PROFITABILITY: SURVIVING AND THRIVING IN A LAND OF GIANTS

Ken Wong

Key Number 1: The Right Priority and the REAL Enemy

2

MARGIN-SUCKINGMAGGOTS

Chasing the WRONG CustomersIn the WRONG Way

For the WRONG Reason

Profit: The Scorecard

3

Price

Cost

Minus

MarketShare

MarketSize

Times

Return OnInvestment

AssetsManaged

NetIncome

DividedBy

UnitMargins

Times

UnitVolumes

A Comparison of Profit Levers

Volume

Variable Cost

Price

3.3%

7.8%

11.1%

A 1% change in...

Creates a change in operating profit of ...

(Average economics of 2,463 businesses in Compustat)

Fixed Cost 2.3%

• The Tradeoffs Are Significant – Every 1% price cuts requires you to either cut variable costs by 1.34%

OR acquire enough new customers to raise volume by 3.4%

• Price cuts often lead to an erosion of quality– Price cuts that have an immediate financial impact focus on “shovel-

ready” sources of cost reduction that makes differentiation impossible– You cannot “automate” a relationship– Efficiency programs take time to implement

• There rarely is enough volume available to offset the cost of acquisition

Nothing destroys profits FASTER than cutting price

5

CUSTOMERS ALWAYS WANT LOWER PRICES

DO WE GIVE THEM THOSE PRICES?

HOW DO WE SUSTAIN PROFITABILITY IF WE DO?

Yes….but

• Four Ways to Enhance Value

1. MAINTAIN QUALITY – REDUCE PRICE

2. REDUCE QUALITY A "LITTLE" – REDUCE PRICE A "LOT"

3. INCREASE QUALITY – MAINTAIN PRICE

4. RAISE QUALITY A "LOT" – RAISE PRICE A "LITTLE"

Value is the RATIO of Quality-to-Price

• Longer strategic window of opportunity/advantage

• Greater economic efficiency

Why We Prefer "Quality-based Value Gains"

% chg 3 years post-recovery (SALES; EBITDA)

Some Evidence

SOURCE: "Roaring Out of Recession" (Gulati & Nohria, HBR 4/2010)

6.6%6.2%

PREVENTION(cut PRICES then

cut COSTS to fiance)

6.3

4.4

PROMOTION(spent heavily)

7.9

6.2

PRAGMATIC(cut costs THEN

reallocated cost toPrice &/or Promotion)

9.49.0

PROGRESSIVE(reallocated costs to

support new value prop)

13.0

12.2

The Giant’s AdvantageAnd how they’ll use it in the future

Economies of Scale - It Can Be a "Good Thing…"

100

1

50

2

12.50

8

25

4

Unit cost

Vol

The Large Firm's PROFIT

TheSmallFirm'sLOSS

11

…Or Even Greater When Used Properly

12

Via experience effects,economies of scale,market power, etc…

MORESCALE

LOWERCOSTS

Via businessplanning

LOWERPRICES

How Great Businesses Use Scale

13

Via experience effects,economies of scale,market power, etc…

MORESCALE

LOWERCOSTS

Via businessplanning

BETTERQUALITY

The Productivity Cycle - Basic Form

Via experience effects,economies of scale,market power, etc…

HIGHERSALESVia sales and

marketing MORESCALE

LOWERCOSTS

Via businessplanning

SUPERIORVALUE

Via execution andimplementation

LOWERPRICES

BETTERQUALITY

AND/OR

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• Price is Not the Best Way to Add Value

– Short strategic window

– Inefficiency relative to quality enhancement

The Giant’s Traditional Game Is Changing

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1. More Automation, Information Technology, Mobile Commerce– Scale underlies the giant’s advantage: people are not scalable

2. Giants will seek to compete on QUALITY OVER PRICE– Limits to Scale: Eventually scale effects bottom out– Market Diversity: Scale Requires Standardization– Profit Impact of Quality-driven value is superior– High-value accounts are less price-sensitive

3. There will be a BLURRING OF INDUSTRY BOUNDARIES– Competition for BASIC services will come from internet-based

competitors, traditional banks, affiliated banks (eg Rogers, Loblaws) and other established brands whose cost advantage is not scale-based

What Should We Expect?

How to Respond

1. Find a way to raise quality WITHOUT raising costs

OR

2. Find a way to reduce costs WITHOUT destroying quality

The Ultimate Strategic Challenge

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Priority One

Know Your Business Arena

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THE VIAGRA RULE

• People DO NOT buy products or services, they buy solutions to problems

• Customer willingness to pay a premium price increases– With the importance of the problem being solved– The complexity of the work – The number of alternative suppliers

• DO NOT TELL PEOPLE WHAT YOU DO - TELL THEM WHY THEY SHOULD CARE

Are You Focused on the Right "Business Arena"?

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Priority

Align Operations With Your Arena

21

• The Reality of A Trip To Disney– Expensive– Long lines– Junk Food– Expensive Food

• Our Response:

“Let’s Go Back!!!”

The Disney Rule

To Sell on Value, Know Your Costs… and the Value They Create

23

LowerCosts

Higher Pricesand Sales

Increase"Value"

Reduce"Waste"

Add "Good" Costs Reduce "Bad"Costs

Total Costs

Higher Profits

Priority Three

Be Bigger Than You Are

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What is Different in These Pictures?

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FILTER

CARAFE

STAND

BASE- On/off

FILTER

CARAFE

STAND

BASE- On/off- Timer

FILTER

CARAFE

STAND

BASE- On/off- Timer- Flavour controls

MODELA

MODEL ASALES

MODELB

MODEL B SALES

MODEL C

MODEL C SALES

100

Unit cost

Vol

COST IF COMMON COMPONETS USED IN MODELS A + B + C

ADDEDPROFIT

FORMODEL A

ADDED PROFIT FOR MODEL B

ADDED PROFIT FOR MODEL C

COMBINED SALES OF A + B + C

How Common Components and Modules Create Value

26

1. Procurement– Common purchased inputs

2. Technological– Common product technology– Common process technology– One product incorporated into the other (component)– Use of products requires a common interface (E.g. stereo equipment)

3. Infrastructure– Common capital– Common staff functions

4. Production– Common location of raw materials (logistics)– Common fabrication process– Common assembly process– Common testing/quality control procedures– Common factory support needs

5. Marketing– Common buyers– Common channels of distribution– Common geographic markets

Five Sources of Interrelationship Between Businesses

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Priority

Focus on the “Right Customers”

28

The Profitability of Selling to Transactional Customers

Profitcontributed by:

Time

Profit

Base profit

Cost of newcustomer

Source: Bain and Company (Frederick Reicheld)

29

The Value of Customer Loyalty

Price premium

Referrals

Lower costs

Increased volume

Profitcontributed by:

0 1 2 3 4 5 6 7

Year

Profit

Base profit

Cost of newcustomer

Source: Bain and Company (Frederick Reicheld)

30

Profit Impact of a One-Percent Increase in Customer Loyalty

0 4 8 12 16 20

7

9

15

16

17

17

17

19

Software

Industrial distribution

Credit cards

Auto service

Auto/Home insurance

Publishing

Bank branch deposits

Advertising agency

Percentage Increase in Profits per Customer

Source: Bain and Company (Frederick Reicheld)

Volume 3.3%

Cost 7.8%

Price 11.1%

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Priority

Know What Matters Most

32

33

What Matters Most

• The “Service Profit Chain“– Profits grow from satisfied customers who receive value due to

satisfied and loyal employees who had proper training, coaching, and support

COMPANY

EMPLOYEES CUSTOMERSInteractive Marketing

ExternalMarketing

InternalMarketing

THE EXECUTION OF THE

MARGIN-SUCKING MAGGOTS

EXECUTION