Profit Share Over Market Share

In the mobile phone market there is almost no correlation between market share and share of the total profit. On one hand we have Nokia that has 45% market share and 59% share of total profit and on the other hand is Apple with 20%  profit share with less than 2% of market share. In the middle there is Sony Ericsson has 10% market share with almost no profit to show for.

Now both Nokia and SonyEricsson are  doing something about it:

Both companies aim for their coming launches to primarily boost profit margins rather than market share.

Nokia also hopes to boost its gross margin and profit by launching an increasing number of touch-screen and full-keyboard devices, Mr. Simonson told Dow Jones Newswires. He added that those efforts would be more important than gaining market share.

This is positively good sign and points to return to what the business should have always focused on – profits not market share.

Instant Coffee Price Is About Skimming

Update 8/19/2010: Via sales stands at $100 million

Instant coffee may be a $21 billion market but Starbucks’s new instant coffee Via is definitely not about taking a share of the revenue.

A trio of single-serve Via packets will sell for $2.95 in the United States and 12 packets will sell for $9.95. Those prices are significantly higher than Nescafe’s Taster’s Choice single-serve packets that sell in Los Angeles for roughly $1.50 for six and around $4 for 20.

At $1 per serving, Via is  four times the price of the market leader, Nestle. Via is priced for profit, not for capturing market share.

Nestle’s overall margin of 12% tells us the upper bound of overall market profit is $2.4 billion. For Via, the cost per serving cannot be any more than twice the retail price of a serving of Taster’s choice (assumption). Conservatively we can assume Via has 40% margin. Starbucks will be more than happy to get just 3% or so market share. How will Via get  its 3% market share? It comes from two sources. One, there always exist a segment that wants premium instant coffee and is willing to pay premium price. Two, by bringing in new customers who have not tried instant coffee before (some of these will be ex-Starbucks customers who stopped visiting the coffee shops).

If Via gets 3% of the $21 billion market, that is $630 million in revenue and $250 million in profit. That is, at 3% market share Via will gain 10% of the market’s total profit. That is not that different from the strategy of Apple and Blackberry that have 30% of the mobile phone profit share with less than 3% of market share.

Pricing Via is about skimming profits not market share and a very prudent one.

Customer Loyalty and Customer Margin

loyalty_margin_matrix

Should you listen to your most loyal customers?

Should you listen to your customers who take the time to write to you asking for specific products or features? The common sense answer seems yes, but should you always listen?

The WSJ has a story of loyal fans of British version of Cadbury’s refusing to accept the version sold in the US markets. The latter is manufactured by Hershey’s under its licensing agreement with Cadbury’s with a recipe tailored to the US market. Should Cadbury’s or Hershey’s listen to these most loyal fans and change their recipe? The article in WSJ describes these fans as someone who,

wants nothing to do with the stuff made in the U.S. “Oh, it’s so yuck,” she says. “You might as well eat a Hershey bar.”

With such loyal fans does it not make sense to a marketer to listen to them? The answer is not straightforward and need to be analyzed from at least three angles

  1. What is the customer saying and what do they really want?
  2. Is the customer insight actionable and profitable?
  3. What is the share of profit from these customers?

The first point is the most repeated story that if Ford had listened to its customers it would have developed faster buggies. In the book Game Changer, P&G’a retired CEO, Mr. A.G.Lafley calls this “customer driven and not customer led”. It is important you listen to your most loyal customers but everything you hear are not the customer insights – not to mention the biases in what we choose to hear and how we interpret it.

The second point is about relevance of customer insights to your business. In the Cadbury’s story the insight you may find is that the customers are really holding on to their memories of living abroad and are trying to relive by reminding themselves of the chocolate they ate there. This would be a valid information but it is insight only if you can act on it, the action required fits your business strategy, and you can generate profits from it through product innovations.

The third point is about  the share of profits you generate from these customers. What is this segment’s willingness to pay for such product variation? What are your costs to produce, distribute and get it to the target segment? It is not just how big this segment is or how much revenue you generate – the segment has to generate enough profit to justify new action.

Next time you see a flood of tweets, blog posts, and other social media expressions of customer likes and dislikes, ask the three questions before you rush to implement change.

PS3 Price Drop Not A Game Changer

Sony was used to being the market leader in gaming consoles prior to PS3. Their previous model, PS2 sold 138 millions units worldwide, far ahead of Microsoft’s XBox and Nintendo’s Gamecube. That all changed in the next generation of gaming consoles. Now Nintendo, with its Wii and its  innovative wireless controller is the leader with 50 million units sold in the three years since its introduction. Sony managed to sell only 24 million units so far.

In an effort to drive up its market share, Sony cut the price of PS3 by $100. Technically it is on a different model they introduced called PS3 Slim.  Is this a good profit maximizing move?Is low market share a concern that requires such drastic price cuts?

I have written before the need to focus on profit share over market-share. In the case of gaming consoles, it is a platform market. The sale does not end with the console rather starts with it. There are many revenue opportunities from sale of games and accessories over the lifetime of the console. Now there is also a new opportunity for subscription revenue from online gaming. It is not enough to just look at gross margin on the hardware, we should include margins from all the complements. In other words, the customer margin.

Larger the market share, larger is the number of games available for it as more developers will commit to developing games for that platform. With marker leadership comes exclusivity. A console maker can convince the game developers to  make certain popular games available only for their platform, at least for a limited time. But this has not been the case lately as Financial Times reports

With many third-party game developers no longer willing to make games exclusive to PlayStation, Sony has also suffered from a lack of hits by its in-house games division compared to Microsoft’s success with its Halo franchise, Mr Baker said.

Suppose we assume the gross margin on the new PS3 is $120 per console. Assume that at current market share and growth rate the incremental margin from sale of games and accessories over the lifetime of the console is $150.  So the total customer margin today is $270. With the price cut of $100  and the expected increase in market share from it, let us assume that the incremental margin per unit goes from $150 to $200. There is however  no reason or data to believe this, given the point made by Mr.Baker in  the FT.com story.  So the total customer margin in the new case is ($120-100+$200) $220.

Sony will be  losing $50 in customer lifetime value per unit sold with its price cut. To make up for it, its sales have to increase (over its current sales rate) by  50/220 = 23%.

The price cut would have given them competitive sales advantage only if Microsoft and Nintendo could not do the same. But it is not the case. Microsoft cut its prices by $100 and Nintendo might do the same (although doubtful).

Microsoft acted to consolidate its lead over Sony in the current generation of games consoles as it cut the price of its top-end Xbox 360 on Thursday to counter a similar move last week by its Japanese rival.

It is now questionable whether Sony can deliver a sales increase of 23% from its price cut. Note that this number will be much higher if the customer margin numbers we used are lower.

The net is, price cut is not going to be a game changer for PS3 sales.

To Be A Substantial Business …

What does it mean to be a substantial business? Having the largest market share? How does a business get to be substantial? Manfred Hasseler, founder of Swoopo, a pennies auction site says,

“to be a substantial business you have to make as many people happy as possible.”

I disagree. First, I do not know what it means to be substantial and how long that lasts and second, should a business strive to make as many people happy as possible?  The key to any business is making choices, choosing the segment to serve and target them and make them “incredibly happy” and do so in a profitable way. Apple and Blackberry (RIM) do not have “substantial” market share in the mobile phone market and definitely they do not make as many people happy as possible, but those they chose to serve are incredibly happy and it shows in their lopsided profit share of 30% with a mere 3% market share.

Success is defined by the long term profit,  not by the size of market share and definitely not achieved by trying to make as many people happy as possible.