Profit Pools
Profit Pools is a concept used in business strategy to identify and evaluate the sources of profit within an industry or market. Profit pools refer to the total profit available in a particular industry or market and how that profit is divided among different players or segments. In essence, profit pools represent the distribution of value and profits across an industry. Profit pools are a way of analyzing the profitability of different segments of a market or industry.
The concept of profit pools was first introduced by Orit Gadiesh and James L. Gilbert, both consultants at Bain & Co., who further developed the concept in their book "Transforming Giants" and subsequent articles. It was later popularized by Harvard Business School professors W. Chan Kim and Renée Mauborgne in their 1997 article "Value Innovation: The Strategic Logic of High Growth," published in the Harvard Business Review. The article introduced the idea of the "blue ocean strategy," which refers to creating uncontested market space by identifying and pursuing new market opportunities.
The authors argued that traditional approaches to competition focused on existing market segments, with competitors fighting over a fixed amount of profit. In contrast, the blue ocean strategy involves identifying and tapping into new profit pools, creating a win-win situation where companies can enjoy high profits while offering customers new and innovative products or services.
The Profit Pool concept involves breaking down an industry into its component parts or segments, then analyzing the profitability of each segment. By doing so, businesses can gain a better understanding of where profits are being generated and where opportunities for growth and profitability may exist.
The Profit Pool analysis is typically done by mapping the flow of money within an industry or market, tracing the path of profits from end customers all the way back to the source of the product or service. This can involve looking at factors such as pricing, margins, and costs across different industry segments, as well as the competitive landscape and market trends.
The ultimate goal of Profit Pool analysis is to identify areas of the market that are underexploited, and that offer the potential for growth and profit. By understanding where the profits are being made and where they could be made in the future, businesses can make better strategic decisions, such as entering new markets, developing new products or services, or optimizing their pricing and cost structures.
To identify profit pools, companies need to analyze their industry's value chain and identify where the most significant profit margins lie. By understanding the drivers of profitability, businesses can identify areas where they can capture a larger share of the profits. This can involve developing new products or services, streamlining processes, or identifying new market opportunities.
By understanding the profit pools in their industry, companies can also gain insights into the competitive landscape and identify areas of potential cooperation or competition with other players. Let's say a company operates in the consumer electronics industry and wants to understand the profit pools in its market better. By analyzing the profit pools, the company realizes that a significant portion of the profits come from smartphone sales, specifically in the high-end segment of the market. They also discover a smaller but growing profit pool is emerging in the smart home devices market.
With this information, the company can identify potential areas of competition and cooperation with other players. For instance, they may decide to focus their efforts on the high-end smartphone market and collaborate with a manufacturer that specializes in smart home devices to enter that market. Alternatively, they may decide to enter the smart home devices market independently and compete with established players in that space.
By analyzing profit pools, companies can make strategic decisions about how to allocate resources. For example, a company may use profit pool analysis to identify a particular product or service line generating a disproportionately high profit relative to its share of the overall market. Based on this analysis, the company may decide to invest additional resources into that product or service line to increase its profitability further and gain a larger share of the market. Alternatively, the company may identify a product or service line generating low profits despite having a large market share and decide to reduce or discontinue investment in that area to allocate resources more effectively.
The idea behind profit pools is that in any market or industry, different segments contribute to overall profitability. By understanding the profitability of each segment, companies can make strategic decisions about where to invest resources and how to compete.
Profitability can be measured in a number of ways. Still, one common method is to look at the profit each segment generates as a percentage of the total profit in the market or industry. This allows companies to see which segments are the most profitable and the least profitable.
How a company applies its profit-pool knowledge will depend on its competitive position, strengths, financials, and goals. Analyzing profit pools does not eliminate the need for effective strategic planning. However, it does provide a solid foundation for such planning.