How To Map Your Industry’s Profit Pools |
Bus J-411 |
Carl Greeno III |
In this article it describes a useful framework for analyzing how profits are distributed among the various activities that form an industry’s value chain. A profit-pool opens a window onto the underlying structure of the industry, helping managers see the economic and competitive forces that are determining the distribution of profits. The strategy of a firm should be informed by an understanding of the sources and distribution of profits generated in an industry. Gadiesh and Gilbert took a value chain perspective to this when developing the profit pool framework. Profitability in different segments and stages of the value chain may vary a lot by product and customer group, by geography, or by channel.
Step 1: Define the pool
Key is to look at the industry ...view middle of the document...
Defining the bounds of a profit pool requires, in short, not just analytical skills but also good, basic business judgment. The pool you draw must be tailored to fit the strategic questions you face.
Step 2: Determine the size of the pool.
At this point, the goal is to estimate overall industry profits, which will serve as a base line. This may require some estimates for individual companies, and already an initial breakdown of aggregated numbers by product, channel, region, etc. Try to cross-check the numbers by combining different perspectives. Focus on the larger companies and key products – you can always extrapolate these numbers to smaller players.
Step 3: Break down the profits by activity.
If you are in an industry where all companies focus on an individual step in the value chain, you can just aggregate their respective numbers. If there are a number of vertically integrated or mixed players, you will need to disaggregate each company’s financial data, and make estimates for specific activities. Again, looking at pure players, and looking at large companies who break out their results in 10Ks by segment, will help you solve 80% of the puzzle, so that you can then extrapolate the other 20%. Don’t forget to look at your own company’s economics as a proxy. And finally, here is where creativity comes in!
Overall, the “profit pools” framework can serve a number of purposes:
- help identify new sources of profits for a company
By this I mean adjusting to your competitors moves and readjusting your strategy. So for example there is a segment in capsim that a lot of the competitors are moving out of you can invest highly in those to gain a profit and dominate a market.
- rethink the role a company plays in the value chain, potentially helping to refocus
Again, this ties into the repositioning of your strategy. Changes will have to be made through the game and you must refocus your strategy to gain an advantage over your competitors.
- assist in product and segment decisions.