for future
profitabilityprofitability
• The models illustrate where the The models illustrate where the keykey sources of sources of profit are, they don’t suggest that this is where profit are, they don’t suggest that this is where allall sales / profits should come fromsales / profits should come from
• There are few “pure” examples of any model - There are few “pure” examples of any model - most successful business use a combination of most successful business use a combination of modelsmodels
Notes about using the Generic Notes about using the Generic Profit Models (con’t)Profit Models (con’t)
• Following is a summary of 15 of the 21 profit Following is a summary of 15 of the 21 profit models used in the Business Modelling theory. A models used in the Business Modelling theory. A full list with more detailed descriptions and full list with more detailed descriptions and examples can be provided if required. examples can be provided if required.
Relative Market Share ProfitRelative Market Share Profit
• Companies with high Companies with high market shares are more market shares are more profitable because they profitable because they enjoy pricing enjoy pricing advantages and cost advantages and cost economies economies (manufacturing experience & (manufacturing experience & purchasing power)purchasing power)
• ExamplesExamplesProcter & Gamble, Procter & Gamble, Coles-MyerColes-Myer
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Relative Market Share
Re
turn
on
Sa
les
TheProfitZone
Source :- Slywotzky & Morrison, The Profit Zone
Cycle ProfitCycle Profit
• Firm profitability is a Firm profitability is a function of position in function of position in the cyclethe cycle
• Maximise profit within Maximise profit within the cycle by …the cycle by …– Lowering your break-Lowering your break-
even pointeven point– Pricing within the cyclePricing within the cycle
• ExampleExampleDow ChemicalsDow Chemicals (leads price (leads price increases as capacity tightens and increases as capacity tightens and lags decreases as capacity lags decreases as capacity declines)declines)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Capacity Utilisation
$ p
er
Un
it
TheProfitZone
Cost
Price
Source :- Slywotzky & Morrison, The Profit Zone
Brand ProfitBrand Profit• Brand company expends Brand company expends
considerable marketing considerable marketing investment in building investment in building awareness, recognition & awareness, recognition & credibilitycredibility
• These “intangibles” are These “intangibles” are reinforced by customer reinforced by customer experienceexperience
• The Brand achieves a The Brand achieves a significant price premium in significant price premium in the marketplacethe marketplace
• ExamplesExamplesNike, Coca-ColaNike, Coca-Cola
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Market BrandPrice Price
Pri
ce
pe
r U
nit
Source :- Slywotzky & Morrison, The Profit Zone
Product Pyramid ProfitProduct Pyramid Profit• Multi-tiered brandingMulti-tiered branding• Most of the Profit is Most of the Profit is
made at the top made at the top segments of the segments of the pyramidpyramid
• Base brands protect top Base brands protect top tier brands tier brands
• ExampleExampleSMHSMH (watch makers who derive (watch makers who derive more than half their profit from more than half their profit from Omega, Longines, Blancpain & Rado Omega, Longines, Blancpain & Rado brands but also have brands like brands but also have brands like Swatch, Tissot, etc.)Swatch, Tissot, etc.)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Volume
Pri
ce
Source :- Slywotzky & Morrison, The Profit Zone
The ProfitZone
Customer Solution ProfitCustomer Solution Profit• Know the customerKnow the customer
• Create a solution (that Create a solution (that reduces total customer reduces total customer system costs)system costs)
• Build the relationshipBuild the relationship
• May incur early lossesMay incur early losses
• But significant profits followBut significant profits follow• ExampleExample
ABB (can build & finance a power station ABB (can build & finance a power station not just supply the generators)not just supply the generators)GE (provides financing, maintenance & GE (provides financing, maintenance & scheduling services as well as selling scheduling services as well as selling locomotives)locomotives)
The Profit Zone
Product
ProductServices Options Financing
Sell the Box, or ...
Sell the Solution
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Time
Pro
fit
Source :- Slywotzky & Morrison, The Profit Zone
After-Sale / Installed Base After-Sale / Installed Base ProfitProfit
• Profit on the Initial sale is Profit on the Initial sale is secondary to profits from secondary to profits from follow-on products & servicesfollow-on products & services
• In the installed base model - In the installed base model - having the base gives you having the base gives you proprietary rights to the proprietary rights to the follow-on follow-on
• In the after-sales model you In the after-sales model you focus on follow-on sales of focus on follow-on sales of yours & others base productsyours & others base products
• ExampleExampleGillette (Razor sales secondary to blade Gillette (Razor sales secondary to blade follow on sales)follow on sales)
The Profit Zone
ProductMaintenance Consumables Accessories
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Hardware Consumables /Base Product Follow-on Products
Pro
fit
Ma
rgin
After-Sales Model
Installed Base Model
Source :- Slywotzky & Morrison, The Profit Zone
New Product ProfitNew Product Profit• New product profits are a New product profits are a
function of newness and growthfunction of newness and growth• New products produce high New products produce high
margins, which reduces as the margins, which reduces as the products matureproducts mature
• Profitability is driven by Profitability is driven by investing to lead the next investing to lead the next generation of products in your generation of products in your industryindustry
• ExampleExampleCompaqCompaq (it’s investment in servers gives it (it’s investment in servers gives it a high margin base while PC profits are a high margin base while PC profits are declining and Laptops are gradually reaching declining and Laptops are gradually reaching maturity) maturity)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Time
To
tal
Sa
les
$
The ProfitZone
Source :- Slywotzky & Morrison, The Profit Zone
““Two steps ahead” ProfitTwo steps ahead” Profit
• First mover generates First mover generates excess returns before excess returns before imitators begin to erode imitators begin to erode marginsmargins
• Create and maintain a Create and maintain a lead time over the next lead time over the next competitor and a competitor and a constant stream of new constant stream of new products products
• ExampleExampleIntelIntel (focuses on being two years (focuses on being two years ahead of nearest rival’s product ahead of nearest rival’s product developments)developments)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Q2 Q4 Q6 Q8 Quarters Post Launch
$ p
er
Un
it
TheProfitZone
Cost
Price
Source :- Slywotzky & Morrison, The Profit Zone
Protectable Intellectual Protectable Intellectual Property ProfitProperty Profit
• Profit comes from increasing Profit comes from increasing proportion of sales coming proportion of sales coming from patentable productsfrom patentable products
• Key driver of profitability is Key driver of profitability is the astute selection of R&D the astute selection of R&D projects to generate projects to generate tomorrow's productstomorrow's products
• ExamplesExamplesMerck, 3MMerck, 3M
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Five Years TodayAgo
Re
ve
nu
e
Source :- Slywotzky & Morrison, The Profit Zone
CommodityProducts
ProtectableIP
Products
CommodityProducts
ProtectableIP
Products
Local Leadership ProfitLocal Leadership Profit
• Profitability is a Profitability is a function of local function of local market strengthmarket strength
• Cost structure is local Cost structure is local in naturein nature
• Profitability supports Profitability supports growth, not the other growth, not the other way around way around
• ExampleExampleWal-martWal-mart (established stores (established stores county by county and focussed on county by county and focussed on achieving local dominance) achieving local dominance)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Local Market Share
Pro
fita
bil
ity
by
Re
gio
n0
The ProfitZone
Source :- Slywotzky & Morrison, The Profit Zone
Value Chain Position ProfitValue Chain Position Profit
• Profit concentrates Profit concentrates itself in certain parts itself in certain parts of the value chainof the value chain
• Profit comes from Profit comes from – participating in the participating in the
more profitable value more profitable value chain segments ORchain segments OR
– capturing downstream capturing downstream margin by leveraging margin by leveraging value chain power value chain power
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
0 25% 50% 75% 100%Share of Industry Revenue
Op
era
tin
g M
arg
in0
5%
10
%1
5%
20
%
Source :- Slywotzky & Morrison, The Profit Zone
Auto Manufacturing
Used Car Dealers
AutoInsurance
Service / Repair
Auto R
entalAfter-
marketParts
Leasing
AutoLoans
Warranty
Gasoline
New CarDealers
Low-Cost Business Low-Cost Business Design ProfitDesign Profit
• New entrant trumps the New entrant trumps the incumbent's low cost (through incumbent's low cost (through experience) business model experience) business model with a new model that with a new model that – Uses new technology to Uses new technology to
produce cheaperproduce cheaper– Uses different go-to-market or Uses different go-to-market or
fulfilment systems to deliver fulfilment systems to deliver better customer valuebetter customer value
– Deletes unnecessary or Deletes unnecessary or obsolete features from product obsolete features from product offer offer
• ExamplesExamplesDell in computing, Nucor in Dell in computing, Nucor in steelsteel
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Conventional Low Cost Business Business Design Design
Co
st
pe
r U
nit
Source :- Slywotzky & Morrison, The Profit Zone
Switchboard ProfitSwitchboard Profit• In marketsIn markets characterised by characterised by
multiple sellers communicating multiple sellers communicating with multiple buyers, with each with multiple buyers, with each incurring high costs in doing so, incurring high costs in doing so, a switchboard can provide a a switchboard can provide a valuable servicevaluable service
• A switchboard becomes the A switchboard becomes the single point of communication, single point of communication, reducing the costs of buyers &reducing the costs of buyers &sellers sellers
• It profits through advertising and/or transaction feesIt profits through advertising and/or transaction fees• The increase in available information often reduces the premium sellers gain in The increase in available information often reduces the premium sellers gain in
selling to uninformed buyersselling to uninformed buyers• ExamplesExamples
Schwab (investments), Auto-by-tel (on-line car sales), Schwab (investments), Auto-by-tel (on-line car sales), ChemConnect (chemical trading on-line)ChemConnect (chemical trading on-line)
Value Capture - Generic Profit ModelsValue Capture - Generic Profit Models
Source :- Slywotzky & Morrison, The Profit Zone
Intermediary(Switchboard)
The ProfitZone
Buyers Sellers
Appendix BAppendix B
Generic Frameworks for Generic Frameworks for Differentiation / Strategic ControlDifferentiation / Strategic Control
What is a Strategic Control Point ?What is a Strategic Control Point ?
• A Strategic Control point is a mechanism A Strategic Control point is a mechanism that helps protect the profits flowing from that helps protect the profits flowing from a business model against the corrosive a business model against the corrosive effects of competition and customer powereffects of competition and customer power
• A business model without a strategic A business model without a strategic control point is like a ship with a hole in its control point is like a ship with a hole in its hull - it will sink much sooner !hull - it will sink much sooner !
• Strategic Control Point keep you in the Strategic Control Point keep you in the profit zone longerprofit zone longer
Examples of Strategic Control Examples of Strategic Control PointsPoints
Business models that have strong ...Business models that have strong ...• Brand, Copyright, PatentsBrand, Copyright, Patents• Control of Distribution / the Value ChainControl of Distribution / the Value Chain• Two year lead in product developmentTwo year lead in product development• Commodity with 10% - 20% cost Commodity with 10% - 20% cost
advantageadvantage
Assessing the strength of your Assessing the strength of your Strategic Control Point(s)Strategic Control Point(s)
• Strength is often different in different industriesStrength is often different in different industries(e.g. Brand is almost irrelevant in OE Automotive but extremely (e.g. Brand is almost irrelevant in OE Automotive but extremely relevant in carbonated beverages)relevant in carbonated beverages)
• Strength is relative to the countervailing strength Strength is relative to the countervailing strength of your competitors & customersof your competitors & customers
• It is also relative to it’s reach It is also relative to it’s reach (e.g. if your have patent protected product only has application in (e.g. if your have patent protected product only has application in a very small segment of the market)a very small segment of the market)
• Strength is cumulative i.e. if you have more than Strength is cumulative i.e. if you have more than one Strategic Control Point you can add their one Strategic Control Point you can add their scores togetherscores together
The TemplateThe TemplatePossession Reach
Strength vs. Competitors /
CustomersIndex Value
Do you Posses it? (Yes=1, No=0)
What %age of your Sales does it
apply to?
Countervailing strength of
Competitors / Customers
Index value for my industry
Extended Value
A B C D AxBxCxD
Commodity with cost disadvantage 1 0.0
Commodity with cost parity 2 0.0
Commodity with 10% to 20% cost advantage
3 0.0
One Year lead in Product development 4 0.0
Two Year lead in Product development 5 0.0
Strong Brand, Copyright or Patent protection
6 0.0
Own the Customer Relationship 7 0.0
String of super-dominant positions 8 0.0
Control the Value Chain / Distribution 9 0.0
Own the Industry Standard 10 0.0
0.0Total Strategic Control Rating
Strategic Control Point
ExamplesExamplesINTEL GE
Possession ReachStrength vs.
Competitors / Customers
Index Value
Do you Posses it? (Yes=1, No=0)
What %age of your Sales does it
apply to?
Countervailing strength of
Competitors / Customers
Index value for my industry
Extended Value
A B C D AxBxCxD
Commodity with cost disadvantage 1 0.0
Commodity with cost parity 2 0.0
Commodity with 10% to 20% cost advantage
1 100% 70% 3 2.1
One Year lead in Product development 4 0.0
Two Year lead in Product development 5 0.0
Strong Brand, Copyright or Patent protection
6 0.0
Own the Customer Relationship 1 100% 70% 7 4.9
String of super-dominant positions 8 0.0
Control the Value Chain / Distribution 9 0.0
Own the Industry Standard 10 0.0
7.0Total Strategic Control Rating
Strategic Control Point
Possession ReachStrength vs.
Competitors / Customers
Index Value
Do you Posses it? (Yes=1, No=0)
What %age of your Sales does it
apply to?
Countervailing strength of
Competitors / Customers
Index value for my industry
Extended Value
A B C D AxBxCxD
Commodity with cost disadvantage 1 0.0
Commodity with cost parity 2 0.0
Commodity with 10% to 20% cost advantage
3 0.0
One Year lead in Product development 4 0.0
Two Year lead in Product development 1 60% 40% 5 1.2
Strong Brand, Copyright or Patent protection
1 100% 70% 6 4.2
Own the Customer Relationship 7 0.0
String of super-dominant positions 8 0.0
Control the Value Chain / Distribution 1 80% 50% 9 3.6
Own the Industry Standard 10 0.0
9.0Total Strategic Control Rating
Strategic Control Point