The Profit Pools method of Orit Gadiesh and James L. Gilbert is a strategy model that can be used to help managers or companies focus on profits, rather than on revenue growth. The idea behind it is: managers need to look beyond revenues to see the shape of their industry’s profit pool. In this way strategies can be created which result in profitable growth.
Orit Gadiesh and James L. Gilbert, consultants at Bain & Co. presented the following definition of Profit Pools in their HBR article “Profit Pools: A Fresh Look at Strategy” – the total profits earned at all points along the value chain of an industry. Companies that see what others do not see, will be best prepared for capturing a disproportionate share of the profits in an industry.
Although the concept is simple, the structure of Profit Pools is usually quite complex. The pool will be deeper in some segments of the value chain than in others, and depths will vary within an individual segment as well. For example, the profitability of a segment may vary widely by customer group, product category, geographic market, and distribution channel. Moreover, the pattern of profit concentration in an industry will often differ from the pattern of revenue concentration.
Mapping the Profit Pool
Mapping a profit pool is, in one sense, a straightforward exercise: you define the value chain activities and then you determine their size and profitability. But while the goal is simple, achieving it can be complicated. Why? Because in most industries, financial data are not reported in nice, neat bundles corresponding to each value-chain activity. Detailed data may be available on individual companies, but those companies will often participate in many different activities. Similarly, there may be good information on product sales or customer purchases or channel volumes, but the products, customers, and channels will rarely line up cleanly with the boundaries of a particular activity. Translating the available data into accurate estimates of an activity’s size and profitability requires considerable creativity.
Although no two companies will perform the analysis in precisely the same way, it is possible to describe a broadly applicable process for getting the answers—a process that lays out the tasks that need to be accomplished, the questions that need to be asked, the types of data that need to be collected, and the types of analyses that need to be done.
Mapping a profit pool involves four steps: defining the pool’s boundaries, estimating the pool’s overall size, estimating the size of each value-chain activity in the pool, and checking and reconciling the calculations. We will describe each step and then provide an example of how the entire process is applied. Finally, we will look at ways of organizing the data in chart form as a first step toward plotting a profit-pool strategy.
Usage of the Profit Pool model
- Identify new sources of profit.
- Rethink the role of a company in the Value Chain.
- Refocusing a company on its traditional sources of profit.
- Make product decisions, pricing decisions and operational decisions.
If you need to illustrate Profit Pools in your business presentations, you can find find them in this compilation of management model PowerPoint templates.
Source: How to Map Your Industry’s Profit Pool, HBR, Gadiesh and Gilbert, 1998Business frameworks like Profit Pools are invaluable to evaluating and analyzing various business problems. You can download business frameworks developed by management consultants and other business professionals at Flevy here.