Profitability: SURVIVING and THRIVING in a LAND OF GIANTS

1. Profitability: SURVIVING and THRIVING in a LAND OF GIANTS Ken Wong

2. Key Number 1: The Right Priority and the REAL Enemy MARGIN-SUCKINGMAGGOTS Chasing the WRONG CustomersIn the WRONG WayFor the WRONG Reason

3. Price Minus Cost Profit: The Scorecard Unit Margins Net Income Times Return On Investment Market Share Divided By Unit Volumes Times Assets Managed Market Size

4. 11.1% 7.8% 2.3% 3.3% A Comparison of Profit Levers A 1% change in... Creates a change in operating profit of ... Price Variable Cost FixedCost Volume (Average economics of 2,463 businesses in Compustat)

5. Nothing destroys profits FASTER than cutting price 5 • The Tradeoffs Are Significant • Every 1% price cuts requires you to either cut variable costs by 1.34% OR acquire enough new customers to raise volume by 3.4% • Price cuts often lead to an erosion of quality • Price cuts that have an immediate financial impact focus on “shovel-ready” sources of cost reduction that makes differentiation impossible • You cannot “automate” a relationship • Efficiency programs take time to implement • There rarely is enough volume available to offset the cost of acquisition

6. Yes….but CUSTOMERS ALWAYS WANT LOWER PRICES DO WE GIVE THEM THOSE PRICES? HOW DO WE SUSTAIN PROFITABILITY IF WE DO?

7. Value is the RATIO of Quality-to-Price • Four Ways to Enhance Value • MAINTAIN QUALITY – REDUCE PRICE • REDUCE QUALITY A "LITTLE" – REDUCE PRICE A "LOT" • INCREASE QUALITY – MAINTAIN PRICE • RAISE QUALITY A "LOT" – RAISE PRICE A "LITTLE"

8. Why We Prefer "Quality-based Value Gains" Longer strategic window of opportunity/advantage Greater economic efficiency

9. Some Evidence 13.0 12.2 9.4 9.0 7.9 6.6% 6.3 6.2% 6.2 4.4 PRAGMATIC (cut costs THEN reallocated cost to Price &/or Promotion) PREVENTION (cut PRICES thencut COSTS to fiance) PROMOTION (spent heavily) PROGRESSIVE (reallocated costs to support new value prop) SOURCE: "Roaring Out of Recession" (Gulati & Nohria, HBR 4/2010) % chg 3 years post-recovery (SALES;EBITDA)

10. The Giant’s Advantage And how they’ll use it in the future

11. 50 25 12.50 1 2 4 8 Economies of Scale - It Can Be a "Good Thing…" Unit cost 100 The Small Firm's LOSS The Large Firm's PROFIT Vol 11

12. Via experience effects, economies of scale, market power, etc… LOWER PRICES Via businessplanning …Or Even Greater When Used Properly MORE SCALE LOWERCOSTS

13. Via experience effects, economies of scale, market power, etc… Via businessplanning BETTER QUALITY How Great Businesses Use Scale MORE SCALE LOWERCOSTS

14. HIGHER SALES Via sales andmarketing MORE SCALE SUPERIOR VALUE Via experience effects, economies of scale, market power, etc… Via execution andimplementation LOWER PRICES Via businessplanning AND/OR BETTER QUALITY The Productivity Cycle - Basic Form LOWERCOSTS 14

15. The Giant’s Traditional Game Is Changing • Price is Not the Best Way to Add Value • Short strategic window • Inefficiency relative to quality enhancement

16. What Should We Expect? • More Automation, Information Technology, Mobile Commerce • Scale underlies the giant’s advantage: people are not scalable • Giants will seek to compete on QUALITY OVER PRICE • Limits to Scale: Eventually scale effects bottom out • Market Diversity: Scale Requires Standardization • Profit Impact of Quality-driven value is superior • High-value accounts are less price-sensitive 3. There will be a BLURRING OF INDUSTRY BOUNDARIES • Competition for BASIC services will come from internet-based competitors, traditional banks, affiliated banks (eg Rogers, Loblaws) and other established brands whose cost advantage is not scale-based

17. How to Respond

18. The Ultimate Strategic Challenge 18 Find a way to raise quality WITHOUT raising costs OR 2. Find a way to reduce costs WITHOUT destroying quality

19. 19 Priority OneKnow Your Business Arena

20. Are You Focused on the Right "Business Arena"? THE VIAGRA RULE • People DO NOT buy products or services, they buy solutions to problems • Customer willingness to pay a premium price increases • With the importance of the problem being solved • The complexity of the work • The number of alternative suppliers • DO NOT TELL PEOPLE WHAT YOU DO - TELL THEM WHY THEY SHOULD CARE

21. 21 PriorityAlign Operations With Your Arena

22. The Disney Rule • The Reality of A Trip To Disney • Expensive • Long lines • Junk Food • Expensive Food • Our Response: “Let’s Go Back!!!”

23. Add "Good" Costs Reduce "Bad"Costs Increase "Value" Reduce"Waste" Lower Costs Higher Prices and Sales Higher Profits To Sell on Value, Know Your Costs… and the Value They Create Total Costs

24. 24 Priority Three Be Bigger Than You Are

25. STAND STAND STAND What is Different in These Pictures? FILTER FILTER FILTER CARAFE CARAFE CARAFE BASE - On/off - Timer BASE - On/off - Timer - Flavour controls BASE - On/off

26. MODEL A MODELB MODEL C MODEL ASALES MODEL B SALES MODEL C SALES COMBINED SALES OF A + B + C How Common Components and Modules Create Value Unit cost 100 ADDEDPROFIT FORMODEL A ADDED PROFIT FOR MODEL B ADDED PROFIT FOR MODEL C COST IF COMMON COMPONETS USED IN MODELS A + B + C Vol 26

27. Five Sources of Interrelationship Between Businesses • Procurement • Common purchased inputs • Technological • Common product technology • Common process technology • One product incorporated into the other (component) • Use of products requires a common interface (E.g. stereo equipment) • Infrastructure • Common capital • Common staff functions • Production • Common location of raw materials (logistics) • Common fabrication process • Common assembly process • Common testing/quality control procedures • Common factory support needs • Marketing • Common buyers • Common channels of distribution • Common geographic markets

28. 28 Priority Focus on the “Right Customers”

29. The Profitability of Selling to Transactional Customers Profitcontributed by: Profit Base profit Cost of newcustomer Time Source: Bain and Company (Frederick Reicheld) 29

30. Price premium Referrals Lower costs Increased volume 2 3 4 5 6 7 The Value of Customer Loyalty Profitcontributed by: Profit Base profit Cost of newcustomer 0 1 Year Source: Bain and Company (Frederick Reicheld) 30

31. Price 11.1% Cost 7.8% 19 Advertising agency 17 Bank branch deposits 17 Publishing 17 Auto/Home insurance 16 Auto service 15 Credit cards 9 Industrial distribution 7 Software Profit Impact of a One-Percent Increase in Customer Loyalty Volume 3.3% 0 4 8 12 16 20 Percentage Increase in Profits per Customer Source: Bain and Company (Frederick Reicheld) 31

32. 32 Priority Know What Matters Most

33. COMPANY CUSTOMERS EMPLOYEES What Matters Most • The “Service Profit Chain“ • Profits grow from satisfied customers who receive value due to satisfied and loyal employees who had proper training, coaching, and support Internal Marketing External Marketing Interactive Marketing

34. EXECUTION THE EXECUTION OF THEMARGIN-SUCKING MAGGOTS