Distilling market noise into market sense

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Profits are Life Blood

[Is profit share overrated as a measure of company viability? Guest author Jay Goldberg takes a contrasting viewpoint to our recent "Profit share trap" article, arguing that profitability has been the key to predicting Apple's past - and future success.]

VisionMobile - Profits are life blood

I like to think I sparked a meme. In 2009, I wrote a analysis comparing the market share of the various handset makers and their respective share of industry profits. At the time, Apple’s had 1% or 2% share of the global handset market, and everyone was writing off the iPhone as an unimportant niche. And by everyone, I mean not just analysts but major companies like Nokia and Motorola. The mobile phone industry had a case of willful ignorance back then, but by looking at profit share versus market share it was pretty clear that something important going on here.

Today, this ‘profit share ‘ line of analysis has become very common, some would say overused. Running a basis by looking at a single metric usually ends badly. There are pitfalls in focusing too much attention on profitability, especially when it comes at the cost of making good products and satisfying customers’ needs. Nonetheless, if you have to pick just one metric, profitability is the one that matters the most.

Profits matter because they give companies options. I could launch a line of phones today and give them away for free. I could reach 100% market share, but I could only do it once. Profits, not market share or revenue, are what let companies survive. Many argue that Apple is facing a host of problems now: Competitors phones are cheaper; Apple cannot do the web or ‘big data’; low-cost phones from Asia, etc. The list is long. But everyone in the industry faces those problems. Apple has the ability to weather this sea of woes because they have profits. They can use those profits to do more marketing, or buy market share with discounts, or glue $100 bills to every iPhone. Samsung can too, but no one else can. By contrast, look at Blackberry. They are now barely profitable, and as a result analysts are wondering how Blackberry will be able to afford the next product cycle. No one is asking that about Apple and Samsung. Because of their profits those two can weather any storms that come their way. Profitability is the best way to assess the long-term health of a company.

You can buy market share, but you have to invest for profitability, and invest wisely.

There is no question that Apple needs to come up with ever-improving products and find new ways to inspire customers. But because of their profitability, they have options. Some would argue that as Android phones get ever cheaper and the OS itself gradually improves, consumers will migrate. After all, the functionality of an Android smartphone is ‘good enough’ when compared to that of an iPhone. But I think that misses the point of what Apple is doing. Their goal has always been to create products that are designed to invoke an emotional response. That was clearly on display during the WWDC keynotes, especially with the new TV ads. Apple can afford to do expensive brand marketing because it has ample profits with which to invest. If they had focused on market share years ago, they would be in no position to defend themselves today and would face constraints in their ability to make those kinds of products and those kinds of ads. Ask Blackberry. Or HTC. Or Sony. Or LG.

  • http://www.tech-thoughts.net Sameer Singh

    Jay,

    Interesting perspective. However, the history of the consumer technology industry is filled with examples of extremely profitable companies that have seen swift declines. Take Nokia for example: In 2007, Nokia's devices & services division posted revenues of $38bn and an operating profit of $7.6 bn. By all accounts, it dominated the industry's profits until that point and had huge financial muscle. Facing a challenge from the iPhone and Android smartphones, they did just what you would expect them to do, i.e. invest in marketing and attempt to buy market share. Unfortunately, that was not enough to make up for the fact that the basis of competition had changed.

    In my opinion, a change in the basis of competition (which occurs either through a new disruption or when the previous basis of competition becomes good enough to no longer matter) is very difficult for incumbents to deal with unless they lead or are fast followers. The presence of a "war chest" may help companies survive these shifts, but will not necessarily help them succeed.

    • D/D Advisors

      Sameer
      I think you make my point for me. Faced with the iPhone, in 2007 Nokia chose to "attempt to buy market share". And that did not turn out very well. They had all kinds of user loyalty and market share statistics working in their favor back then, but none of that helped. I'm not arguing that profitability will cure all ills, just trying to point out that chasing market share is usually a recipe for disaster. There are other important metrics but profitability is the clearest and easiest to quantify.

  • http://www.tech-thoughts.net Sameer Singh

    Jay,

    I think you misunderstood my point. When the iPhone was released, the basis of competition in the smartphone market shifted from the hardware itself to the software/applications ecosystem. As the basis of competition had shifted, Nokia's attempts failed badly. Any attempts to "buy market share" obviously fail when your product's attributes no longer fit the primary basis of competition in the market.

    Now we're in a situation where the basis of competition is beginning to shift again (if software ecosystems are good enough, services and price are the two remaining factors). Therefore, margins are dropping and lower end vendors are gaining ground. I think you should keep a close eye on the tablet industry to see this effect more clearly. In the absence of any price distortions, the shift to low-end vendors is happening far more quickly than anyone could have imagined.

  • DesDizzy

    With all due respect, I think you both miss the point. If you designed to satisfy a need and which is relentlessly improved will generate profits. Providing the need remains and the focused improvements continue, tech history suggests that that company will prosper. Industrial history teaches us that when companies stop focusing on customer utility and focus on profit, they will decline. Profit follows utility and focus. Not the other way round.

    Nokia is a perfect example. It had all the ingredients of success and the ingredients for success. However, it lost focus and followed a scattergun approach (see Samsung), which involved trying to be all things to all men, but master of none. The Nokia Communicator, for instance could have been the future of smartphones. But because of internecine strife other products were favoured and there was no focus on the consumer need (see MSF).

    Utility, focus and discipline will ensure profits. However, profits will not ensure utility, focus and discipline.

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