The Case of the Neglected Profit Pool

The Case of the Neglected Profit Pool

Susan believed the customer was stretching the truth

Susan’s Suspicions

In her move to a new company, Susan, as Dir. Bus. Dev., inherited an out-of-control development project.

Her predecessor began the project in response to a panic call from the Sales VP.

“Help! Eng-corp is our sole customer, for SPA (a catalyst). Our contact there, Sr.VP, Licensing, says we need to reduce the price 10%. If we don’t, an emerging process will replace SPA.”

Hearing the panic call, Susan’s predecessor authorized the development project. The result was a year of expensive engineering experiments. Unfortunately, each experiment to cut manufacturing costs also cut SPA’s activity.

Susan’s Solution

Susan discovered that her company did not know the profit pool of the SPA process industry. Susan stopped the engineering experiments. She engaged me for a project to understand the industry’s profit pool.

A profit pool can be defined as the total profits eared in an industry at all points along the industry’s value chain”1

Understanding SPA’s Industry-Level Profit Pool: Executive Summary

Background

For 28 years Susan’s company has made SPA that has a consistent, high activity.. They ship the product to eng-corp who distributes it to oil refineries.

My first task was to build a list of 210 knowledgable individuals in the SPA process industry. Then following the Rule of 39 method,2 I called people on the list. In each conversation, I told the respondent that the client had a new process to replace the SPA process.

Results

Conversations with 30 knowledgable individuals elicited little interest in replacing the SPA process.

  • Following is an example:

“Why would I want to replace the SPA process? It does a great job of converting cracking byproducts into octane improvers.

It’s one of the few processes in my refinery that’s easy to run. It is mild. It doesn’t corrode the process vessel.

Our other catalytic processes corrode the process vessels. We have to shut down the refinery every few years to rebuild them.”
       Engineering Mgr. at major oil refinery

  • Three refinery operations mgrs. made the following observation.

Your client’s process sounds like something the guys from eng-corp keep trying to peddle to us. They present it as replacing their SPA process. We and other oil companies have evaluated it. For us, it has no advantage over the SPA process.
     Operations Mgrs. at major oil refineries

The Profit Pool for the SPA Process Industry

SPA Process Industry’s Value Chain

Catalyst Manufacturer (cat-corp) > Distribution (eng-corp) > End-Users (oil refineries)

In the industry’s profit pool:

End-users dominate

High octane gasoline commands a premium price, revenues are several billion

No cost incentive to switch from SPA process.

Distribution has < 0.1% share of pool.

No capital asset costs. Low labor costs.

Costs of switching to another SPA catalyst suppler are steep

SPA Catalyst Manufacturer has < 0.1% share of pool.

Cat-corp’s Competitive Advantages

  • Exclusive access to low cost, key raw material for making SPA catalyst
  • Trade-secret learnings from 28 years of SPA manufacturing experience

Outcome

In a meeting with Susan, her staff, and the Sales VP, we reviewed the project’s discoveries. They agreed that the Sr.VP, Licensing at eng-corp request for a price decrease was unfair. They created options for their next response to him

Susan decided her company, and eng-corp, could capture a larger share of the industry’s profit pool. Her strategy was to raise the price of SPA catalyst 20% within six months.

Next response to eng-corp

She, the Sales VP, and their division’s Sr. VP met with eng-corp’s Sr.VP, Licensing. They shared the Executive Summary of the project with him. They hinted that new environmental laws would raise the cost of SPA’s key raw material.

A 20% raise in SPA price could result in a 20% increase in eng-corp share of the distribution price they charged end-users. Both Susan’s company and eng-corp would benefit from an increase in their share of the profit pool.

The Sr.VP, Licensing agreed with the strategy. Eng-corp’s sales agents sold the price increase to the oil refineries.

Thirteen years later:

  • The SPA process is still the high octane process of choice in 400+ units
  • Eng-corp is still the distributor of SPA
  • Susan’s company is still the singular manufacturer of the catalyst

Endnotes

1 Profit Pools: A Fresh Look at Strategy Gadiesh, G. and Gilbert, J. L. Harvard Business Review LK https://hbr.org/1998/05/profit-pools-a-fresh-look-at-strategy

2 My work followed the Rule of 30 method

  • Blind study 
  • Gathered intelligence through 30 elicitation conversations with experts in the SPA process industry. They were from a random sample of 210 knowledgeable individuals.