A Conversation with Adrian Slywotzky, author of The Art of Profitability (Warner Business Books)
Adrian Slywotzky is the bestselling coauthor of The Profit Zone and Profit Patterns, and How Digital Is Your Business?, as well as the author of Value Migration. A graduate of Harvard College, Harvard Business School, and Harvard Law School, he is a vice president of Mercer Management Consulting, Inc., a global management consulting firm that focuses on profit growth in changing markets.
Does the book's title suggest that there is an art to profitability?
You can't trace a copy of a Picasso and call yourself an artist. You also can't copy another company's business model or learn a formula that is going to lead to profitability. This book is about learning how to think independently and mastering the art of applying the right profit model to a given business situation.
Is the path to profitability any different today than it was fifty years ago?
Twenty years ago, the largest market share player was the most profitable in each industry. But over the last decade and a half the classic rules of strategy have started to break down. Companies began to gain market share with no corresponding rise in profitability, and new entrepreneurs have produced tremendous innovation in profit models that are benefiting a wide range of companies.
What exactly is a profit model?
Wherever there is profit, you can find the essential forces that cause it to happen in a particular situation. Ohno at Toyota always said, "Ask 'Why?'" five times. By the fifth time, you'll start getting close to the real answer." You have to treat profitability as a puzzle and find out how it can happen for your business. I've chosen 23 profit models for this book and used illustrations and stories to show readers how they work.
What's the biggest mistake that companies are making that is preventing them from making a profit?
Profitability has to be understood by each company on its own terms. They can't just copy a profit model that worked for another company. They have to choose the right model after carefully analyzing their business, their customers, and their competitors.
How can a company stay profitable if their competitors keep coming in with copies of its products at lower prices?
Several ways. Intel uses a "time profit" model. When they are first to market with a new product, profits happen in the first four or five quarters and then drop down very quickly to almost zero after that. To make a profit, Intel must work hard to maintain a two to three-year lead over its competitors. Diffusing the product as instantly as possible helps extend their period of profitability.
Why does a company like SMH, makers of Swatch, bother selling all those low-profit margin plastic watches when the majority of their profit comes from their luxury lines of watches? Isn't that keeping the company less profitable?
You're right that the plastic Swatches made by the parent company SMH have low profit margins, but actually they are just as important to SMH's profitability as the high-margin watches. By producing the plastic watches, SMH builds a firewall against competitors who may try to produce cheaper imitations. They won't be able to develop the economics to move up the pyramid. This is called a Pyramid Profit Model because the profit-generating watches are at the top of the pyramid and the defensive plastic watches at the bottom. It turns out that 70% to 80% of SMH's profit is from the top of the pyramid, but the base of the pyramid is just as important.
I can see how you can sell the same product to different levels of customers at different prices, but can you sell the same product to the same customer at different prices?
It happens all the time. Coca-Cola, for example, sells you a soda for 8 to 10 cents per ounce in a vending machine, 10 or more cents per ounce at a restaurant, but only 2 cents per ounce at a grocery store. All of us as customers behave differently in different situations; therefore, to maintain profitability, prices should reflect different price sensitivities in different environments.
Do these profit models work in tough times like today's economy?
They are even more important in a tough economy like today's, and many of the models in the book work particularly well in hard times. Toyota uses a cycle profit that reduces their costs so that when competitors lose money, they break even; when others break even, they make money. Southwest Air developed an ingenious low-cost business design profit model that is perfectly suited to today's economy. By creating an innovative and cost-effective business model, Southwest can offer significantly lower prices than their competitors.
Weren't Enron's and WorldCom's problems caused by overdoing fancy mathematical models?
Earnings models maybe, but profit models definitely not. These scandals prove that it is profitability, not just earnings, that leads to a company's success. I hope these recent events will urge more companies to think harder about profitability and making "real" profitability happen.
Why did you choose a fictional format for the book?
In my discussions with business school students and professors, entrepreneurs, corporate executives, and investment analysts, I sensed the desire for a format that would make some of my ideas on profitability more understandable and entertaining than a standard business book would allow.
Is the mentor character, David Zhao, based on a real person?
David Zhao is based on two business school professors of mine who stood out as particularly tough-minded and inspirational. They could engage their students with tough dialogue. They pushed and prodded us to think through a problem completely on our own until we really understood the nature of the situation we were facing. Their stories compelled us to understand the ideas not as abstract concepts but situations in the real world with all of its compromises and all of its tradeoffs. In The Art of Profitability, I have tried to make the same impact on readers as these professors made on me.
In a nutshell, what's the first step to understanding profitability?
Fully understanding customers and their behaviors in all situations.
Recommended Reading in The CEO Refresher