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Author:DanaPeckReviewer:MichaelCollinsProfitPoolsDecember1998Copyright©1998Bain&Company,Inc.CHIProfitPools2Agenda•ProfitPoolsConcept•Applications•ProfitPoolSteps•ClientExample•KeyTakeawaysCHIProfitPools3•Profitpoolsarethetotalprofitsearnedinanindustryatallpointsalongtheindustry’svaluechain•Patternofprofitconcentrationinanindustryisverydifferentfromthepatternofrevenueconcentration(seeexample)•Forexample,profitsandrevenuesintheautomotiveindustrycanbedividedamongmanyvaluechainactivities-vehiclemanufacturing,newandusedcarsales,gasolineretailing,insurance,after-salesserviceandparts,andleasefinancing-althoughcarmanufacturinganddealersaccountforalmost60%ofindustryrevenue-autoleasingandfinancingarebyfarthemostprofitablebusinessesWhatareProfitPools?Profitpoolsanswerthequestion:“Whereandhowismoneybeingmade?”Source:ProfitPools:AFreshLookatStrategy(May-June1998):OritGadieshandJamesL.GilbertCHIProfitPools4WhatisProfit?•Accountingprofit-representscompany’searningsasformallyreported-mostcommonlyusedasthebasicprofitmeasure-examplesincludenetincomeorearningspersharecalculations•Returnoninvestment-representscompany’searningsaftertakingintoaccountthecostofcapitalinvestedinthebusiness.Twocommonlyusedmeasuresinclude:-ROC,accountingbasedReturnonCapital(bookvalue)-ROIC,accountingbasedReturnonInvestedCapital(bookvalue)•Cash-flowcontribution-company’searningsbeforetakingfixed-assetandcapitalcostsintoaccount(e.g.EBITDA)-representstheamountofcashleftfromasaleaftersubtractingthevariablecostsassociatedwiththatsale-usedasabasisfordecision-makinginmature,highfixedcostandcyclicalindustriesProfitcanbedefinedinoneofthreeways:BeawareofdifferencesinaccountingstandardswhenevaluatingcompanieswithprofitsspanningdifferentindustriesSource:HowtoMapYourIndustry’sProfitPool(May-June1998);OritGadieshandJamesL.GilbertCHIProfitPools5Revenuevs.ProfitSplitTruckFinancePartsandServiceBodyManufacturingandTruckAssemblyChassisManufacturingandSalesTruckFinancePartsandServiceBodyManufacturingandTruckAssemblyChassisManufacturingandSalesRevenueSplitbyActivityProfitSplitbyActivity$3,865MM$600MM0%20%40%60%80%100%PercentofTotalSource:PBIRProfileoftheU.S.TruckBodyIndustry;R.L.PolkRegistrationDatabase;LiteratureSearch;TEMFinancials;PriorBainPLPanalysis(7/96);BainestimatesThepatternofprofitconcentrationinthetruckmanufacturingindustryisverydifferentfromthepatternofrevenueconcentration.TruckManufacturingBusinessExampleCHIProfitPools6WhyUseProfitPools?•Offeraviewoftheunderlyingindustrystructure•Helpillustratetheeconomicandcompetitiveforcesdrivingtheindustry’sprofitdistribution•Offeradifferentperspectiveonanindustry•Illustraterelationshipbetweenprofitandrevenues•Highlightspotentialwatchouts(chokepointsinthevaluechain)whichcaninfluencetheprofitflowinanindustryIllustratetheCurrentStateoftheIndustryProvideaCompetitiveAdvantagetoYourClientHelptoDevelopInnovativeStrategies•Helpcompaniesseewhattheirrivalsdon’tsee•Fosterthepotentialtodictatethetermsofcompetitionwithintheindustry•Keepcompaniesabreastofchangesinrapidlychanging(turbulent)industries-alertpotentialshiftsinprofitdistributionalongthevaluechain-illustratepotentialchangeinprofitsourcesfromnewentrants•Helpguideimportantdecisionsaboutacompany’soperationandstrategy•Encouragerethinkingolddecisionsandpursuingcounterintuitiveinitiativestocreateandcontrolprofitpools•Reducethepossibilityofblindspotsinacompany’sstrategicvision-reducepotentialtooverlookattractiveprofitbuildingopportunities-lessonpotentialtobecometrappedinareasofweak/fadingprofitability•ExampleapplicationsCompaniesthatrecognizethevariabilityofprofitabilityandcanexploitthedeepestpoolswillearnsuperiorreturns.Source:ProfitPools:AFreshLookatStrategy(May-June1998):OritGadieshandJamesL.GilbertCHIProfitPools7HowProfitPoolsIllustratetheStateoftheIndustry•Thevaryingconcentrationsofprofitalongthevaluechain(knownastheshapeoftheprofitpool)reflectthecompetitivedynamicsofabusiness-profitconcentrationsresultfromtheactionsandinteractionsofcompaniesandcustomers-profitpoolsforminareaswherebarrierstocompetitionexist-profitpoolsexistinareasthathavebeenoverlookedbycompetitors•Everymarkethasanunevendistributionofprofitbetweenproductcategories,customergroups,geographicregionsand/ordistributionchannels•Profitpoolsarenotstagnant-aspowershiftsamongtheplayersinanindustry(competitors,suppliers,andcustomers),thestructureoftheprofitpoolchangesTherearemanydifferentsourcesofprofitinanybusinessProfitpoolsprovideameanstoevaluatethecompetitivedynamicsofanindustry.Source:ProfitPools:AFreshLookatStrategy(May-June1998):OritGadieshandJamesL.GilbertCHIProfitPools8ProfitPoolWatchouts(ComputerIndustryExample)Examples:Beawareof“chokepoints”-particularbusinessactivitiesthatcontroltheflowofprofitsthroughoutanindustry.Impact:Controlofachokepointcaninfluencethedistributionofprofitsamongcompetitorsandmoredistantvalue-chainparticipants•Intel’sdominanceofmicroprocessors•Establishmentofanindustrywidestandardthatallcompaniesmustnowobey•Microsoft’sdominanceofWindows•Consolidationofcontroloverthecustomerinterface*includ