The pandemic forced many businesses to dramatically alter their businesses. From embracing remote work and its enabling technologies such as cloud-based software, to learning how to host virtual events, businesses across the economy were forced to adopt new technologies and adapt to novel conditions. The lesson of the pandemic era is clear, as market conditions change, business models must evolve. Success is not, as you would think, about having stable business models across market conditions. It is not the business that resists change that succeeds, it is the business that is best able to adapt to changing market conditions with an adaptable business model. In this article, we will give 5 tips for a post-pandemic model so that your business can adapt to changing market conditions.
Find a Defensible Market Segment
There is one consideration that should be paramount in your thinking about your business model. You want to have competitive advantages in your market, or what Warren Buffett calls a moat. The most important competitive advantage is the presence of barriers to entry. What this means is that it is difficult for entrants to compete in your market. The reason this is important is because competition is anathema to successful businesses. Though consumers may benefit in the form of lower prices and more choice, a business in a highly competitive industry will struggle for profitability because its resources will go towards fending off an increasing number of rivals.
In order to grow your business’ economic value, there are two routes open to you: (1) you can do it by increasing customer value, (2) reduce your costs to serve. A third option, hard to achieve, is to go for both. As you will read below, your business can earn sustainable economic profits by attacking profitable markets in which you have competitive advantages or reducing your cost to serve. One thing that you have to take note of is the market fragmentation that the pandemic brought about. We should no longer think in broad market terms but in terms of segments. Understanding your market segments will not only help you to drive profitability, it will help you to understand business risk and better design an adaptable business model.
Clarify What Your Company’s Profit Segmentation Is
The first step in evolving your business model is to clarify exactly what your current profit segmentation is. This is a shift from broad market thinking, but it is a shift that research suggests can lead to higher profitability. Using a more granular, transaction-based approach (along with the necessary metrics and analytics) will help you discover three main profit segments:
- the “Profit peaks” segment, with its high-profit, high-revenue customers (as a rule of thumb, makes up around 10% to 15% % of a business and generate about 150% of its profits;
- the “profit drains” segment, with its low-profit, high revenue customers (typically, they make up 15% to 50% of customers and erode 50% of profits);
- the “profit deserts” segment, with its low-profit, low revenue customers, who, despite producing minimal profit, consume around 50% of a company’s resources.
These profit segments, based on research by Jonathan Byrnes and John Wass, are your company’s primary value drivers.
This analysis will help you to evolve your business and target one of these profit segments. Take note that, even with an adaptable business model, it is very difficult to target more than one segment at a time.
Focus on the Most Profitable Customers and Help Them Reduce Their Costs
As we have said, the trouble with focusing on broad markets, aggregate revenue and gross margins, is that this approach does not show us what the bottom line is for every transaction. Gross margins, for instance, do not reflect the overhead, operating and supply chain costs or sales and marketing costs. When you think in terms of market segments, it becomes clear that some of a business’ activities are unprofitable. In other words, there are transactions from which a business does not make any money. As we saw above, Brynes and Wass’ research shows that only around 20% of a business’ customers are very profitable to serve. What you want to do, ideally, is to focus on your profit peaks. The impulse of many people is to try and fix their profit drains, but many of these are transactional shoppers who are only there because the price is right and can easily be gotten by a rival.
Counter-intuitively, what you should be doing is focusing your energies on your profit peaks with an adaptable business model. This goes against the instincts of many managers, who are taught to fix every problem, and become unwilling to simply walk away. Your profit peaks are the company’s most loyal customers. These are your loyal fans. They love your offering, they promote your business, they want more. Yet, this segment often gets neglected as managers chase after profit drains. By increasing sales to profit peaks by, let’s say 10% to 15% and converting 20% of the profit drains into profit peaks, which you can realistically achieve, a business’ overall profitability can increase by at least 10% to 30%.
As for the deserts that cannot be profitably served, you must reduce the cost to serve them. This can be done by limiting order frequency, eliminating special shipping for them, among other things.
Another way to think about this process is “choosing your customers”.
Have the Right Segment, with the Right Business Model
As market conditions change, you have to be willing to change your strategic posture. As we have argued on this site, businesses should be flexible. Once you have “chosen your customers”, you have to develop an innovative and high-profit business model that suits the needs of your highly profitable customers, providing them with either more customer value or reduced cost to serve, or even both. Amazon succeeded, not by getting customers nobody else had, but by focusing on a narrow segment and innovating relentlessly to deliver.
Think Like a Value Entrepreneur
Jeff Bezos inculcated the idea that Amazon had to be relentlessly focused on its customers if it was to become a truly exceptional company. You have to know your customers better than what the usual interviews and surveys yield. If you can unlock the secrets of your customers, understand them better than any other company, developing solutions for them will be easy. Innovation starts with understanding your customers and building an adaptable business model around them.