Business Models For Dummies
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If you’re looking for the gold standard of margin innovation, look no further than the Minnesota Mining and Manufacturing Company (3M). Growing from a humble sandpaper manufacturer, 3M is now a Fortune 100 global powerhouse with 84,000 employees in 65 countries. 3M’s growth is a result of relentless innovation. The company historically encouraged its 10,000 researchers to spend 15 percent of their workday on a hobby or pet project.

Even though this practice has waned at 3M, the result of this decades-long commitment to innovation is that 3M holds more than 20,000 patents and gets 25 percent of its revenue from products that are less than five years old. These new, innovative products carry a healthy margin too. Some of 3M’s product innovations/inventions include

  • Masking tape

  • Post-it Notes

  • Reflective road signs

  • Scotchgard fabric protector

  • Scotch Tape (the first cellophane tape)

  • Waterproof sandpaper

Dozens of factors, including the following, can increase your margin:

  • Access to resources: Why are many high-tech companies located in Silicon Valley? They have access to employees, venture capital, and other much-needed resources there. Eastern Washington has aluminum smelting operations located there because of the abundance of cheap hydro-electric power.

  • Better clients: Company A’s clients don’t pay their bills, are fussy, and never reorder without significant involvement from the sales force. Company B, in the same business, has clients who always pay their bills, aren’t demanding, and typically reorder with no questions asked. Does Company B enjoy better margins than Company A? You bet.

  • Control of the distribution channel: It’s rumored that Apple intentionally purchases a multiyear supply of the key components for their products to lock up 100 percent of the supply of the vendor. If competitors want to knock off an iPhone or iPad, they’re forced to do so without being able to purchase components from the same suppliers.

    Apple’s tactic not only slows down competitor innovation, but also forces the competition to source from second-best vendors.

  • First mover: Being a first mover can help you create a category of one. No one knows whether the iPad will continue to sell well ten years from now. However, it’s a fairly safe bet that Apple had an easier time selling iPads at a greater margin when they had the market all to themselves.

  • Focus: Taiwan Semiconductor doesn’t design or market computer chips. Taiwan Semi focuses solely on manufacturing chips. This extreme focus has resulted in Taiwan Semi being able to produce chips for less than nearly all its competitors.

  • Guts: Mid-sized and small companies generally fear raising prices. Sometimes the easiest way to increase margins is to simply ask customers to pay more.

  • Innovation: A company that can out-innovate its competitors always has an advantage and can typically make other higher-margin products.

  • Location: Customers pay a premium to buy the right item at the right place.

  • Lower cost structure: Rather than build the same cookie-cutter store, Dollar General tries to locate in inexpensive locations. For instance, as CVS has moved many of its locations from strip malls to larger corner lots, Dollar General has moved into these old CVS locations cheaply.

  • Move up the value chain: In most markets, some vendors create more value than others. Sometimes it’s hard to understand why the market values some activities more than others, but it does. In many situations, the vendor closest to the end purchaser makes better margins. The Gap makes $5 selling a $10 t-shirt. The manufacturer of the t-shirt makes only $1.

    The company removing crude oil from the earth (Chevron, Exxon) and the company supplying oil field equipment/services (Oceaneering, Halliburton) tend to make better margins than the gasoline retailer or refiner. If you’re stuck in the lower value-added portion of the chain, moving to a more lucrative portion can be beneficial.

    For instance, IBM realized that selling software and services to customers is more profitable than selling hardware and shifted its focus to these better margin items.

  • Product mix: When McDonald’s first came out with its dollar menu, some franchisees refused to offer many of the items for $1. It’s tough to run a business by selling a double cheeseburger that costs $0.65 for a buck. However, these franchisees eventually discovered that the cheap cheeseburgers got customers to buy high-margin French fries and sodas.

    Getting your customers to buy more of your high-margin items can make a big difference in total margin generated.

  • Proprietary feature: Something proprietary about your offering puts you in a category of one. Some portion of the market will always pay a premium for this feature.

  • Strategic vendor: Have you ever had a vendor you wanted to keep secret? Sometimes, having access to the right vendor can create a strategic advantage resulting in greater margin. Coca-Cola bottlers enjoy a strategic and protected relationship with Coca-Cola that allows them access to the syrup.

  • Strong brand: Companies like Coach, BMW, Starbucks, Cisco, and Disney command strong premiums for their products versus the competition.

  • Vertical integration: In many cases, vertical integration increases the total margin generated from a single sale. Integration could include expanding forward into your customer’s markets to gain control of distribution channels or backward into your supply chain to reduce the power suppliers have over your company. An example of backward integration is a clothing manufacturer buying or starting a fabric company.

Not all businesses have 90-percent margins. Your margin is based upon your competitors or industry. You can have a terrific business model with only a 10-percent margin, as long as your competitors have a 5-percent margin.

About This Article

This article is from the book:

About the book author:

Jim Muehlhausen is the founder and President of the Business Model Institute as well as consultant and speaker to businesses large and small. He is the author of The 51 Fatal Business Errors and How to Avoid Them and a frequent contributor to Entrepreneur, Businessweek, and dozens of other publications.

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