What strategy enables a company to enter an existing market, win over and keep customers, take the lion’s share of profits, turn the screws on the competition – and then eliminate it – thereby setting the stage for long-term growth? The answer is the profit share strategy. The profit share strategy works in markets that are highly underserved. It’s quite literally the opposite of the low-end disruption strategy made popular by Harvard Business School professor Clayton Christensen. Low-end disruption opened up new markets by offering highly overserved customers a product or service much, much more cheaply than any other option on the field, sacrificing only features that the overserved population didn’t value in the first place. The profit share strategy, by contrast, addresses a highly underserved population that’s willing to pay much, much more to get a job done significantly better than is currently possible. Here’s how it works:
It starts by identifying the focal segment of highly underserved customers. These customers, who may comprise as little as 10 percent of the market, are highly underserved because the products available today fail to consider their unique situation. While executing the same job (task) as others, these customers are different: they face complexities that others do not; they face unique obstacles; they are forced to push the envelope; failure is not an option; they seek perfection. Consequently, they struggle more than others to execute their job-to-be-done and will pay a lot more for a solution that delivers.
A company enters this market by offering these underserved customers a product that will help them get their job done significantly (20 to 30 percent) better than any existing alternative. Because its solution is so much better and the need is so great, the company is able to price its new product two to five times higher than the products it is competing against. While this pricing strategy alienates most of the market, the severely underserved segment of customers is willing to pay.
Here is how the profit share strategy unfolds. With the release of version 1.0 of the product, the company wins a small percentage of market share (because only a small number of customers are so underserved that they are willing to pay the significant price differential), but it wins a respectable amount of profit share (because the price differential is so great).
With the revenue generated by the sale of this product, the company finances the release of version 2.0 of the product, again targeting the segment of highly underserved customers. Offered at the same price point as version 1.0, this new version once again helps customers get the job done – and offers some improvements on version 1.0.
With the release of the new version, the company cuts the price on version 1.0, making it more affordable for other underserved customers who are less willing or able to pay a significant price differential. This gains the company additional market share, and it continues to grow its profit share.
The company uses the revenues from the first two releases of the product to fund a third version and repeats the process. Version 3.0 is again significantly better and offered at the high price point. The prices of both version 2.0 and 1.0 are lowered, attracting an even larger percentage of the underserved population. The process continues until version 1.0 is priced to optimize market and profit share.
After several iterations, the company has successfully won the market from the top down. With often less than 10 percent market share, the company is able to secure 50 percent or more of all the profits earned in the market. It establishes itself as a market leader. Its competitors, left with overserved customers or those unwilling or unable to pay more for a superior solution, are starved of profits. Adopting the profit share strategy puts the company in a very attractive financial position that is also highly defensible. Here’s why:
Even if the company stops innovating after a couple of generations of its product, it’s still far ahead of its competitors, who must work through a number of product iterations to catch up. Assuming the company continues to make incremental product improvements, catching up could take years, or even decades.
As an additional strategic advantage, the company has the option to eventually lower the price of version 1.0 to match its cost. This puts the company in an exceptional position to both maintain and gain profit share while making it very difficult for competitors to disrupt the market from the low end.
The conclusion? The profit share strategy should be the vision, the envy, and the goal of every product and marketing manager. Where appropriate, it should be embraced.
In the next blog post, I will discuss companies that have pursued the profit share strategy.