We know that way back the little David defeated the giant Goliath on the battle field but could a little David have a greater bargaining power than a giant Goliath in today’s business environment? Can a $100 million company achieve a bargaining edge over a $100 billion company?
It is possible and you could do it too. The trick is to utilize the power of your profit pool effectively.
Case In Point
Few years back, one of our clients – a division of one of the Big Three auto companies of Detroit – found itself at the losing side of the Goliath-David bargaining situation. This division of the auto company is in the Auto-Glass Replacement (AGR) business, which is a large market
especially for an auto company that sells 15-16 millions autos a year.
The supply chain of AGR market consists of manufacturers, consolidators, wholesalers, retailers/installers and customers/consumers. The above-mentioned glass-division (GD) of the auto-company acts as a consolidator. It gets the windshields and other glass from its manufacturing plants and then ships it to its network of wholesalers. Previously it used to have its own warehouses but few years back it got out of that business model. It does not ship directly to the retailers. Glass wholesalers in turn ship the glass to retailers. A number of wholesalers also operate their own retail outlets.
Being the primary OEM supplier of the glass to the manufacturing plant GD has a very large share of the AGR market though it gets stiff competition from various other auto-glass makers. As an OEM supplier its brand also has a better pull (brand-equity) in the market than its competitors. In most of its dealings with wholesalers, even with very large wholesalers, GD had been successful in converting this higher brand-equity in to favorable pricing structure. However, there is one wholesaler that has been able to get better terms than others.
To begin with this glass-wholesaler (GW) has an exclusive distribution arrangement for a large geographic region. But that is not the primary reason for GW to get better terms. GW also operates two chains of retail glass installations. Chain A is mostly in the rural area where pickup trucks are more popular and Chain B is in urban area where cars are more in number. It has employed an effective product strategy for these two chains that gives it an upper hand not only with its competition but also with its supplier – the glass-division of the big auto company.
In addition to auto-glass the two chains of GW also offer other products. Chain A – the rural chain – offers a number of truck accessories and the Chain B – the urban chain – offers security products. Both these product categories are of higher margin, which gives GW a very good competitive advantage.
The primary competitive factors for auto glass retailers are price and service. Both retail chains – Chain A and Chain B – compete with their competition primarily on price. By keeping their glass replacement prices low these chains are able to get the customers into their shops. Once inside the shop they become captive customers for other products offered by the chains.
The net result is that both these chains get close to 60% of their revenue from low priced auto-glass and remaining revenue from other products – truck-accessories for Chain A and security-products for Chain B. However, the profit ratios are reversed. The auto-glass generates around 40% of chains’ profit and other products generate close to 60% of profit.
Profit Pool Effect
The combination of low-priced auto-glass and high-margin truck-accessories & security products forms a profit pool for the GW, which gives it a strong competitive advantage.
Firstly, it allows the GW to offer auto-glass – the primary reason for customers to come to its shops – at much better prices than its competition. Secondly, since the chain’s volume is high and the overall market prices are low it is able to negotiate better sourcing price from its supplier, GD of the auto-company.
Since most of the profit for GW comes from products other than auto-glass it does not depend as heavily upon auto-glass for profitability as GD does. Even though its margins on the glass is low – and perhaps getting lower – its profit pool gives it the capability to make-up for that reduction from other products, whose sale is being driven by the sales of auto-glass.
The GD of the big auto-company, the Goliath, does not have such capability, which reduces its bargaining power vis-à-vis the GW, the David.
Simple Mechanisms
The profit-pool concept is very simple and many a times quite intuitive. There are four parts to it:
Strong Primary Product Attraction
First within your profit-pool you should have at least one product that has the primary attraction for your customers to come to your establishment. In the case above the primary product is auto-glass. Another example is gas stations that combine their gas pumps with Food-Marts. The primary product is gas and Food-Mart becomes major component of the profit-pool.
Captive Customer Base
Your primary product should have the capability to convert your customers into captive customers. This means that they have lots of idle time while waiting to be served or may have a number of interaction with you.
Benihana Restaurant employs it very effectively. In Benihana’s the customers eat on a table that seats about eight people. The food is cooked right in front of the customers on their table by expert chefs.
Since they seat parties of eight at a time customers need to wait for the whole group to form. The average turnover time for customers to come, be seated and finish their dinner is one hour – up to one and half hour in slow periods.
Each Benihana Restaurant has bar/lounge/holding area that is proportional to the dining area and the number of customer that visit the establishment. The customers wait in this area waiting to be seated thus forming a very profitable captive customer base.
Compelling Secondary Product Offerings
Third you should offer the types of products that either the customers need immediately or that falls in impulse-buying category or they should be of types that do not warrant a separate trip to stores.
Most of the gas-stations keep the types of products that people may need on a large trip but usually forget to buy when they go shopping. Grocery stores and super-markets put a number of items next to check-count that people buy on impulse.
High Gross Margins For Secondary Products
The beverage sales of Benihana’s holding areas are pretty substantial. The margins are also good. On average a Benihana store gets 75% of revenue from food sales and 25% of revenue from beverage sales. The gross margins for these two is 55% and 75% respectively.
Another aspect is that the overhead portion of food-business is much higher than the overhead portion of beverage-business. This means that profit contribution of beverage sales from the holding area is much higher than the food sale from the dining area.
The profit pool concept is a not a new one. Many businesses have been employing it for years using various strategies and tactics. However, the creation of a profit-pool and its subsequent usage calls for an imagination that usually becomes the differentiating factors for the success of a business. You too could embrace this concept and once you do that then it would become the foundation for your competitive advantage.
