Wednesday, November 6, 2013

Profit pools: looking beyond revenues. Key to the success of U-Haul

Every summer, or just before a new semester begins, we see a lot of trucks with an orange strip circulating in Pittsburgh. Students use these trucks to move their stuff from one place to another. The rental truck business seems to have a peak in its demand at the beginning or end of the school semesters. How can this business (rental trucks) be profitable the rest of the year? Is the normal demand (from people moving to a new house) enough to keep the business alive?. This week, I would like to talk about how businesses can be profitable by going beyond its core business by using a concept called profit pools. An industry's profit pool can be defined as "the total profits earned at all points along the industry's value chain"

A classic strategy for businesses consists of focusing in trying to grow revenues, assuming that this will increase profits and it is not always the case. I found an interesting article that explains how U-Haul adapted its strategy to stay on top of business. U-Haul gained competitive advantage by developing sophisticated profit-pool strategies. The structure of a profit pool is not trivial and the profitability of each segment depends on many factors such as customer groups, product categories, markets and distribution channels.

In the 90's U-Haul had old trucks which required maintenance constantly. Despite U-Haul low prices, it was the most profitable company in the industry. The key behind the U-Haul's success is that, unlike competitors, who tried to maximize profits by modifying prices of the core business (truck rentals), U-Haul kept prices low and it was able to find new sources of profit, for example, accessories used when moving out, insurances, and rental of storage space in which U-Haul enjoyed the first mover advantages since it got the cheapest storage space in key locations. The idea was simple: keep low prices for rentals in order to attract many customers (customers make a great effort in finding the best daily rate). After U-Haul has captured a customer, it can get high profits for accessories since customers stop comparing prices once they have signed a rental agreement. Basically, U-Haul identified that rentals provide most of the revenues but not most of the profits.

This strategy seems to me be very effective, since as customer I am more concerned about what will be the price of the truck rather than the price of a simple cardboard box (maybe it is a matter of appearances, since the size of the truck indicates that it will be the most expensive expense in my move). We can say as a conclusion that "there are many different sources of profit in any business, and the company that sees what others do not—namely, the profit pools it might create or exploit—will be best prepared to capture a disproportionate share of industry profits".

A question that comes to my mind is: Can you think in other industries in which this approach might work? I have one: information goods, do you agree?


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