KNect365 Insights, Marketing & Innovation is part of the Informa Connect Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 3099067.

Informa
Edge of Innovation

A community that brings innovation leaders together through creative, inspirational, educational, and thought-provoking content.

The Importance of Profit Share Strategy

By: Tony
Ulwick, Strategyn

What strategy enables a company to enter an existing
market, win over and keep customers, take the lion's share of profits, turn the
screws on the competition ' and then eliminate it ' thereby setting the stage
for long-term growth? The answer is the profit share strategy. The
profit share strategy works in markets that are highly underserved. It's quite
literally the opposite of the low-end disruption strategy made popular by
Harvard Business School professor Clayton Christensen. Low-end disruption
opened up new markets by offering highly overserved customers a product or
service much, much more cheaply than any other option on the field, sacrificing
only features that the overserved population didn't value in the first place.
The profit share strategy, by contrast, addresses a highly underserved
population that's willing to pay much, much more to get a job done
significantly better than is currently possible. 

Here's how it works:

It starts by identifying the focal segment of highly underserved
customers. These customers, who may comprise as little as 10 percent of the
market, are highly underserved because the products available today fail to
consider their unique situation. While executing the same job (task) as others,
these customers are different: they face complexities that others do not; they
face unique obstacles; they are forced to push the envelope; failure is not an
option; they seek perfection. Consequently, they struggle more than others to
execute their job-to-be-done
and will pay a lot more for a solution that delivers.

A company enters this market by offering these underserved
customers a product that will help them get their job done significantly (20 to
30 percent) better than any existing alternative. Because its solution is so
much better and the need is so great, the company is able to price its new
product two to five times higher than the products it is competing against.
While this pricing strategy alienates most of the market, the severely
underserved segment of customers is willing to pay.

Here is how the profit share strategy unfolds. With the
release of version 1.0 of the product, the company wins a small percentage of
market share (because only a small number of customers are so underserved that
they are willing to pay the significant price differential), but it wins a
respectable amount of profit share (because the price differential is so
great).

With the revenue generated by the sale of this product, the
company finances the release of version 2.0 of the product, again targeting the
segment of highly underserved customers. Offered at the same price point as
version 1.0, this new version once again helps customers get the job done ' and
offers some improvements on version 1.0.

With the release of the new version, the company cuts the
price on version 1.0, making it more affordable for other underserved customers
who are less willing or able to pay a significant price differential. This
gains the company additional market share, and it continues to grow its profit
share.
The company uses the revenues from the first two releases
of the product to fund a third version and repeats the process. Version 3.0 is
again significantly better and offered at the high price point. The prices of
both version 2.0 and 1.0 are lowered, attracting an even larger percentage of
the underserved population. The process continues until version 1.0 is priced
to optimize market and profit share.

After several iterations, the company has successfully won
the market from the top down. With often less than 10 percent market share, the
company is able to secure 50 percent or more of all the profits earned in the
market. It establishes itself as a market leader. Its competitors, left with
overserved customers or those unwilling or unable to pay more for a superior
solution, are starved of profits. Adopting the profit share strategy puts the
company in a very attractive financial position that is also highly defensible. 

Here's why:

Even if the company stops innovating after a couple of
generations of its product, it's still far ahead of its competitors, who must
work through a number of product iterations to catch up. Assuming the company
continues to make incremental product improvements, catching up could take
years, or even decades.

As an additional strategic advantage, the company has the
option to eventually lower the price of version 1.0 to match its cost. This
puts the company in an exceptional position to both maintain and gain profit
share while making it very difficult for competitors to disrupt the market from
the low end.

The conclusion? The profit share strategy should be the
vision, the envy, and the goal of every product and marketing manager. Where
appropriate, it should be embraced.

Author: Tony Ulwick,
Strategyn