A Profit Paradox or Simply Good Business Practice?

profit paradox

In this blog post, I provide an alternative perspective from the point of view of business strategy to the profit paradox.

The Profit Paradox

The Profit Paradox by Jan Eeckhout (ISBN: 978-0691214474), published by Princeton University Press, tells a story about firms exploiting market power enabled by technological innovation. Market power enables firms to set selling prices higher than they would be in competitive markets. Furthermore, the resulting increase in firm profits are kept within the firm rather than passed on to employees.

A key statistic is that the ratio of profit share vis-a-vis labor share of revenue has increased. In the early 1980s, firm profit share was 2% of revenue and labor wage share was 20%. Today, firm profit is 10% of revenue while labor wage share remains stagnant at 20%. So, the ratio of firm share to wage share increased from 5% to 50%.

The Profit Paradox points out that technological innovation is both good and bad for everyone. It is good because in competitive markets it lowers the cost of goods and services, therefore, lower the price of those goods and services to consumers. It is bad, because firms use the technological innovation to construct moats and increase barriers to entry to make the market less competitive. Due to the less competitive markets, the cost-savings from technological innovation actually end up maintaining the high prices for the consumers.

It reminds me of this incredible Counterpoint statistic I saw a while ago, which stated that, within the global smartphone market, Apple captured 85% of the operating profits with only 48% of the revenue share and a measly 18% of the shipment share.

A Business Strategist’s Perspective

As a consumer, my instant reaction to the significant increase of firm profits vis-à-vis stagnant wages is anger. Firm profits could be passed on to the consumer as lower prices or to employees as higher wages. I feel that’s very much the popular sentiment that drives the fight against “corporate greed.” However, as a business strategist, I can’t align that sentiment with what I see day-to-day.

Another perspective may be considered if we look at the post-1980 explosion in the field of corporate and business strategy theory (i.e., Porter’s Five Forces) and the subsequent rapid increase of professionals (MBAs) applying those theories in the real world.

Source: National Center for Education Statistics (NCES)

These professional managers are first and foremost tasked with looking after the firm’s health, not the broader economy. The increased productivity comes partly from professional managers focusing more intensely on best practices (i.e., Toyota TPS) which enable higher efficiency with a given capital investment. Suppose productivity increases are firm-specific, meaning the inter-firm optimized interaction between people and assets. In that case, it seems fair to attribute the resulting increases in profit to the firm and not employee wages. Hence, we get an increase of the profit share vis-à-vis the wage share.

toyota tps

Furthermore, business strategists have learned that competition is bad for business precisely because consumers will pick the lowest price if all other things are equal. So, there’s a solid incentive to devise business strategies that avoid competition (i.e., Blue Ocean vs Red Ocean). Operating within a “blue ocean” with no direct competitors offering near-identical products or services enables companies to set pricing as they see fit. That results in higher prices and higher profits.

Lastly, perhaps we should not say “higher” prices and profits but “healthier” prices and profits, at least from the firm’s perspective. Healthy operating profits are essential to firms because they enable healthy reinvestment in the firm. This reinvestment comes in various forms, including hiring more people, increasing inventory levels for faster customer delivery, expanding operations, or diversifying into new markets. Too low profits prohibit these “healthy” business activities. Too high profits entice other firms to compete and steal some market or, even worse, have innovation disruptors come for your entire market. In other words: maintaining a healthy profit share is simply good business practice, even if that means less goes to wages and consumers pay higher prices.

This reasoning would ultimately imply that healthy businesses are bad for the economy. I find that hard to wrap my head around.

May 10, 2023 Update

Following my blog post, I reached out to the author for additional feedback on my line of thinking. The author was kind enough to provide an insightful clarification on the topic which adds more food for thought.

The crux of the argument laid out in the Profit Paradox is that the while business efficiency improvements (like Toyota TPS) are help improve the efficiency of the company, they don’t necessarily improve the efficiency of the market as a whole. Less efficient markets – where certain players exert excess market power – are not good for the consumer as they end up paying higher prices and see their wages stagnate.

Healthy markets provide a platform for many firms to make healthy profits, but avoids few firms making excess profits.

As a final note, I also appreciate the author’s perspective on mergers and acquisitions. Not only because of the arguments related to increasing market power as laid out in the book but also because M&A is notorious for being the #1 firm value destroyer, as NYU professor Mr. Damodaran has argued many times over.

Whether it’s increasing market power or destroying firm value, M&A tends to benefit no one other than those collecting fees and commissions on executing the transaction. Therefore it’s probably in most people’s best interest to put the onus on the acquirer to prove a transaction will create value prior to regulator approval.

Cracking the Code: What Makes a Premium Company

premium company positioning

In this blog post, I provide a framework that helps you understand what you can do to become or continue to be a premium company.

What is a Premium Company

To get straight to the point, here’s my definition:

A premium company is a company that can consistently convince its customers to pay more than what they had initially intended for a certain product or service by virtue of its value proposition.

Let’s now dissect this definition and provide more context.

Product vs. Company

The first essential element to clarify is the difference between company, business, and product.

  • A company or firm is the organizational structure, in legal terms no not, that operates one or more businesses.
  • A business is the exchange of goods produced or services provided for money.
  • A product is one of the outputs of a business.

Avoiding product- or pricing-specific answers is essential when trying to answer what makes a premium company. They are not mutually exclusive. A premium company can offer non-premium products, and a non-premium company can offer premium products. However, what makes a premium company is its ability to deliver premium products to the market consistently.

Relative Positioning

The second important element to clarify is that “premium” is not an absolute or fixed position in the market but relative to the target customer needs. We can draw upon Clayton Christensen’s disruptive innovation framework to clarify this idea.

The framework defines a market or arena with multiple customer types: high-end, mid-end, and low-end. To avoid confusing these terms by their commonly used association with pricing, let’s call these high-needs, medium-needs, and low-needs customers instead.

High-needs customers require the product to offer various attributes and features. In addition, the features must be up to standard. To put it in terms I used in an earlier blog post titled “Attributes and Values: Business Strategy Core,” high-needs customers have many attributes that need satisfying and more than a few that need championing.

Low-needs customers require the product to meet their basic needs sufficiently and nothing more. They are willing to accept sub-standard attributes or forego them entirely.

Medium-needs customers fall in between high-needs and low-needs customers.

Collectively, we define the needs of a customer type as the required product performance.

Firms can now develop and market products catering to different customer types. Generally, the goal for the firm is to understand the customer performance expectations appropriately, then deliver a product that closely matches those expectations. We can call upon the price/value framework from an earlier blog post titled “Value and Price Dynamic” to understand the tension between Value Offered, Value Perceived, and Purchase Price.

This framework offers three possible customer segments in a market with high-, medium-, and low-needs customers. However, in relative positioning, the firm also has the option to make a deliberate choice to either exceed the customer expectations or fall short of the customer expectation. Let’s call this premium and discount positioning.

In premium positioning, the firm delivers a product that offers more or better attributes than the customer needs or expects. It also comes with a slightly higher price tag. The company must communicate to the customer the extra value offered and why it’s worth the additional money. Customers may be willing to spend more than planned if they appreciate the additional value offered.

In discount positioning, the firm delivers a product that offers fewer or worse attributes than the customer needs or expects. It also comes with a slightly lower price tag. The company must communicate to the customer why the lack of value offered is not a concern. Customers who appreciate this story will happily pay less for the product.

The Premium Company

Let’s return to the definition of a premium company. A company is a premium company when it can consistently market premium products relative to its target customer needs and consistently convince customers to pay more for those products.

Notice how I emphasize the word “consistently?” One premium product doesn’t make a premium business. And one premium business doesn’t make a premium company. The challenge of becoming and staying a premium company is that you need to consistently outperform your customer expectations, even when those expectations increase year after year.

Another critical challenge of being a premium company is thoroughly understanding your customer’s needs and wants. Based on that information, you must plan to exceed those needs and wants. And if that’s not enough, you must also be able to execute this plan. It’s tough being a premium company!

The benefit of being a premium company is that over time customers will associate premium with your brand and products and thus will automatically expect to pay a higher price than for an equivalent product of another brand.

Premium Company Margins and ROI

As a final note, I want to cover the topic of profit margins of premium companies briefly.

Following the framework of the premium company, we can say these companies can charge higher average selling prices (ASPs) and higher margins. Thus, the premium companies enjoy higher ROE and can invest in new projects more easily.

However, we must separate the premium positioning from a firm’s ability to capture the value. Whereas premium positioning allows a firm to charge higher ASPs, the margin and associate ROE highly depend on the operating model. Inefficient premium companies won’t be able to capture the appropriate margin and may not achieve the expected return on investment as a premium company.

Notes on Disruptive Innovation: Intellectual History and Future Paths

My notes on HBS Working Paper 17-057 (PDF) titled Disruptive Innovation: Intellectual History and Future Paths by Christensen C., Altman E., McDonald R., and Palmer J. It complements my previous blog posts like Business Theory of Disruptive Innovation, Jobs To Be Done: Business Raison d’Etre, and Managing the Six Phases of Transient Competitive Advantage

3 principal components of disruptive innovation:

  1. The pace of technological progress outstrips growth in market demand for higher-performing technologies, causing incumbents to overserve the market and, as a result, creating a gap in lower market
  2. There is a strategically important distinction between different types of innovation
    • Sustaining innovations: improve product along existing dimensions of performance (make a good product great)
    • Disruptive innovations: usually cheaper but better at other dimensions (create a new product)
  3. Established profit models constrain investment in new innovations because they are typically less profitable

Anomalies uncovered in further research

  1. At first, the idea is that incumbents don’t invest in disruptive innovation. But that’s not true: investment ranges from little to freely flowing
    • Opportunity framing vs. threat framing: threat framing usually leads to greater resource allocation
    • However, despite investments, inertial forces prevented from adoption
  2. A small subset of incumbent leaders successfully dealt with disruptive innovations
    • autonomous business unit separate from parent company free to enact own business mode
  3. Different types of disruptive innovation:
    • Low-end disruptions: enter the low-end of the market, solidify market share and position in the value network, then move up-market
    • New-market disruptions: compete against non-consumptions
  4. For disruption to occur, industries must be structured so that producing higher-performing products and services results in higher profitability for firms, giving them an incentive to go upmarket.
  5. Specific industries have an “extendable core” that allows firms to produce at first simple products at low cost, but eventually can make more sophisticated things at lower cost

Causal Pathway for Disruptive Innovation theory

  1. Insidious resource allocation process within the organization that favors “sure” investments
  2. Customers ultimately provide the firm with the resources it needs to survive
    • Sustaining innovation serves and is valued by existing customers
  3. As performance improves, there is a more significant overlap between different market segments
    • Disrupters invade contested up-market to increase economies of scale
    • Incumbents retreat to uncontested up-market to protect profitability

Research with Intel on investment in disruptive innovation.


  • If the innovation was sustaining and Intel was an incumbent in the target market, the venture would succeed.
  • If the innovation was sustaining and Intel was an entrant in the target market, the venture would fail.
  • If the innovation was disruptive and an autonomous business unit was formed to pursue it, the venture would succeed.
  • If the innovation was disruptive and an integrated business unit was formed to pursue it, the venture would fail.

Using business plans to classify the ventures and survival to proxy performance, the theory correctly predicted the outcomes of 45 of the 48 businesses (94 percent accuracy rate) (Raynor, 2011)

Refining Performance Trajectories

  • The variance in the speed of disruption across different industries
  • The variance in speed of disruption within the same industry over time

Responding to Disruptive Innovation

Incumbent Response Strategies

  • Separate organizational unit tasked with developing or commercializing the new innovation
  • Aggressively invest in existing capabilities to extend current performance improvement trajectories to slow or delay the onset of disruption
  • Boldly retreat by proactively repositioning to profitable new niches
  • Organizational ambidexterity to manage conflicts arising from pursuing different types of innovations simultaneously
  • Redefine the organization’s identity to convince customers to value their products not on functional dimensions but on characteristics like nostalgia, authenticity, etc
  • Partner with or license startup technology once it advances beyond a certain threshold or acquire it altogether
  • High brand status can help incumbents re-emerge after experiencing a decline due to disruption

Hybrid offerings

  • Combine the new technology with the existing one to ensure a smoother transition
  • Improve existing technology while learning the uncertain technology
  • The performance difference between using new technology to enhance existing products and deliver to an existing customer base (sustaining) versus using hybrid technology to target new customers or applications (disruptive)
  • Hybrid may be of particular use to enter a market to support both legacy and new use
  • Business model hybrids?

Platform Businesses


  • Platform businesses are built around modular architectures; the primary competitive advantage is interaction with one another and building upon the others’ products
  • Platform and network-based business strategies are emerging more rapidly, especially in IT- and cloud-enabled business models
  • When products are not yet good enough to satisfy customer performance requirements, firms rely on highly internally interdependent and integrated product architectures to maximize performance. Firms cannot afford to adopt modular architectures because standard interfaces compromise performance
  • When performance is satisfied, the basis of competition shifts to other product dimensions such as convenience, customization, price, and flexibility
  • When the shift to less integrated happens, modular architectures enable simpler and more efficient interfaces between products. Disruptive entrant incorporating modularity strategy can be highly effective

Disruption through incumbent transitions to platform business

  • When in an industry’s lifecycle, it’s effective for the incumbent to transition to modular/platform
    • If differentiation is performance-based, platform business is sub-optimal
    • If the industry over-serves and competition basis shifts to convenience, the platform may prove viable

Disruption through complementor ecosystem and network effect

  • A strong link between the management of complementor ecosystems for disruptive innovation
  • The competitive success of platform strategy hinges on the ability to create and harness network effects
  • A pricing strategy can disrupt the incumbent. E.g., offer free products to gain adoption
  • To build network effects, a firm may adopt strategies that rely on revenue sharing or royalties rather than sales revenues
  • Coopetition as a form of defense against disruption

Financial Metrics

  • Disruption is not a technology problem; it is a business model problem (and tightly related to the profit model)
  • Two problems with Profit Model
    • A measure of success -> drives investment decisions, especially when compensation is tied to financial success
    • Shows short-term success -> drives investment decisions, avoiding the long-term return perspective
  • New startups without defined profit formula as a success metric gauge success in different ways
  • The use of financial metrics may unconsciously create bias against disruptive innovations
    • Implications of marginal cost thinking and sunk cost fallacy
    • Valuation metrics don’t work if you underestimate the true benefits of innovation
    • Ratio-based metrics = manage by metrics (balance sheet management)

Updates to My Blog Post

I have updated my blog post titled “Managing the Six Phases of Transient Competitive Advantage” to include the Management Priority in each of the six phases:

Phase 1: The management is focused on its vision and aims to deeply understand the job to be done.

Phase 2: The management is focused on its vision and aims to find the right customers for its new product or service.

Phase 3: The management is focused on the operations as it aims to establish the right business and profit model to repeatedly deliver to the customer needs.

Phase 4: The management is focused on the operations as it aims to maximize the market opportunity.

Phase 5: The management is focused on finance as it aims to maximize the profit & loss statement.

Phase 6: The management is focused on finance as it aims to maximize the balance sheet statement.

Managing the Six Phases of Transient Competitive Advantage

The traditional goal of corporate strategy is to obtain a sustainable competitive advantage. However, this paradigm is outdated in the fast-moving globalized world we live in today. Instead, firms should consider their business models flowing from one transient competitive advantage into another.

What is a sustained competitive advantage?

A sustained competitive advantage includes everything that allows a firm to meet its customers’ needs better than competitors or substitutes. It consists of any attributes of the product sold, or service offered that the customer values highly, the perceived value of your brand, the business operating and profit model, etc.

By definition, a sustained competitive advantage is sufficiently strong, unique, and inimitable. That allows the firm to indefinitely fend off competitors vying for the same customers, discourage new entrants from entering the market, and prevent customers from considering any available substitutes.

The sustained competitive advantage is often described as an economic moat, similar to the deep and wide trench around a castle. In this parallel, the castle is your business, and the size of your moat determines how well your firm can protect its business.

In the past, firms would search for this sustained competitive advantage by deeply analyzing a target market, its customers, and the existing supply chain. Once a potential competitive advantage was uncovered, the firm would go to market and do everything possible to turn the advantage into a sustained advantage.

What is a transient competitive advantage?

In a globalized world, barriers to entry have lowered significantly. So, your position in the market with a competitive advantage is exposed to many more players than before. A threat can now be mounted from any country, not just known players in your vicinity.

Furthermore, the rapid increase in information flow and the digital world also exposes these potential disruptive threats to investment markets. Capital has increased visibility on attractive opportunities and can deploy resources to go after them if necessary.

The transitive competitive advantage distinguishes itself in that it is, by definition, not indefinite but limited in time. This significantly affects how a firm should approach ensuring its long-term success.

With a traditional sustained competitive advantage, the assumption is that a competitive advantage can be sustained indefinitely. So, the firm is primarily concerned with reinvesting in the economic moat around its castle to protect its business. The best firms can dig the deepest and largest trenches and, therefore, can protect their business indefinitely.

With a transient competitive advantage, the assumption is that no competitive edge can sustain forever. Therefore, the firm is no longer focused on protecting the existing economic moat at all costs but on the continuous transformation process.

The focus on transformation shifts the firm’s priority from protecting the economic moat to managing the rise and demise of competitive advantages.

How should a transient competitive advantage be managed?

We outline six distinct phases of the transient competitive advantage paradigm. We differentiate the phases from the perspective of McGrath’s “Transient Waves,Damodaran’s “Corporate Lifecycle,Christensen’s “Innovation Cycle,” and Ulrich’s “MOE Organization.”

Phase 1 – Launch of Disruptive Start-Up Team

The first phase of the transient advantage wave begins with identifying a new business opportunity and the decision to mobilize resources to capture it.

In this phase, the team is small. It operates like a start-up, focusing on developing a product that gets a well-defined job done better than anything else currently available. The identified opportunity can take many shapes, including:

  • Addressing a market need for which demand far exceeds supply
  • Low-end disruption in a market where an existing product or service overserves a significant portion of the customers, and therefore there is an opportunity to better serve the customer with a lower-cost business model.
  • New market disruption addresses under-served customers with a more suited product or service offering.

The management is focused on its vision and aims to deeply understand the job to be done.

The team leader is a visionary who can tell a compelling and plausible business story with potential upside for huge profits. The leader must connect the dots between the business opportunity, how the product addresses this opportunity, and what business model can capture the value created. The strength of the story will draw employees and investors to the vision.

The visionary is surrounded by RD innovators and out-of-the-box thinkers who are comfortable with experimentation and iteration and have a fundamental belief in the positive outcome of the project. The RD innovator’s priority is to turn the business idea into a feasible prototype that can be brought to market.

At this point in the business lifecycle, the revenue growth is non-existent, the operational cash flow is negative, and the reinvestment needs are high. Since the business is not generating any surplus cash, there can be no dividends returned to the shareholder. Also, there is no money to pay interest on the debt. Therefore, financing should be done exclusively with equity.

Phase 2 – Ramp Up of Disruptive Young Growth Team

The second phase of the transient advantage wave takes the working prototype to market. It aims to scale the business by turning the business opportunity into a revenue stream.

In this phase, the team remains small. Still, it adds market-oriented capabilities such as marketing and sales and operational-oriented capabilities such as supply chain management.

The management is focused on its vision and aims to find the right customers for its new product or service.

The team leader is a pragmatist (not a purist) who stays consistent in words and action with the business story that launched the business. The leader’s primary focus is to ensure the team remains focused on developing a disruptive product that “gets the job done” and finds customers who “need to get that job done.” At the same time, make the compromises required to ensure market viability.

A common mistake is that the business team pivots too quickly away from the business idea to address the initial customers’ needs. Especially when the team is part of an already established organization with an existing customer base. Another common mistake is to see the narrow, pure vision as the only yardstick of success which may prevent the business from taking off in the first place. The business leader must manage the friction between the “pure vision” original team members (developers) and “pragmatic” new team members (marketing, sales, supply chain).

At this point in the business lifecycle, revenue grows exponentially, starting from a low base. While the (re)investment rate remains high, the business should aim to achieve at least the operational breakeven point. Since profitability remains near zero, there is still no surplus cash to return to shareholders or money to pay interest on the debt. Therefore, financing should still be done exclusively with equity.

Phase 3 – Exploitation of Sustained High Growth Team

The third phase of the transient advantage wave aims to scale up and expand the business operations to capture profits by exploiting the fast-growing business

In this phase, the business is considered more than viable and success hinges on the team’s ability to turn revenue into profitability. The team shifts the focus from entrepreneurship and innovation to business management, operational excellence, and sustained RD development. In addition, the organizational focus shifts from focusing on the product alignment with the initial business idea to expanding the offering into a portfolio developed to address the growing or changing customer needs.

The management is focused on the operations as it aims to establish the right business and profit model to repeatedly deliver to the customer needs.

The team leader is a builder who can deliver the financial numbers in alignment with the original business story. They accomplish that by setting up a scalable organization with the capacity to build business processes that allow repeated success in the market.

The organization grows rapidly in size and capabilities, including but not limited to a variety of operational, finance, and human resource management. This is often associated with severe growing pains and a challenge to maintain a thriving company culture.

At this point in the business lifecycle, revenue growth remains high while operational costs are growing slower due to the benefits of scale. As a result, the business profitability is growing and should have a low but growing operating cash flow. The (re)investment needs remain high; therefore, there is still no surplus cash available for the shareholder. Since there is a positive cash flow, there’s room for small debt financing as long as it doesn’t waste the money needed for reinvestment. So, equity financing is still the primary choice.

Phase 4 – Exploitation of Sustained Mature Growth Platform

The fourth phase of the transient advantage wave focuses on leveraging a solidified position in the market and associated profitability to transform the business team into a business platform.

In this phase, the business has a double focus: internal and external. The external focus remains entirely on addressing the customer needs by continuously updating and refining the portfolio offering with new and better products. Since the customer knows and trusts your business and products, their willingness to pay is at its highest point. The internal focus is new to the business team. It addresses the need to find appropriate purposes for the increasing cash surplus generated from operations by transforming into a business platform.

Due to the double needs, two leaders are now required: a platform leader and a business leader.

The management is focused on the operations as it aims to maximize the market opportunity.

The business leader is an opportunist who keeps the business story in check with the numbers and quickly captures any new opportunities that extend from the existing business and may include M&A. Furthermore, the business leader aids the transformation from a business team focused on generating profits to a business platform that can support different business teams with capabilities and financing.

The platform leader focuses on repurposing the surplus cash to establish a business platform to fund new waves of transient advantage.

The organization continues to grow in size and diversity in capabilities. By now, the business should have several idiosyncratic internal processes that are inimitable competitive advantages. “The way we work” is a crucial differentiating feature within the broader market. The unique, idiosyncratic qualities are fundamental to the transformation from a business team into a business platform

At this point in the business cycle, revenue growth is slowing but still above the market average. However, thanks to a finetuned operating engine, profitability and operating cash flow are high and growing. At the same time, the reinvestment needs are less. Thus, there is a surplus of cash. The cash surplus can be used to transform the business team into a business platform or return to the shareholder. In the case of the former, the business platform can invest surplus cash in beginning a new wave of transient advantage. Debt financing is generally cheaper than equity financing, and there’s more than sufficient cash to pay interest on debt, so business operations should be financed primarily by debt.

Phase 5 – Reconfiguration of Efficient Mature Stable Platform

In the fifth phase of the transient advantage wave, the business platform reconfigures the organization to allocate internal resources where they are most needed.

In this phase, the business is no longer growing. Furthermore, there is increasing tough competition trying to steal your market share. Thus, it is important to reconfigure the organization to make resources available for new business opportunities. The platform and business leaders continue to manage the internal and external focus, respectively.

The management is focused on finance as it aims to maximize the profit & loss statement.

The platform leader focuses on absorbing the idiosyncratic capabilities and repurposing the surplus cash to establish a business platform that will fund new waves of transient advantage.

The business leader is a defender who adjusts the business story to reflect the mature nature of the business. They shift focus from finding new markets to defending existing market share, which is necessary to ensure further profits are extracted from the business and transferred to the platform.

The organization shifts its focus from sustaining development to efficiency optimizations where the same is done with increasingly fewer resources. The organization reduces headcount and outsources capabilities that are not essential to the business’s survival. The RD developer is replaced with an RD optimizer focusing on reducing product costs.

An essential part of reconfiguration is to ensure that, while resource allocation is dynamic, the organizational platform structure and support provide a stable environment for people to thrive. If people fear that reconfiguration equates to job insecurity, there may be significant organizational resistance to free up resources.

At this point in the business cycle, revenues are stable but not growing beyond the market average. Due to increased competition, profitability is under pressure. It requires the organization to become more efficient to ensure positive operational cashflows. At the same time, (re)investment needs are low, so there’s surplus cash that should, in its entirety, either be returned to the shareholder or reinvested via the business platform. There is no need to risk equity to finance the continued operation of the business, so debt financing is preferred.

Phase 6 – Disengagement from Efficient Declining Assets

The sixth and final phase of the transient advantage wave focuses on healthy disengagement from the business by either liquidating or absorbing the assets into the platform.

In this phase, the business has run its course and is no longer of value to the shareholders or the business platform. Healthy disengagement is as vital as continuous innovation.

The management is focused on finance as it aims to maximize the balance sheet statement.

The platform leader focuses on absorbing the remaining valuable assets and capabilities and repurposing the surplus cash to fund new waves of transient advantage.

The business leader is a liquidator who dismantles the business and sells the assets of no further use to the business platform. They can maximize the cash received for the sold-off assets by ensuring timely disposal. They can avoid bad press and, if possible, reduce the business operations so that the platform is well-compensated to maintain legacy support.

The organization is dismantled with only critical roles remaining if there’s a need to maintain legacy support. People transfer within the business platform into new positions. In the end, the business is discontinued entirely.

At this point in the business cycle, revenue continues to decline until the business is discontinued. Due to the reducing revenues and increased competition, profitability declines faster than revenue. Thus, there is a declining operating cash flow. There are no reinvestment needs, and as assets are converted into cash, there’s a negative reinvestment rate. The surplus cash is either transferred to the business platform or returned to the shareholder. Any outstanding debt is retired in an orderly manner.

Table1: Six Phases of Transient Competitive Advantage

Phase 1Phase 2Phase 3Phase 4Phase 5Phase 6
McGrath's “Transient Wave”LaunchRamp UpExploitExploitReconfigureDisengage
Damodaran's “Corporate Lifecycle”StartupYoung GrowthHigh GrowthMature GrowthMature StableDecline
Christensen's “Innovation Cycle”DisruptiveDisruptiveSustainingSustainingEfficiencyEfficiency
Ulrich's “MOE Organization”TeamTeamTeamPlatformPlatformAssets
Business LeaderVisionaryPragmatistBuilderOpportunistDefenderLiquidator
Business CapabilitiesEntrepreneur
RD Innovator
+ Marketing
+ Sales
+ Supply chain
- Entrepreneur
- RD innovator
+ business manager
+ RD developer
+ Op manager
+ Finance manager
+ M&A - RD developer
+ RD optimizer
- Marketing
- Sales
- Supply chain
- RD Optimizer
Business PriorityBusiness ideaCreate revenue streamAchieve profitabilityMaximize profitabilityDefend market positionScale down business
Management FocusVision: Understand the job to be done
Vision: Find the right customers
Operation: Build the business operations
Operation: Maximize the market opportunityFinance: Manage the P&LFinance: Manage the balance sheet
Product focusDevelop productScale productExpand portfolioMaintain portfolioReduce portfolioLiquidate assets
KPI PriorityProductProductCustomerCustomerPlatform Platform
Revenue growthNoneExponential from a low baseHighAbove market but slowingStagnating to market averageDeclining
Operating cash flowNegative BreakevenLow but growingHigh and still growingHigh but stagnatingDeclining
Reinvestment needsHighHighHighAverageLowNegative
ProfitabilityNegativeBreakevenGrowingHigh and growingHigh Declining
FinancingEquityEquityEquity and low debtEquity but mostly debtDebtRetiring debt

Attributes and Values: Business Strategy Core

The core of each business strategy centers around identifying and addressing those attributes and values your customers care about most.

In the Strategic Blueprint for Business World Domination I outlined three fundamental questions for each business that wants to achieve sustainable growth. In this post we continue expanding on the opportunity question. When you figured out the raison d’etre of your business – the job to be done – and have carefully considered the business macro- and micro-environment, it’s time to move forward with the business strategy.

business strategy
Fundament of business

Business Strategy Definition

In a blog post I wrote one year ago I used the following definition of business strategy.

“Thus, we can propose the following definition: a business strategy defines the unique set of specific attributes the firm chooses to focus on aiming to achieve superior long-term return on invested capital.”

While the definition above still holds true, I’d like to expand on that definition and be more specific.

“A business strategy sets out to identify the existing and potential attributes or values of a product or service, choose those attributes and values your target customers are willing to pay for, and focus on achieving market-leading performance on those specific attributes and values.”

Notice there are four important aspects of the business strategy.

  1. Identification all the existing and potentially new attributes that your target customer may or may not care about
  2. Championing of those attributes you believe the customer values most and therefore is willing to pay for
  3. Satisfying those attributes your customer deems as a minimum requirement but isn’t necessarily willing to pay for
  4. Eliminating those attributes your customers don’t value at all

The identification process is rooted in the job-to-be-done analysis. The better you understand what your customer is trying to get done, the more specific you’ll be identifying the attributes. Note that we mention both the attributes your customers care and those they don’t care about as both are significant. In strategy formulation it’s important to not only know what you want to do but equally important to know what you don’t want to do.

Eventually you should have a list that comprises of three distinct types of attributes: the ones that you absolutely need to get right (champion), the ones you need to have (satisfy), and the ones you shouldn’t have (eliminate).

Categories of Attributes and Values

We can identify two broad categories of attributes and values and further segment into five distinct categories.

  • Functional Attributes
    • Attributes related to quality (how well does it get the job done?)
    • Attributes related to reliability (how long can it perform at the right quality?)
    • Attributes related to convenience (is it easy to acquire or hire?)
  • Emotional Attributes
    • Attributes related to personal needs or desires
  • Social Attributes
    • Attributes related to social needs or desires

Generally, the functional attributes are the most important to any product.

When thinking about attributes and values related to the business strategy formulation, it’s useful to link two related topics. First, the Blue Ocean Strategy and second the relationship between Value and Price in marketing strategy.

Blue Ocean Strategy

Blue Ocean

Blue Ocean Strategy is a business theory and published book written by W. Chan Kim and Renée Mauborgne, both professors at INSEAD. The theory asserts that business should systematically focus on unexplored new market areas (blue oceans) rather than endlessly compete in existing markets and industries (red oceans).

Red oceans are red because they feature cutthroat competition between companies targeting the same customers with similar products. The companies fight for market share by constantly trying to outperform their rivals. As more companies enter the market space, the prospects for profits and growth come under pressure. The cutthroat nature of the rivalry makes the market blood red.

Blue oceans are blue because they untainted by competition. They are in fact unexplored markets. The demand is created rather than competed over. Neither the total market size nor the profit formula is set in stone, meaning there’s plenty of room for growth and profit.

business attributes blue ocean value innovation

The cornerstone of Blue Ocean Strategy is Value Innovation. Value innovation is the simultaneous pursuit of differentiation and low cost, creating a leap in value for both buyers and the company. The point of value innovation is to make the competition irrelevant by reducing the total cost as well as increase the overall value. Cost savings can be achieved by eliminating and reducing the attributes an industry is currently competing on while value is lifted by creating attributes the industry has never offered.

This is very much aligned with the process outlined above. Cost savings are essentially a satisfying the identified attributes the customer doesn’t really care about but deems a minimum requirement. Satisfying doesn’t mean matching the industry standard, but in fact matching the customer expectation. Value lifting is championing the new potential attributes that the customer cares a lot about.

On the Blue Ocean Strategy website, you can find plenty of useful tools to help you explore the framework. One tool I find particularly useful is the Strategy Canvas which visually captures the difference between current market landscape and the future prospect of your business strategy.

Value and Price

In a blog post titled Value and Price Dynamic, I covered the dynamic between three distinct perspectives:

  1. The firm’s perspective on the value offered
  2. The customer’s perspective on the value perceived
  3. The firm’s perspective on the price

Whether a customer is willing to pay for your product or service depends on whether they believe to capture a significant amount of value. That value is the difference between the value perceived by the customer and the price to pay. The higher the customer incentive to purchase (CIP), the more likely the customer is to purchase.

From a company perspective, the goal is to maximize the value perceived while minimizing the cost. This can be achieved by following the process of Value Innovation as proposed in the Blue Ocean Strategy or by following the steps outlined earlier in the post.

  1. Identification of attributes will help you understand what the customer perceives as valuable and what they perceive as not valuable
  2. Championing attributes ensures that the customer will perceive your product as more valuable than competitor products as you offer the best performance
  3. Satisfying attributes ensures that the customer isn’t paying for things they don’t inherently find valuable while avoiding removing attributes they deem a necessity. These are crucial attributes because including them doesn’t add much value but excluding lowers the value significantly
  4. Eliminating attributes ensures that the value gap between the firm’s offered and customer’s perceived value is low, and reduces the overall cost

Economic Moat

As the business is increasingly proficient at identifying, championing, satisfying, and eliminating those attributes and values the customer cares and doesn’t care about, two things will happen. First, your product or service value proposition becomes increasingly unique in the marketplace and more difficult for competitors to copy. Second, you become increasingly more proficient at optimizing the total cost ownership of the specific set of attributes that makes your product unique. This makes it difficult for a competitor to copy your product with a lower cost.

With the right business strategy and the right execution, inevitably your business will develop inimitable sustained competitive advantages and economic moat.