Take a Dive Into the Deep End (of the Profit Pool)

Posted on 20. Jan, 2006 by in Accounting

For some reason, after writing about becoming a profitable blog network in “Show Me the Money!” I have had profit on the brain. And this week I happened to come across an interesting concept first introduced by Gadeish & Gilbert called “Profit Pools” that has an impact not only on my previous comments but also on your current business and future decisions.

A Profit Pool can be defined as any point along the value-chain of an industry. In the car industry this can be car manufacturers, new car dealers, used car dealers, insurance, gas, leasing, financing, repair, etc. And by identifying the profit pools in your industry you can potentially find the deepest pool that will make your business money. For example, new car dealers have consistently posted the lowest margins in the car industry (below 5%) whereas leasing has proved to be the pool with the highest margin (over 20%). This is why car dealers will no longer give you a break if you want to pay for your car in cash because they want you to use their financing arm – that’s where the margins – and the profits – are.

Traditionally, managers have focused only on revenue strategies or market growth. However, there are different sources of profit in any business and any industry if you will take the time to identify the profit pools and align your strategy appropriately.

The classic example of this concept is the rental truck industry. The major players always struggled, just like the airline industry and the hotel industry, in making money in such a fixed-cost business. Think about it – after purchasing all those trucks that were sitting unused on the lot – how could the truck rental companies recover their investments? By competing on price. That’s why the industry had very low margins and therefore posted only marginal gains over the years. However, one player took a close look at the entire industry – mapped it out – and found a profit pool that hadn’t been tapped yet.

UHaul looked beyond the truck rental business to the accessories business – boxes, insurance, tape, storage spaces, etc. They quickly realized that after customers aggressively shopped for the lowest-cost carrier, they stopped caring about price and were “captive” to UHaul – quickly buying boxes and storage spaces that had much larger margins. UHaul then quickly bought up cheap land for storage spaces and lowered their truck rental prices – enticing customers in that would make up the rental cost loss by purchasing accessories galore. UHaul saw what others did not and made a significant profit!

However, you might be thinking to yourself, “All of the profit pools in my industry have been tapped out – everyone has found them all.” The story of computer manufacturers such as Dell will tell you otherwise. Although the chip manufacturers (Intel) and software makers (Microsoft) have the highest margins, the hardware manufacturers traditionally have the lowest margins. However, that didn’t stop Dell. Dell looked deeply into its profit pool and found a pocket of profit that it could create or tap. The companies such as Dell that recognize the variability of profit and can exploit the deepest pools will earn superior returns, even amid a sea of seemingly identical customers and products.

“Profit pools can take many shapes, depending on the economic and competitive forces at work in an industry or industry segment. And companies can use their understanding of the pool in many different ways: to identify new sources of profit in low margin industries, as U-Haul has done; to chart acquisitions and expansion strategy, as Merck has done; to decide which customers to pursue and which channels to use, as Dell has done; or to guide product, pricing, and operating decisions, as Anheuser-Busch has done. In fact, an understanding of profit-pool dynamics can help guide important decisions about every facet of a company’s operation and strategy, leading in many cases to the development of new, more profitable business models. ”

The bottom line is that if you are looking for ways to make money – even in industries that you think are exhausted – there is hope. You must use the profit pool lens to identify the profit pools and look for ways to identify unused pools, undiscovered pools, pools that could be dug deeper, or pools that need to be moved to a different location. So even though it seems as though the “Blog Network Industry” has been tapped out and that there are only a few that can make money… think again. Go ahead, take a dive into the profit pool!

3 Responses to “Take a Dive Into the Deep End (of the Profit Pool)”

  1. Gomer

    20. Apr, 2006

    Thank you!

  2. huntforte

    28. Jul, 2007

    I’m doing a paper on profit pools for my MBA program. Seems like everyone is rehashing Gadeish & Gilbert, but without really showing how to do the profit pool analysis. The only graphic I’ve seen is that HBS one on profit pools in the auto industry, which you refer to. I wish you–or someone–would do a more thorough demo on what is meant by identifying “pools along the value chain”. How much money is made at the wrapper stage of making candy? Selling crushed rock to sculptors who need some new thing to charge $40,000 to install?…

  3. tianne

    14. Apr, 2008

    thanks! i found it helpful just reading the example of the car industry. I was able to use that and translate it into my own industry.

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