Professor Ken Homa
Georgetown University
Profit Pool Analysis
Profit Pool Mapping
Incomplete Without Extensive Oral Elaboration
Proprietary Material
© K.E. Homa
Profit Pool Analysis
Guiding Principle
The starting point for industry analysis is a very
simple question: What is the level of profitability
in an industry and what determines it?
Grant, Contemporary Strategy Analysis
Profit Pool Analysis is how to answer the question.
Profit Pool Analysis
Three sequential activities:
1. Estimate aggregate industry profits
2. Disaggregate profits into components
3. Visualize (display) the results
Profit Pool Maps are the
end-product of the process …
Profit Pool Maps
Key Elements
Sources of Profitability
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
Profit Pool Maps
Key Elements
Sources of Profitability
Profitability
• ROS
• ROI
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
Profit Pool Maps
Key Elements
Sources of Profitability
Profitability
• ROS
• ROI
Scale of Participation
Revenue, Capital Deployed
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
Profit Pool Maps
Key Elements
Sources of Profitability
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
Profitability
• ROS
• ROI
Note: By def’n. the
box areas = Profits
Scale of Participation
Revenue, Capital Deployed
Profit Pool Maps
Key Elements
Sources of Profitability
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
Profitability
• ROS
• ROI
Note: By def’n. the
box areas = Profits
Scale of Participation
Revenue, Capital Deployed
See Appendix
for Examples
Profit Pool Maps
The Gold Standard
Strategy guru Michael Porter argues that:
•
Organizations are supposed to use all resources
effectively … by producing goods or services whose
value exceeds the sum of the costs of all the inputs
•
So, he best financial measure that is return on
invested capital since ROIC since it weighs the profits a
company generates versus all the funds invested in it.
Source: Margretta, Understanding Michael Porter
Profit Pool Maps
The Gold Standard
Sources of Profitability
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
ROIC
Capital Deployed
See Appendix
for Examples
The Gold Standard – relating capital
deployed to ROIC – is often difficult to
derive because of accounting complexity
and data limitations …
More typically, the profitability metric used
is return on sales (ROS) and revenue is
used as a measure of scale…
Profit Pool Maps
Typical Application
Sources of Profitability
•
•
•
•
Value Chain Steps
Products / Markets
Customer Segments
Distribution Channels
ROS
Revenue
See Appendix
for Examples
Profit Pool Mapping: Why bother?
Profit Pool Maps
Derived Benefits
• Adds depth of understanding re: industry
structure and competitive dynamics
• Reveals location and size of profit
concentrations within an industry
• Identifies and isolates the most critical
drivers of future industry profitability
Profit Pool Mapping:
An under-used tool …
Profit Pool Maps
An Under-used Tool
• Managers unaware of implications
• Financial data unavailable or
inconsistently reported
• Requires extensive time, effort
and analytical dexterity
Profit Pool Maps
The Process
Source: How to Map Profit Pools
Profit Pool Maps
Tricks of the Trade
• Start by mining government and analyst reports
• If compiling from scratch, start with direct competitors,
especially “pure plays” that report profit by segments
• Extrapolate from data-rich competitors to others
• Take several views – split by multiple profit sources.
• Don’t get bogged down … think 80-20 … better to be
directionally right than precisely wrong.
Profit Pool Analysis
Takeaways
•
Profit Pools are the ultimate metric of industry attractiveness
•
Strong ties to Porter’s Five Forces and Value Chain Analysis
•
Profit Pools can be split along several dimensions: business
segment, competitors, products, regions, value chain stage
•
Profit metrics applied range from ROS % (most typical) to
ROCE (conceptually, the most pure)
•
Often, multiple views are required to get a full industry
perspective.
Appendix
Profit Pool Maps
Examples
Industry-level Profit Pools can be split
into different categories …
Often, multiple views are needed to get
a complete perspective on the industry.
Examples 
U.S. PC Industry Profit Pool -- Late 1990s
3. Profit is stated relative
sales (i.e. ROS %)
4. Area of each bar represents
proportion of total profits
1. Profits split by product categories…
horizontally sequenced by activity
stage – parts, finished goods, etc.
2. Width of each bar is proportional
to the all categories’ total
Source: Profit Pools: New Look at Strategy
U.S. Auto Industry Profit Pool -- Late 1990s
Profits split by business segment
… horizontally sequenced by activity
stage – make, sell, service, etc.
Source: Grant, Strategic Analysis from Profit Pools: New Look at Strategy
Profits split by value chain stages
Source: Breakthrough Imperative
Profits split by business segment
http://www.bain.com/publications/articles/healthcare-2020.aspx
The prior examples all calibrated profitability
based on ROS (return on sales), but …
Strategy guru Michael Porter argues that:
•
Organizations are supposed to use all resources
effectively … by producing goods or services whose
value exceeds the sum of the costs of all the inputs
•
So, he best financial measure that is return on
invested capital since ROIC since it weighs the profits a
company generates versus all the funds invested in it.
Source: Margretta, Understanding Michael Porter
Some economists and financial analysts follow
Porter’s guidance and use some variant of ROIC
in their profit pool maps …
For example, Credit Suisse analysts calculate a
net cash flow ROI (over the firm’s WACC), and
relate it to relative levels of net investment (not
revenues).
Examples 
1. Profits split by
industry sector
2. Profit is stated based on
net ROIC (over the WACC)
3. Width of each bar is proportional to
the industry’s total net investment
http://analystreports.som.yale.edu/internal/F2013/MJ/Measuring%20the%20Moat.pdf
Profits are split
by company
http://analystreports.som.yale.edu/internal/F2013/MJ/Measuring%20the%20Moat.pdf
Profits are split
by business segment
http://analystreports.som.yale.edu/internal/F2013/MJ/Measuring%20the%20Moat.pdf
1. Profits are split by
value chain stage
2. Profit is stated based
on net ROCE
3. Note that axes are mismatched
so areas do not equal profits
Revenues x ROCE ≠ Profits
Professor Ken Homa
Georgetown University
Profit Pool Analysis
Profit Pool Mapping
Proprietary Material
© K.E. Homa