Profit Pools and Industry Analysis James Oldroyd Kellogg Graduate School of Management Northwestern University TNRB

SUPPLIER POWER HIGH strong labor unions concentrated aircraft makers THREAT OF ENTRY HIGH entrants have cost advantages low capital requirements little product differentiation deregulation of governmental barriers INDUSTRY COMPETITIVENESS HIGH many companies little differentiation excess capacity high fixed/variable costs cyclical demand THREAT OF SUBSTITUTES MEDIUM Autos/train for short distances BUYER POWER MEDIUM/HIGH Buyers extremely price sensitive Good access to information Low switching costs Example: Airlines Source: J. de la Torre

SUPPLIER POWER LOW THREAT OF ENTRY LOW economies of scale capital requirements for R&D and clinical trials product differentiation control of distribution channels patent protection INDUSTRY COMPETITIVENESS LOW high concentration product differentiation patent protection steady demand growth no cyclical fluctuations of demand THREAT OF SUBSTITUTES LOW No substitutes. (Changing as managed care encourages generics.) BUYER POWER LOW Physician as buyer: Not price sensitive No bargaining power. (Changing with managed care.) Example: Pharmaceuticals Source: J. de la Torre

3 What are the problems with the 5 forces model?

4 What is a value chain?

5 THE PC INDUSTRY’S PROFIT POOL 40% % Share of Industry Revenue operating margin microprocessors other components personal computers software peripherals services The value chain for the PC industry includes six key activities; the profitability of the activities varies widely. Manufacturers compete in the largest but least-profitable segment of the chain. source: Gadiesh and Gilbert, Harvard Business Review, May-June 1998

6 THE U.S. AUTO INDUSTRY’S PROFIT POOL 25% % Share of Industry Revenue operating margin auto manufacturing new car dealers used car dealers auto loans auto insurance aftermarket parts 20 leasing warranty gasoline service repair auto rental The automotive industry encompasses many value-chain activities. The way that profits and revenues are distributed among these activities varies greatly. The most profitable areas of the car business are not the ones that generate the biggest revenues. source: Gadiesh and Gilbert, Harvard Business Review, May-June 1998

7 Profit Pools: Company Examples Companies Automakers U-Haul Elevators (OTIS) Iomega Polaroid Core Business Auto manufacturing Truck Rental Elevator Manufacturing Zip Drives Instant Photography Cameras Sources of Highest ROI Leasing, insurance, service. Packing materials, storage Service Zip Disks; Storage Film

The Challenges of Expanding Product or Service Offerings Why don’t firms simply offer the entire value chain to customers? What is a pool? How big is a pool?

9 Source: Adapted from Treacy and Wiersema, The Discipline of Market Leaders. Perseus Books Customer Intimacy Product Leadership Operational Excellence Faster Better Closer Focus

10 The Claimed Focus Customer Intimacy Product Leadership Operational Excellence

11 Source: Adapted from Treacy and Wiersema, The Discipline of Market Leaders. Perseus Books The Reality 197 Operating Companies Customer Intimacy Product Leadership Operational Excellence Faster Better Closer ?

12 Challenges – Overcoming Firm Legacy 1948 First instant camera 1981 Formation of electronic group 1989 Polaroid capable of 1.9 m pixels vs. competitors 480k 1990 Research investments cut, lab sold to MIT, focus on marketing 1992 Prototype of digital camera ready 1996 Digital camera announced (already 40 competitors) 1998 Photo play category introduced Polaroid Onxy monochrome digital images printed from mobile handheld devices Opal Color prints in 1 second vs. 40 seconds of current technology $10 billion invested over 10 years Two new technologies: Stock falls from over $40 to.03 in 4 years

13 Trade Off’s High Low Independent Integrated Ability to Coordinate Activities Accountability

14 The Added Cost of Coordination Newspaper- Broadcast-Interactive Sales Force Media Net Sales Force Tribune is double counting commissions Resulting in Twice the Sales Cost Makes a Sale

15 Problem of Aligning Perception Your Idea… The Customer’s Idea … 2+2=3 Willingness to Pay Supplier opportunity cost Cost Price Value Captured by Customer Value Captured by Firm Value Captured by Supplier Willingness to Pay Supplier opportunity cost Cost Price Value Captured by Customer Value Captured by Firm Value Captured by Supplier

16 Problem of Managerial Skills ABC In depth Knowledge about the specific product/ services DE Broad understanding of the overarching business solution and the ability to perform consultative selling Moving From In- Depth to Breadth

17 Alignment Challenges 11 Newspapers 2 Cable Channels Broadcast Print Interactive Events Advertising Agencies Miss Match TMN 23 Broadcast Stations Interactive Events

18 Channel Challenges 3 million independent sales representatives J.C. Penney and other retail outlets The Market Barrier

19 Channel Continued… The Corporation The Channel The Market Barrier Ford Corporation Purchased Dealerships to give it direct customer access In 2002 “Ford is selling its Company-owned dealerships” Source: 2001 Annual Report Direct Approach via Ford.com and other online sites

20 Online access to account information – Account activity & balances – Portfolio holdings Online access to Merrill Lynch research Ability to with financial consultant Online bill payment capabilities Access to Merrill Lynch analytical tools Ability to execute trades Source: ml.com Channel Continued… Brokers The Market ml.com Merrill Lynch sought to involve brokers in the online process to minimize dissatisfaction

21 Channel Continued… The Market The Travel Agent The Airlines The Solution Frequent Flier Programs

22 Economic Challenges It takes a substantial investment to:  identify the market  And Interpret the Market  Adapt to the Market

23 Product Dilemma We knew products had reached maturity when we introduced several new products and did not get the bump in market share we were used to getting Corporate Executive, 2002 What is the point of another flavor of toothpaste, another feature crammed into Microsoft Word, or another gizmo on the dash of a Ford minivan? Tom Kelly, GM of IDEO, as quoted in Business Week, 2001

24 Product Parity Forces Firms into the Bottom Half of the Circle Profits over time 0% 20% 40% 60% 80% 100% Growth ConsolidationMaturity Decline Industry trend Product Service Value Added Price Radical Innovation Product Features Focus

25 Maturing Markets Profitability High Low Strong Weak Position in the Supply Chain Ability to Generate Value Enhancing Ideas ExtensiveLimited Typical Path Maturity

26 The Drive for Solutions Product Parity New Delivery Vehicles Internet and aggregators Customer Needs are Changing

27 Dimensions of Value Value Price Differentiation Product Service Bottom Line Value Top Line Value Willingness to Pay Cost Price Value Captured by Customer Value Captured by Firm Value Captured by Supplier Supplier Opportunity Costs

28 THREE DISTINCT STRATEGIES TO BEAT THE COMMODITY TRAP Scope Extension Company focus Significant Limited ProductService 132 What you do Who you are

29 SEVERAL COMPANIES HAVE MADE THIS TRANSITION SUCCESSFULLY Scope Extension Company focus Significant Limited ProductService 132 Cemex Starbucks Cisco GEMS Tribune What you do Who you are

30 Significant Limited ProductService 132 CemexStarbucks Cisco GEMS Tribune Scope Extension Company focus What you do Who you are ALTHOUGH VALUE CAN BE GENERATED BY MOVING TOWARDS SOLUTIONS OR CUSTOMERS A COMPLETE TURN ESSENTIAL TO SUSTAIN STRONG POSITION Taking the Turn

31 GEMS CHANGING SCOPE AND THEN COMPANY FOCUS Scope Extension Company focus Significant Limited ProductService Introduction Market leader in diagnostic imaging with over 40% market share Grew in the 90s through acquisitions Scope extension ideas Slowly moving pure equipment sales to financial and consulting services Education of customers (TIP TV) Quality and Productivity programs Changing company focus Use of Field Engineers not only as technical experts but onsite customer relationship developers Change organization focus to allow dedicated resource focusing on customer service "Becoming better than the best through a boundaryless corporation" "Becoming better than the best through a boundaryless corporation"

32 STARBUCKS CHANGING FOCUS AND THEN SCOPE Introduction Gourmet coffee reseller focusing on creating "Starbucks culture" current market cap $1.6bn Changing company focus Built strong brand recognition through distinct culture building exercise Created "customers as partners" philosophy Joint branding and licensing agreements exercise creating faster product recognition Starbucks/Pepsi frappuccino, Starbucks/Dreyers ice cream Scope extension ideas Extending service offering to include new products gourmet lunches, Tazo teas, music Established strong partnerships allowing access to alternate mediums of sale partnership with United Airlines, Barnes & Noble, Craft "Creating a new customer culture, providing a suite of solutions " "Creating a new customer culture, providing a suite of solutions " Scope Extension Company focus Significant Limited ProductService

33 Introduction Large networking solutions provider Exponential growth through acquisition strategy underlying growth philosophy is new product ideas through acquisitions, partnerships, external; R&D acquisition focused on small companies with customer focus Changing company focus Acquisition focus on companies controlling customer intimacy rather than companies with technology capabilities Worked with customers to tailor make networks Customer advocacy cornerstone of culture customer satisfaction based compensation Moving from segment focus business model to product focus Scope extension ideas Moved from router only company to end to end networking solutions CISCO CHANGING FOCUS AND THEN SCOPE "Customer Advocacy is the company agenda " Scope Extension Company focus Significant Limited ProductService

34 CEMEX A COMPANY THAT PURSUED THE HYBRID APPROACH Introduction Cemex started as a Mexican cement company and is today the 3rd largest cement producer in the world vertically integrated into distribution of construction materials largest steel and cement transporter in Mexico Scope extension ideas Broader product categories cement cement + cement derivatives + construction materials Extensive client support programs including product education, delivery speed, inventory management, financing of project, infrastructure cost sharing Reconfiguration of sales channel introduction of Arkio, online/offline sales channel introduction of Promexma program, own distribution centers Changing company focus Changed performance metrics to reward on customer satisfaction Leveraging IT and internet capabilities to get closer to customers "Generating returns by providing comprehensive construction solutions to targeted customers" "Generating returns by providing comprehensive construction solutions to targeted customers" Scope Extension Company focus Significant Limited ProductService

35 What is a Solution? First Steps  Product Extension  Service Extension  Philosophical Extension Purchase Experience Product Needs Customer Guest 63% of Fortune 100 Firms claim to offer solutions. Solution helps customers succeed in the marketplace by enhancing revenues, reducing current or future costs. Finally  Co-created value add  Integrated Offering  Creates some risk  Requires intimate customer knowledge  Is completely customized Source: Adapted from “From Solutions to Symbiosis” Sharma, Lucier, and Molloy. Strategy and Business, 2002

36 The Proliferation of Solutions Change in shift from selling products/services to selling value-added solutions Change in shift from selling products/services to selling value-added solutions

37 Challenges of Providing a Solution Solution must increase the Willingness to Pay and the price or decrease the cost to Serve to add value to the firm Some Common Pitfalls Firm provides more product features or services (solution) but customers are unwilling to pay for the features or additional services Firm is unable to quantify the value added and thus is not remunerated for the effort Customer requirements vary resulting in the need for an infinitely flexible system Solution is not scalable Firm is unwilling to bear higher initial cost necessary to create a solution Supplier opportunity cost Willingness to Pay Cost Price Value Captured by Customer Value Captured by Firm Value Captured by Supplier

38 Challenges of Pricing a Solution The Key is to generate new revenue or be able to charge a premium for the additional service Source: McKinsey Quarterly Putting a Price on Solutions, 2001, Number 3. Customer Value of Solutions Offered +/ Marginal Revenue Marginal Cost Marginal Investment Revenue without new systems Revenue with new systems Revenue from new systems Revenue from old systems Revenue from related products and services Revenue from old system Revenue from related products and services Number of new systems users and frequency of use Fees User fees and access fees Add on product fees and service

39 Challenges of Selling Solutions Product Performance Customer Performance Intra Organizational Coordination Inter Organizational Coordination Product Selling Consultative Selling Vs. Only Product Risk Performance Risk Vs.

40 Product vs. Service Traffic Server Sales a software solution for around $25,000 plus the required hardware Problems: Capital expenditures and risks are fully shouldered by Akamai - Model is difficult to Scale Benefits: Software is easy to scale. Costs are fixed. Benefits: Easy to sell. Low upfront costs. Problems: Huge upfront costs. Key Customer: AOL Key Customer: Yahoo! Content Delivery

41 Mega Aggregators- A serious attempt Scheduling Electronic Charting Insurance Reimbursement Co-pay Electronic Prescription Reporting Compliance Offers the Physician one software, hardware and support to allow an office to move all records to electronic format.

Three Tools of industry analysis

43 Bargaining Power of Suppliers Threat of New Entrants Threat of New Entrants Rivalry among Existing Competitors Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes Threat of Substitutes Industry Analysis Porter’s Five Forces Model

44 SWOT Analysis: Additional Industry Analysis Tools Numerous Environmental O pportunities S ubstantial Internal Strengths Major Environmental T hreats Critical Internal W eaknesses Overcome Weaknesses Grow DiversifyRestructure

45 THE U.S. AUTO INDUSTRY’S PROFIT POOL 25% % Share of Industry Revenue operating margin auto manufacturing new car dealers used car dealers auto loans auto insurance aftermarket parts 20 leasing warranty gasoline service repair auto rental The automotive industry encompasses many value-chain activities. The way that profits and revenues are distributed among these activities varies greatly. The most profitable areas of the car business are not the ones that generate the biggest revenues. source: Gadiesh and Gilbert, Harvard Business Review, May-June 1998