Skate to Where the Money Will Be

What was it Wayne Gretzky said about why he was so good at hockey? He just skated to where the puck was going next. Executives and investors wish they could do so, too--to sense where profits are going next. Following a six-year study of profitability patterns, the authors have developed a model for doing just that. In the early stages of a product's evolution, companies compete on the basis of performance. And because they can't make substantial improvements in product performance unless the entire value chain is housed under one organizational roof, it works best if companies are vertically integrated. But as the underlying technology improves to meet the needs of most customers, companies begin to compete on the basis of convenience, customization, price, and flexibility. At that point, vertical integration is no longer an advantage--in fact, it quickly becomes a disadvantage. Different links in the industry value chain become modular, and the chain subsequently fragments. In either stage, most profitability goes to the companies that own the interdependent links in the value chain--the places where everyone's still vying to satisfy their customers with ever-better product functionality. Initially, that's the makers of the proprietary products aimed at the end-use consumers. But as those products become standardized, profitability shifts to the makers of components, and as components themselves become standardized, it can shift further back in the value chain. That's predictable, but it causes a problem for incumbents. As their products become commodities and profits decline, pressure from investors to maintain ROA causes them to spin off asset-intensive units that design and manufacture components--the very places where profits are heading.

• Profitability
• Vertical integration
• Competitive strategy