Derek Sivers

Entrepreneur, programmer, avid student of life. I make useful things, and share what I learn.

The Art of Profitability - by Adrian Slywotzky

The Art of Profitability - by Adrian Slywotzky

Amazon page for details and reviews.

25 different models of profitability presented in examples you can relate to your own business, making you realize profit-sources you’d never thought of before.

my notes

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

One of the ugliest moments in business is when the customer changes, the profit model changes, so the business design has to change. It's horrible. You don't want to move mentally because you've been so successful, yet you must move or you'll stagnate or go bankrupt. The more deeply you're enmeshed in yesterday's success system, the more impossible it is for you to imagine what tomorrow's success system will be.

Innumeracy lesson: you 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.

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.

Make notes on implications for your organization. Some questions to get you started:
* - Which of these profit models are at work in my business? Can I identify others?
* - How does profit happen in my competitors' businesses?
* - What can I do in the next 90 days to intensify my organization's focus on profitability?
* - Which profit models would enable us to maximize profit this year?
* - Is my organization aligned to capitalize on the profit models in my business?


############################### 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.
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.
Potential applications: Anything, except where there is no relationship-building.
Where does it NOT work?

############################### PYRAMID PROFIT
Company 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.
Can't build a pyramid without understanding all of the customers: current and potential.
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.
Premium gas = bad pyramid because there's no reason to buy the top one. American Express Platinum card = so-so pyramid for same reason.
Can only be applied in a few situations: 1 out of 50.
The customers themselves form a heirarchy, with different expectations and attitudes towards price. The pyramid is made to capture them all.
Other examples: Nokia phones, Swatch, GM cars. Think of 10 more?

############################### 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.
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.
Story of guy who saw bookstore could be a base for building several new high-profit components: corporate business, book-group business, personal service business. Dramatically intensify outbound selling activities. Have a couple account managers call on corporate libraries and HR depts to promote latest business books. Services to local book groups. Promoting sales to high-purchase individuals. (Their best customers bought $500/year, but never realized these people represented a separate component of their business that they could consciously deliberately target and grow.)
With little increase in labor (+ 2 account managers) and no increase in assets, bookstores that were barely surviving turned into obscsenely profitable businesses.
Developed 200 company accounts (corps, law firms, accountants), 200 book groups, 500 high-purchase individuals. Increased not just sales but customer satisfaction, flow of info as to what customers wanted.
(in $M) trad-only trad+outbound
revenue 10 12
cost 9.9 11
profit 0.1 1.0
salesreturn 1% 8%
assets 3 3
assetreturn 3% 33%

############################### 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.
Ovitz put most of entire movie needs together: representing writer, actors, director.
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. Probability of striking a deal goes way way up. Studio has to deal with you.
Profitability per unit of effort and unit of time is probably 7-10 times greater than in the traditional model.
Examples: EBAY, Wilson & Sonsini (Silicon Valley startups), Michael Ovits (Hollywood deals)

############################### TIME PROFIT
Takes 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.
When a product is new, it earns premium profits. Then, when a competitor copies the innovation, price competition drives profits to zero. Companies relying on this model make continuous innovation the modus operandi.
Invent. Then make a ton of money before the imitation starts.
Needs instant diffusion: a faster way to squeeze out the juice before everyone else learns the secret. Systemize: 2 weeks before announcing a new product, email 200 clients letting them know it's on the way, a week in advance call them to tell them again, a few days before launch train all employees covering every detail of it until everyone is ready to cover every detail of it in their sleep. Launch Monday and sign up a ton of people immediately.
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.
Projects in R&D that have trivial value are left to die. 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.
Develop an imaginary portfolio of the top 15 blockbuster opportunities in your market, whether or not you have a corresponding product.
Search for all you're not doing: assign at least one research molecule directed at each of the 15.
In "A Technique for Producing Ideas", study front-end loading: putting the cramming in the beginning. Total immersion, early. Read as much as you can as fast as you can all at the beginning. You get a structure of knowledge that's incomplete but powerful because every new fact or idea you run into later gets integrated into an evolving structure that keps getting stronger over time.
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.
Different from the Multi-Component profit because it's not the same product : it's different products from the same original asset.
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 PROFIT
Totally 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.".
Jack is cheap, precise. More detailed knowledge of where all his nickels are than most people have of their $20 bills. Preaches frugality with passion. A psychology of saving. Challenges necessities. Does meetings by phone instead of in-person. Gets rock-bottom prices from suppliers, making them understand how they'll benefit if Jack can keep growing twice as fast as the rest of his industry. Plans in advance, hyperorganized.
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 PROFIT
Specialists 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 PROFIT
Initial 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.
Let customers guide you : they're the ones who decide what they're willing to pay for, and how much.
Examples: All suppliers of laser printers and video game players. Sony (Playstation), Hewlett Packard (printers, cameras), Canon (printers, cameras), Gillette (razors)

############################### 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.
The dyestuff business had been a specialty product business like big pharma. 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.
Read Sam Walton Made In America and Shultz' Pour Your Heart Into it for examples of local leadership.
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.
NOT: "You take whatever business you can get." (that's what every salesman says about every customer. got to get the revenue, no matter how unprofitable it might be.)
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. How many doors did you refuse to enter? Drawn to the shiny lure of the next thing that came up. Losing sense of long-term self-interest, strategy, the smart thing to do.
Revenue increases proportionately with transaction volume but materials, construction, and or distribution costs do not.
Examples: Microsoft (Office software), Morgan Stanley (finance deals), Yahoo (website hosting)

############################### 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.
Intel and Microsoft as suppliers to the industry.
Would you rather be Wal-Mart or a supplier to Wal-Mart? (Wal-Mart)
Would you rather be Tom Clancy or his publisher? (Tom Clancy)
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.)
Note radical shifts in control points. 3 shifts from integrated system to specialists who control the action: computing, athletic shoes, Hollywood.
Note new control points that will arise in the next 2 years.
Partner with other members of the value chain (suppliers) to provide a more complete customer oriented service.
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 PROFIT
Price 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.
But people will pay top dollar for a car in big demand.
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.
Similarities to Installed Base model, except in this one, lots of different companies can benefit.
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.
Company sells financing and services to support equipment and goods originally purchased from other suppliers.
Example: General Electric (nuclear power plant services, auto loans, insurance)

############################### NEW PRODUCT PROFIT
Profit 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.
Starts with Gold Rush, goes to Pike's Peak, then No Profit Zone.
Problem is: during the Gold Rush, swept into the psychology, into the zone where even weak producers make money because demand is so strong. You can't think clearly about how to manage strategically.
Step #1: admit this is all true. (It's like a 22-year-old admitting he'll get old and impotent.)
Step #2: manage Parabola strategically: Overinvest by a factor of 3 on the left-hand side, and underinvest by a factor of 3 on the right-hand side. On the left-hand side fight for mindshare, be seen as the leader. Be everywhere.
Start measuring things that will give you clues you're at Pike's Peak. Growth rates. Customer excitement or boredom.
Then reverse the investment ratio a year before hitting the peak. Not getting out of the market, just managing the business to maximize cash flow and minimize the risk profile on the other side. Start building flexible plants instead of dedicated ones. Look for opportunities to sell dedicated plants to inevitable latecomers who still wanted to get into the game.
Be in a great position when things start getting ugly. Pull back on advertising, since everyone knows you from early mindshare grab. Serve the good customers & drop some bad ones.
Then be looking for the next wave. Spend a tremendous amount of time scouting the lanscape, looking for early signals of the inflection.
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 PROFIT
Companies 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.) Microscope versus radar screen. Can't be looking at both at the same time.
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 PROFIT
The 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 (book): 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.

############################### DIGITAL PROFIT: (duh)


from http://www.wjones.com/profit/profit/profit_forms.html :

*** Flawless Transaction Profit
Design expectation exceeding efficiency and elegance into each stage of the service transaction. Fosters a strong, passionate bond between customer and brand.
Examples: Apple, Dell, Ritz Carlton

*** Intellectual Property Profit
Similar to Time Profit with government protected competitive advantage expiring with patent or copyright.
Examples: Drug Makers, 3M (Post-It)

*** Big Bang Profit
Drive sales with a clear, strongly advertised message that has high market recall.
Examples: Afflak (supplementary insurance, advertising duck), IBM e-Business

*** Buzz Play Profit:
Invest in Public Relations to generate industry and customer chatter to drive sales. Often requires secrecy and controlled leaks to information hubs.
Examples: George Lucas (Star Wars), Apple (Macworld Conference), Harry Potter publishing franchise

*** Focus Profit:
Define limited, high value service priorities. Reduce costs in areas not associated with priorities. Focus brand, service development, customer support, investment on priorities.
Examples: IBM e-Business

*** Build-to-Order Profit:
Services are purchased before construction costs are incurred.

*** Geopolitical Profit:
Services are produced to maximize value of government factors in competition and costs of taxes, levies and business processes required by regulation.

*** Global Sourcing Profit:
The company selects operating locations for design, materials, construction and distribution to take advantage of better quality, lower cost natural resources, human resources, infrastructure and markets.

*** Governance Profit:
Policies and procedures are structured to identify and mitigate risks early in service development process. For companies with typically high costs due to liability.

*** Automation Profit:
Company achieves greater cost efficiencies over competitors via better use of technology in materials, construction or delivery.

*** Liquidation Profit:
Company sells non-core assets to reduce costs and increase short term profits.

*** Process Improvement Profit:
Company reduces manufacturing costs by reducing rework and improving plant output via techniques such as Six Sigma and Total Quality Management.

*** Price Cut Profit:
Trim prices to grow revenue In a price sensitive Market. In industries where the unit margin (difference between sale price and cost for a unit sold) is high, then month over month revenue growth will likely be more important to growing profit.

*** Global Expansion Profit:
Take existing products and expand into new international markets. Requires development of low cost distribution channels, localized marketing expertise, and localized legal and geopolitical expertise to minimize risks that could eliminate profitability.