To protect profit, you must validate value

Protecting Profit

If you care about your profit potential next month, next year and next decade, read this article and take the following statement to heart: You will only be able to profit to the extent that you can provide more real value than your competitors.

Where does profit come from? We often take it for granted, but profit is a byproduct of circumstances. If you've ever bought a soda in a movie theater, you've been face to face with this concept. That soda you bought for $4 cost the theater about $0.10 to provide. You handed them $3.90 in profit because the concession stand was the only source and because you decided that the value of enjoying that soda during the movie outweighed a cost that would be ridiculous under other circumstances. The circumstance that creates that profit is the fact that the theater is the only place to watch that movie, at that time, on a giant screen.

The theater enjoys a closed environment, where they can block out beverage competition, but if someone else could stand in that lobby offering you an identical soda for $2, you'd buy that one. Then if someone else came along with a $1 price, you'd switch again. The movie theater will likely never face that kind of beverage competition, but innovation and deal seeking will cut their profit potential anyway. Comcast now offers some movies OnDemand at the same time they arrive in theaters. Beyond that, huge high-def flat panel TVs give people a living room theater experience that rivals or exceeds the big theaters. The movie theater loses the value of being the only place to see the movie, and therefore loses the opportunity to capture big profits from that soda.

Very few businesses enjoy a closed environment, and those that do face an army of entrepreneurs trying to figure out how to breach the walls and take some of that profit for themselves. There are three major trends that are tearing down walls of circumstance in every industry and every country: "deal mania", virtualization and crowd communication:

  • Deal Mania. "A penny saved is a penny earned", and more people believe that now than have in a long time. Groupon and its army of clones are pulling deep discounts and offers out of everyone they can get their hands on. Consumers are bouncing around from deal to deal (and B2B-oriented deal offerings are popping up too). Even though deal-fatigue is starting to set in, new offerings will make it easier and easier for customers to instantly find and filter everyone's "best offer".
  • Virtualization. Location and proximity have long been great protectors of profit potential. Your realistic choices were limited by who was within range to provide the products or services. This one started to break down long ago, with the invention of mail order. eCommerce, drop-shipping and globalized high-speed communications are tearing these walls down to the ground. For business services, the ability to quickly send large files, run videoconferences, and utilize various other new collaboration tools means you can shop the world for the best fit.
  • Crowd Communication. The power of the crowd could easily fill another dozen articles, but for purposes of this one what it represents is an end to the barriers of "awareness" and "discovery". Social networks, microblogging, review sites and a constant social desire to be the "hero" (who introduces the world to the cool new thing) all mean that you can easily discover and research a huge range of options for whatever you're seeking. As a business, you can't expect customers to stay in the dark about a better product just because it's not immediately visible nearby. The crowd will find it.

So where's the upside? Well, I'm writing this post while sitting in a Starbucks, drinking a not-inexpensive cup of coffee. I could easily get cheaper coffee, but I choose not to, and in the process I hand Starbucks a nice profit, because they are giving me value. One of the key values they give me is consistency. I know that I can walk into any of thousands of stores and get the kind of coffee I like, along with a pleasant environment and (almost always) great service. I am paying a premium on the product for a reduction in the risk that I'll have a bad experience.

There are a lot of factors that can contribute to value (and thereby, contribute to profits):

  • Uniqueness of product. If you manufacture or produce something proprietary, and your product itself has distinctive and desirable qualities, you’re in good shape. If those advantages are protected by registered intellectual property or control of scarce natural resources, you’re in great shape.
  • Convenience. Time is money, and the more time (and effort) you can save a customer, the more room you'll have to charge a premium.
  • Consistency. People are naturally risk-averse. They will weigh the benefits of trying something new (for instance, the benefit of a lower price) against the potential downside of a bad experience. The more you can protect them from the downside risk, the more room you have to charge a premium over the “unknown” option.
  • Flexibility. Just look at the airlines for a great example of this. The lowest fare classes are “non-refundable” with high change fees. The more flexible tickets are sold at a premium, even though the seat that ends up being occupied is exactly the same end product.
  • The Experience. Benihana serves food, just like many other restaurants. They could probably produce that food more efficiently if they cooked it in the kitchen and sent it out, but they add value by presenting the cooking process as an entertaining show.

How does your business provide meaningful value? It could be any mixture of these factors or others. Every business is different, but whatever your mix is, the key is for you to identify it, validate it (from the perspective of your customers) and maintain or improve it, even as your competition multiplies and evolves.

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