Why Baseball Is in Trouble, How GE Makes Money, And Other Insights Into The True Origin Of Corporate Profits.

Navigation: Main page

Author: Fisher, Anne

We all know where profits come from. Create a product that is demonstrably better, aim for maximum market share, and push that model as hard as you can. So why doesn't it work the way it used to? In their new book, The Profit Zone: How Strategic Business Design Will Lead You to Tomorrow's Profits (Times Books, $25), Mercer Management consultants Adrian J. Slywotzky and David J. Morrison analyze 12 superior business enterprises--including GE, Intel, Disney, and Coca-Cola--and detail where their profits really originate. FORTUNE's Anne Fisher recently met with Morrison and Slywotzky to talk about their surprising findings.

Let's start by looking at the conventional wisdom about the importance of market share. What's wrong with it?

Morrison: Unfortunately, it doesn't work anymore. We all learned in business schools in the '60s and '70s that the biggest market share would give you the biggest revenues and the lowest cost per unit, and there you'd be, on top of the world. And as consultants we took this for granted for many years.

Slywotzky: It had the twin advantages of being both simple and correct. Then the world changed. We started to see situations like General Motors--huge market share, but where were the profits? Sears, same thing, and American Airlines, IBM, and many others you could name. Now, this is not to say that market share doesn't matter at all anymore. Of course it does. Just look at Microsoft. But what matters far more is the design of your business, by which we mean setting up your business in such a way that you understand where your real profits are and you continually refine that and expand that.

Can you give us an example?

Slywotzky: Twenty years ago, you didn't have to question where your profits were, because if you had a good product, you could make a profit in almost any business--and if you told me a company's market share, I could estimate profitability within 10%. Now it's all off. We are witnessing a tremendous value migration, and profit migration, away from products to services, or away from what you might think of as the main product to spinouts. Jack Welch figured this out years ago. Look at GE's jet-engine business. Okay, you start with a great jet engine, which gets you your basic customer relationship--but the profits are mostly in financing, service, spare parts, overhauling old engines. So GE Capital, and the acquisitions Welch has made in aircraft servicing and support, are in what we would call the profit zone. Manufacturing becomes almost incidental.

Morrison: So many companies running unprofitable product-centered businesses have simply not caught on to this yet. That's why we wrote the book, to try to wake them up. Disney is a terrific example, and anybody with small children knows what I mean. Does Disney make money from the movie The Lion King? Some, yes --and don't get me wrong, Michael Eisner is not going to start shipping movies out to theaters for free. But having a couple of young daughters, I can clearly see how Disney cleaned up: royalties and licensing fees on videotapes, puzzles, clothes, books, toys, T-shirts.... Again, the movie is almost incidental.

So we should all be imitating GE and Disney?

Morrison: Not necessarily. It's important to point out that we're not saying there's just one way to make a profit, or just three ways, or just ten. In the book, we talk about 22 business designs for maximizing profitability--but maybe there are 50 or 100. The point is, do you know where your company's profit zone is? Do you know how to find it? Do you know how to get there once you do find it?

Slywotzky: The best U.S. companies all have in common that they have started with the customer and worked back from there. The other part of this--and it is the scary part for companies that are not accustomed to it yet--is that once you have redesigned your business to focus it on whatever your profit zone happens to be, you can't stop there. It's like the difference between archery and skeet shooting. You are aiming at a moving target, and you have to keep doing that. The target is not going to stop moving. If you are not rethinking your business model every five years, you are running your business at a very high level of risk.

What other aspects of your research findings do managers find scary?

Slywotzky: Well, one thing that surprises people when we go into client companies is that everybody is focused on strategies like treating every customer as if he were your only customer, and trying to get as many customers as possible even if they are high-maintenance, high-cost customers. People are a little shocked when we tell them that probably about 15% of your customers right now are creating a drain on profitability, and you have to be willing to get rid of them. Jettison them. We talk a lot about this in the book. You don't want just a lot of customers. You want to identify the right ones.

Another scary idea is, so many managers now are intent on core competencies, on looking at "What are we good at? How can we get better at it?" But if you look at very, very profitable companies, that question is secondary. The first question is, "What will we have to be good at tomorrow, or next year, in order to stay relevant to customers and stay profitable?" And that is a much more uncomfortable question. It takes more imagination, and it requires you to start thinking not like an incumbent but like an innovator, an upstart. Not everybody in big companies is good at that or willing to try that. So there are a lot of industries--think of the U.S. steel industry--where the incumbent market-share leaders don't respond to the upstarts outside the gates, and look what happens to them.

Morrison: This doesn't mean that the incumbent leaders in any given industry are necessarily doomed.

Slywotzky: No, but to build sustainable long-term value growth, like Coca-Cola or like Disney, you have to plow your profits back into the business to keep providing a better deal for the customer. That's what the big steel companies didn't do. Look at television networks today. The networks deliver advertising minutes to consumer advertisers, but it's not a good deal. It's twice as expensive as cable, and it's much more hit or miss. That's not a sustainable situation.

Morrison: One thing you can count on is that in today's economy more than ever, partly because of the huge amount of venture capital available out there, if you don't create a better deal for your customer, somebody else will.

Slywotzky: Another situation that doesn't look sustainable to me is professional sports. There was a time when you made money in pro sports by selling tickets to fans--you know, the guy who wants to spend $30 and get a hot dog and a beer and watch the home team play. Not anymore. Now it's all cable TV rights and luxury boxes. That's the whole profit zone in pro sports. And what happens to that money? Most of it ends up in the pockets of whichever stars can negotiate big contracts.

So you see this huge value migration from the television contracts and luxury boxes to a few very rich athletes. What is happening to the average consumer, the average fan? He or she is losing interest in the game. Baseball is not creating a better deal for the average customer, and that is why baseball is going to be in trouble--because the owners and the players and the broadcasters are not asking, "Who is the customer, and how can we keep giving him a better deal?" In a venture-capitalized world, where new competitors are always looking for an opening, finding answers to those questions is any company's, or any industry's, only long-term protection against eroding profits.

So far we've been talking mostly about American companies, but since this is supposed to be the "Asian century," let's look at the other side of the Pacific. Are Asian companies any better at sustaining profitability long term?

Slywotzky: This ties back in to the role of venture capital in increasing the creativity and the competitiveness of the U.S. Venture capital has created the world's biggest open laboratory of business-design or business-model innovation. Yes, it has a high failure rate, but the successes are spectacular and create enormous value. But if you look at where Asia is today, there are still a lot of traditional conglomerates and still a lot of export-driven, manufacturing-based business models and strategies. Asia is not yet focused on understanding the customer and developing new markets internally. But I think one of the biggest changes in business over the next ten years will be that the venture-capital economy will move to Asia, and that is going to create a much more interesting economy there than the one that is in place now.

Morrison: The same is true in Europe, by the way. But it will take some time. Think of the differences in culture between the U.S. and Europe. Here we start a new venture. We fail. We put it on our resume, chalk it up to experience, and move on. In Europe, if you do that you suffer a decade or two of social stigmatism. But as we see venture capital looking for new fields of opportunity, that is going to change too.

Any last word of advice for companies that want to get or stay profitable?

Morrison: Yes. Think of designing a new business model for your company --one that will get you into the profit zone--as an investment, because that is what it is. Look at what companies spend on product research and development, including some big chemical companies that spend $1 billion a year on R&D. Then ask executives at those companies how much they have put in to doing a little business-design research--a little analysis of where their profits come from. Often the answer is nothing, not a dime. And yet that kind of research and rethinking and redefining--learning how to shoot skeet rather than aiming at the same old target--could determine whether you survive into the 21st century.

PHOTO (COLOR): ADRIAN J. SLYWOTZKY

PHOTO (COLOR): DAVID J. MORRISON

PHOTO (COLOR): ADRIAN J. SLYWOTZKY

PHOTO (COLOR): DAVID J. MORRISON

~~~~~~~~

By ANNE FISHER; DAVID J. MORRISON; ADRIAN J. SLYWOTZKY