Why Are Some Companies More Profitable Than Others?

by Paul Simister on March 21, 2013

There are two fundamental questions that business owners and managers ask all over the world:

  • Why are some companies and businesses more profitable than others?

It’s a great starting point for the second, and even more important question.

  • How can we this business or company more profitable?

Profit Or Sales

We know some people focus on the wrong issue.

They look to grow the top line rather than the bottom line in the mistaken belief that high sales revenue automatically leads to high profits.

That’s nonsense of course.

The biggest corporate losses in history come from giant businesses with huge sales revenues.

There’s a famous saying, sometimes called the Banker’s Mantra:

“Turnover is vanity, profit is sanity but cash is reality”

My advice is to forget all the ideas about mergers and acquisitions that create big businesses unless a very strong case can be made for much bigger bottom line profits.

Why Are Some Companies More Profitable Than Others?

This is the question that Professor Michael Porter set out to answer in his book, Competitive Strategy in 1980.

His answer was surprisingly simple although the answers led to some very cl;ever thinking on complicated subjects.

The most profitable businesses:

  • Operate in industries that are particularly profitable; and
  • Have big competitive advantages that mean they can capture a bigger share of the available profits than their competitors.

Businesses can make a good profit by meeting one of those conditions.

The weaker the performance in each dimension, the worse the business will perform so the most unprofitable companies:

  • Operate in a particularly bad industry; and
  • Have big competitive disadvantages which make it difficult to win business from customers or to service any orders profitably.

That’s why strategy is concerned with both the inside and the outside issues of a business.

It’s only by looking at both aspects that a business can map out the most likely route to profitable success.

What Can You Do To Make Sure You Have A Profitable Business?

Do you have a business or are you thinking about starting a business?

If you’re starting, you need to think about?

  • Is the market niche you’re thinking about entering an attractive one that can provide you with good profits or is it a potential profit trap? The Five Competitive Forces Analysis and STEP Analysis are good starting points.
  • When you enter this market, will you have a competitive advantage in terms of a differentiated value proposition or lower costs?

If the answer is No to both questions, don’t waste your time and money.It’s better to find another business opportunity that excites you.

If you have two Maybe’s or a Yes and a No, I think you need to think very carefully. Consider your options. Is this a market that you’re really committed to? Can you find a better niche? Can you find a business proposition and model that offers you the chance to have a competitive advantage?

A useful article to read is Will My New Business Venture Succeed Or Fail?

If you already having a business and it’s not performing very well, I think you need to ask yourself three questions:

  1. If the market is bad, can you find a more profitable niche or segment that you can move to with confidence? This is easier if you’re a general business who needs to specialise rather than a specialist who has a reputation in one field and needs to jump to another specialism.
  2. Do you have a competitive advantage that you’re not making the most of (it happens) that you can promote more extensively or can you development a competitive advantage (differentiation is usually easier than cost leadership)?
  3. Are things so bad that you need to leave this market by selling or closing the business? Sometimes a business that isn’t commercial viable on its own can become a profitable sideline in a better established business through synergies and shared costs.

{ 1 comment }

Nishadha September 3, 2013 at 6:06 am

Love this simple explanation. We’re competing in a somewhat tough niche where the desktop offering is dominated by MS Visio and the online offering is crowded by multiple players. So we went ahead and become the first and probably the only one to offer a desktop and an online offering that sync automatically. One of the key reasons for the growth of our company.

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