How Profit Happens

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How profit happens
How profit happens
by ADRIAN J. SLYWOTZKY and DAVID J. MORRISON

Adrian J. Slywotzky and David J. Morrison are vice presidents and members of the board of directors of Mercer Management Consulting in Boston. This article was adapted for Viewpoint from their book The Profit Zone and is reprinted bypermission of Times Books, a division of Random House, Inc. Mr. Slywotzky is also the author of Value Migration.

See also: http://www.mmc.com/views2/Rothschild200404.pdf What are the 10 most profitable companies you know? Why are they so profitable? Are the reasons the same?

In the product-centricworld of the past, profit was an outcome of a strong market share. Companies focused on one goal: sellmore, to anyone willing to buy. Companies generated revenue on each unit sold. How the company profited from those sales was all but taken for granted. Today, profit is not generated merely from the products a company sells, and profit cannot be taken for granted. Today, profit is an outcome of smart business design. In fact, the value recapture dimension of a business design--the "How do I getpaid?" dimension--is one of its most critical components. Without a clear understanding of how profit happens and how businesses must be designed to capture it, there will not be any profit. Articulating and designing the profit model is now a critical strategic skill. The profit models we describe below illustrate that there are many different ways of solving the "profit-by-design" problem. Don'tmake another major investment until you have satisfied yourself that the company knows exactly how it will make money and what tactical actions will be required to do so consistently.

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Profitability is an extraordinarily complex phenomenon. How and why profitability occurs varies significantly from one industry or company toanother. There are at least 22 models/patterns of profitability that explain how profit happens in various businesses. More will be discovered in the next few years. And, in certain businesses, the interplay of two or more of these models explains how profit really happens in the business. A review of these different models shows how different the mechanisms of profitability can be. It also revealsthe central role of the customer--in terms of acquisition cost, buying behavior, price sensitivity, bargaining power and so on--in the mechanism of action of each model.
Profit-Centric Business Design

One of the most productive questions you can ask your organization today is: What is our profit model? How do we make money? In the past, profit-centric thinking was not a key part of the strategyprocess because it didn't need to be. The classic rules of strategy said: "Gain market share and profits will follow." Empirically, this was an accurate rule-of-thumb for most industries. The driver, the central issue in strategy, wasn't profit--it was market share. The sequence was as follows: Create or gain competitive advantage. Then competitive advantage will gain market share. The gain inmarket share will make the company increasingly profitable. In the past decade, the classic rules of strategy broke down. The close correlation between market share leadership and superior profitability collapsed. What happened? The rules changed. Rapid technological change and enormous influxes of venture capital lowered barriers to entry and cost-to-serve in many industries. In the newenvironment, enormous market share with the wrong business model is a liability, not an advantage. In the new profitcentric world, massive market share doesn't matter. What matters is understanding where you can make a profit in your industry. Within that potentially profitable zone, is your business model closely matched to what customers want and are willing to pay? Is your business model cost-effective...
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