What was it Wayne Gretzky said about why he was so good at hockey? He just
skated to where the puck was going next. Executives and investors wish they
could do so too, to sense where profits are going next. Following a six-ye
ar study of profitability patterns, the authors have developed a model for
doing just that.
In the early stages of a product's evolution, companies compete on the basi
s of performance. And since they can't make substantial improvements in pro
duct performance unless the entire value chain is housed under one organiza
tional roof, it works best if companies are vertically integrated. But as t
he underlying technology improves to meet the needs of most customers, comp
anies begin to compete on the basis of convenience, customization, price, a
nd flexibility. At that point, vertical integration is no longer an advanta
ge - in fact, it quickly becomes a disadvantage. Different links in the ind
ustry value chain become modular, and the chain subsequently fragments.
In either stage, most profitability goes to the companies that own the inte
rdependent links in the value chain - the places where everyone's still vyi
ng to satisfy their customers with ever-better product functionality. Initi
ally, that's the makers of the proprietary products aimed at the end-use co
nsumers. But as those products become standardized, profitability shifts to
the makers of components, and as components themselves become standardized
, it can shift further back in the value chain.
That's predictable, but it causes a problem for incumbents. As their produc
ts become commodities and profits decline, pressure from investors to maint
ain ROA causes them to spin off asset-intensive units that design and manuf
acture components - the very places where profits are heading.