Skate to where the money will be

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.