Tag Archives: competitive advantage

Notes – The Snowball, By Alice Schroeder: Part V, Chap. 43-52

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder (buy on Amazon.com). This post covers Part V: The King of Wall Street, Chap. 43-52

[These notes were never published on time. They may be incomplete as posted now.]

The modern Buffett

In Part V of the Snowball, we see Buffett’s transformation from the early, cigar butt-picking, Grahamian value-minded Buffett, through the filter of his Fisherite partner, Charlie Munger, into the mega cap conglomerator and franchise-buyer Buffett who is popularly known to investors and the public the world round.

It is in this part that we also see Buffett make one of his biggest missteps, a stumble which almost turns into a fall and which either way appears to shock and humble the maturing Buffett. It is in this era of his investing life that we see Buffett make some of his biggest rationalizations, become entangled in numerous scandals he never would’ve tolerated in his past and dive ever deeper into the world of “elephant bumping” and gross philanthropy, partly under the tutelage of his new best friend and Microsoft-founder, Bill Gates.

The lesson

Buffett made a series of poor investments but ultimately survived them all because of MoS. There will be challenges, struggles, and stress. But after the storm, comes the calm.

The keys to the fortress

From the late seventies until the late nineties, despite numerous economic and financial cycles Buffett’s fortune grew relentlessly under a seemingly unstoppable torrent of new capital:

Much of the money used for Buffett’s late seventies spending spree came from a bonanza of float from insurance and trading stamps

This “float” (negative working capital which was paid to Buffett’s companies in advance of services rendered, which he was able to invest at a profit in the meantime) was market agnostic, meaning that its volume was not much affected by the financial market booming or crashing. For example, if you owe premiums on your homeowner’s insurance, you don’t get to suspend payment on your coverage just because the Dow Jones has sold off or the economy is officially in a recession.

The growth in Buffett’s fortune, the wilting of his family

Between 1978 and the end of 1983, the Buffetts’ net worth had increased by a stunning amount, from $89 million to $680 million

Meanwhile Buffett proves he’s ever the worthless parent:

he handed the kids their Berkshire stock without stressing how important it might be to them someday, explaining compounding, or mentioning that they could borrow against the stock without selling it

Buffett had once written to a friend when his children were toddlers that he wanted to see “what the tree has produced” before deciding what to do about giving them money

(he didn’t actively parent though)

Buffett’s private equity shop

Another tool in Buffett’s investment arsenal was to purchase small private companies with dominant franchises and little need for capital reinvestment whose excess earnings could be siphoned off and used to make other investments in the public financial markets.

Continuing on with his success in acquiring the See’s Candy company, Buffett’s next private equity-style buyout involved the Nebraska Furniture Mart, run by a devoted Russian immigrant named Rose Blumkin and her family. And, much like the department store chain he once bought for a song from an emotionally-motivated seller, Buffett beat out a German group offering Rose Blumkin over $90M for her company, instead settling with Buffett on $55M for 90% of the company, quite a discount for a “fair valuation” of practically an entire business in the private market, especially considering the competing bid.

An audit of the company after purchase showed that the store was worth $85M. According to Rose Blumkin, the store earned $15M a year, meaning Buffett got it for 4x earnings. But Rose had buyers remorse and she eventually opened up a competing shop across the street from the one she had sold, waging war on the NFM until Buffett offered to buy her out for $5M, including the use of her name and her lease.

One secret to Buffett’s success in the private equity field? Personality:

“She really liked and trusted me. She would make up her mind about people and that was that.”

Buffett’s special priveleges

On hiding Rose Blumkin’s financial privacy: Buffet had no worries about getting a waiver from the SEC

Buffett got special dispensation from the SEC to not disclose his trades until the end of the year “to avoid moving markets”

The gorilla escapes its cage

Another theme of Buffett’s investing in the late 1980s and 1990s was his continual role as a “gorilla” investor who could protect potential LBO-targets from hostile takeover bids. The first of these was his $517M investment for 15% of Tom Murphy-controlled Cap Cities/ABC, a media conglomerate. Buffett left the board of the Washington Post to join the board of his latest investment.

Another white knight scenario involved Buffett’s investment in Ohio conglomerate Scott Fetzer, which Berkshire purchased for $410M.

Then Buffett got into Salomon Brothers, a Wall Street arbitrage shop that was being hunted by private equity boss Ron Perelman. Buffett bought $700M of preferred stock w/ a 9% coupon that was convertible into common stock at $38/share, for a total return potential of about 15%. It even came with a put option to return it to Salomon and get his money back.

But Buffett had stepped outside of his circle of competence:

He seemed to understand little of the details of how the business was run, and adjusting to a business that wasn’t literally made of bricks-and-mortar or run like an assembly line was not easy for him… he had made the investment in Salomon purely because of Gutfreund

Buffett’s disgusting ignorance and hypocrisy

Buffett:

I would force you to give back a huge chunk to society, so that hospitals get built and kids get educated too

Buffett decides to sell the assets of Berkshire’s textile mills– on the books for $50M, he gets $163,122 at the auction. He refused to face his workers and then had the gall to say

“The market isn’t perfect. You can’t rely on the market to give every single person a decent living.”

Buffett on John Gutfreund:

an outstanding, honorable man of integrity

Assorted quotes

Peter Kiewit, a wealthy businessman from Omaha, on reputation:

A reputation is like fine china: expensive to acquire, and easily broken… If you’re not sure if something is right or wrong, consider whether you’d want it reported in the morning paper

Buffett on Wall St:

Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway

Review – Oglivy On Advertising (#advertising)

Oglivy On Advertising (buy on Amazon.com)

by David Oglivy, published 1985

A “valueprax” review always serves two purposes: to inform the reader, and to remind the writer. Find more reviews by visiting the Virtual Library.

How to produce advertising that sells

  • Advertising doesn’t need to be “creative”, it needs to be so interesting that a person is compelled to buy the product
  • When Aeschines spoke, they said, “How well he speaks.” But when Demosthenes spoke, they said, “Let us march against Philip.”
  • The wrong advertising can actually reduce the sales of a product
  • Study the product you are going to advertise and look for a “big idea” that can sell it (a big idea whose genesis is found in your research of the product itself)
  • Find out what kind of advertising your competitors have been doing for similar products, and with what success, to get your bearings
  • Consumer research: investigate how they think about your kind of product, what language they use when they discuss the subject, what attributes are important to them and what promises would be most likely to make them buy your brand
  • Product positioning: what the product does, and who it is for
  • Decide what image (personality) you want for your brand
  • Your advertising should consistently project the same image, year after year
  • People don’t pick products, they pick images; few customers try all products within a space and compare before picking one they like best
  • Unless your advertising contains a big idea, it will pass like a ship in the night
  • When researching: stuff your conscious mind with information and then unhook your rational thought process and see what creative ideas flow in
  • Questions to ask about a potential “big idea”: did it make me gasp when I first saw it? do I wish I had thought of it myself? is it unique? does it fit the strategy to perfection? could it be used for 30 years?
  • Make the product itself the hero of your advertising
  • Just say what’s good about your product, and do a clearer, more honest, more informative job of saying it
  • If you are lucky enough to write a good advertisement, repeat it until it stops selling
  • A good advertisement can be thought of as a radar sweep, constantly hunting new prospects as they enter the market
  • Lessons from direct response: use 2-minute commercials (not 30-seconds), there are more sales late at night (not during prime time), use long copy (not short copy)
  • Do your homework, avoid committees, learn from research, watch what the direct-response advertisers do

How to run an advertising agency

  • If each of us hires people who are smaller than us, we will become a company of dwarfs; but if each of us hires people who are taller than us, we will become a company of giants
  • Everytime I give someone a title, I make a hundred people angry and one person ungrateful
  • Even a mature agency with a pool of potential leaders does well to refresh its blood occasionally by hiring partners from outside
  • Don’t hire: your friends, partners’ children, your own children, or clients’ children (ambitious people won’t stay in organizations following nepotism)
  • It is suicide to settle for second-rate performance
  • It is a good idea to start the year by writing down exactly what you want to accomplish, and end it by measuring how much you accomplished (you can pay people bonuses based on something like this)
  • Companies cannot grow without innovation
  • Be ruthless and let all the “chefs” feel that they work in the “best kitchen in the world”
  • The more centers of leadership you create, the stronger your agency will become
  • The final test of a leader is the feeling you have after you leave his presence after a conference; have you a feeling of uplift and confidence?
  • Every company should have a written list of principles and purpose
  • Agencies are seldom for sale unless they’re in some kind of trouble
  • Retirement planning: buy the building that houses your office with your excess capital
  • Never allow two people to do a job that could be handled by one
  • Never summon people to your office, go to see them in their offices, unannounced
  • If you want to get action, communicate verbally

How to get clients/how to find an agency

  • Only first-class business, and that in a first-class kind of way
  • What you should worry about is not the price of your agency, but the selling power of its advertisements
  • Tear out the advertisements you envy, and find out which agency did them
  • Pick the agency whose campaign interests you the most
  • Don’t haggle over price and if anything, offer to pay more to ensure extra attention and service
  • Don’t keep a dog and then bark yourself

Print advertising

  • Five times as many people read the headlines as read the body copy
  • Unless your headline sells your product, you have wasted 90% of your money
  • Promise the reader a benefit
  • Headlines which contain news are sure-fire
  • Headlines that offer the reader helpful information attract above-average readership
  • Include the brand name in your headline
  • In local advertising, including the name of the city in the headline attracts better readership
  • The silliest thing of all is to run an ad without a headline
  • On illustrations: have a remarkable idea; the reader should ask, “What goes on here?” at a glance; illustrate the end-result of using your product; crowd scenes don’t pull; don’t show the human face scaled larger-than-life; babies, animals and sex catch the most attention; when you use photographs of a woman, men ignore the advertisement and vice versa
  • Remember: when people read your copy, they are alone
  • Copy should be written in a language people use everyday
  • Avoid analogies, stay away from superlatives, include a testimonial
  • An ad’s chance of success is directly proportional to the number of pertinent merchandise facts included in the copy
  • Until you have a better answer, copy others
  • Illustration at the top, headline underneath illustration, copy under headline
  • Capitals retard easy reading; don’t place periods at the end of headlines; use serifed fonts as they aid easy reading

How to make TV commercials that sell

  • The more amateurish the performance, the more credible
  • Commercials which name competing brands are less believable and more confusing
  • Provided they are relevant to your product, characters are above average in their ability to change brand-preference
  • Cartoons can sell things to children but they are below average in selling to adults
  • Use the name within the first ten seconds
  • Play games with the name
  • Open with the fire, you only have 30 seconds
  • Sound effects can make a positive difference
  • It is better to have the actors talk on camera
  • Show the viewer something she has never seen before
  • The only limit is your imagination
  • Make your commercials crystal clear
  • Because radio is a high-frequency medium, people get tired quickly of the same commercial so make several

Competing with Procter & Gamble

  • They use research to determine the most effective strategy, and they never change a successful strategy
  • They always promise the customer one important benefit
  • They believe that the first duty of advertising is to communicate effectively
  • All their commercials include a ‘moment of confirmation’
  • In 60% of commercials, they use demonstrations
  • Their commercials talk directly to the consumer, using language and situations which are familiar to her
  • They communicate the brand name, always within the first 10 seconds and an average of 3 times in addition thereafter
  • Their commercials deliver the promise verbally and reinforce it with supers
  • They show consumers what the product will do for them
  • They show the users of their products deriving some emotional benefit
  • They use slices of life, user testimonials and talking heads, all proven ad techniques
  • They do not spend their money naming competing brands
  • Continually test new executions of ongoing strategies
  • Continually test higher levels of expenditure
  • Almost all brands are advertised throughout the year

Miracles of research

  • Research lets you measure the reputation of your company
  • Research can estimate the sales of new products and the advertising expenditures necessary to earn maximum profits
  • Research can help you determine optimum positioning of your product
  • Research can define your target audience
  • Research can find out what factors are most important in the purchase decision and what vocab consumers use when talking about your kind of product
  • Research can save you time and money by ‘reading’ your competitor’s test markets
  • Research can determine the most persuasive promise; advertising which promises no benefit to the consumer does not sell, yet the majority of campaigns contain no promise; the selection of the promise is the most valuable contribution that research can make to the advertising process; try to find a process that is not only persuasive, but unique
  • Research can tell you which of several premiums work best
  • Use research to measure a commercial’s ability to change brand preferences; recall testing is a waste of time

What little I know about marketing

  • You can judge the vitality of a company by the number of new products it brings to market
  • Concentrate your time, your brains and your advertising money on your successes
  • In the long run, the manufacturer who dedicates his advertising to building the most sharply defined image for his product gets the largest market share
  • Sales are a function of product-value and advertising. Promotions can not produce more than a temporary kink in the sales curve
  • Regard advertising as part of the product, to be treated as a production cost, not a selling cost
  • The task of advertising is not primarily one of conversion but rather of reinforcement and assurance

This Just Blew My Mind: The Moneyball Secret & Warren Buffett (#valueinvesting, #baseball, #success)

I read Michael Lewis’s Moneyball a few months ago after having seen the film. I would’ve preferred to do it in the other order (if I had ended up seeing the film at all) but I hadn’t gotten to the book yet on my reading list and an opportunity to see the movie presented itself that I decided not to turn down.

As I understood the story, the basic premise was the principles of Grahamite value investing in baseball– buy cheap things rather quality things and wait for reversion to the mean to kick in. These cheap things may not be worth much, but you can buy them at such a discount it doesn’t matter as they’d have to be truly worthless for you to have made a mistake in the aggregate.

Specifically, Billy Bean, the GM of the Oakland Athletics at the time, was recruiting players with no star power and no salary-negotiation power that could fill his roster with an above-average on base percentage. In contrast, all the big teams with the big budgets were buying the massive stars who were known for their RBIs and home run percentages. Billy Bean’s motto was “don’t make mistakes”, like a value investor who looks for a margin of safety. The other big teams with their massive budgets were operating with the motto “Aim for the stands, hit it out of the park”, like the huge mutual funds with their marketing machines and their reliance on investor expectations to add super fuel to the market.

That’s the story I thought I read, anyway, and it made a lot of sense. Inspiring stuff for a little value investor guy like me.

Today, I sat in a marketing presentation from a vendor who used Moneyball as a metaphor and he threw this image up on the projector during his slide show:

oakland_asThis is a picture of the Oakland A’s stadium. It is a shared stadium meaning it is not dedicated to the A’s but also serves as the Oakland Raiders football team home field. As a result, the baseball diamond has a lot of extra foul zone on the first and home base lines, which you might be able to see if you get real close to your monitor and squint.

I had never seen the A’s stadium before. I had no idea it had extra large foul zones. I didn’t realize that in a 160-odd game series the As would play around half, or nearly 80 games, at a stadium that had extra large foul zones.

I had no idea that a lot of players who had high on-base percentages got there because they hit balls that would normally end up in the stands at most other stadiums, but at the A’s home field it’d end up in the extra large foul zone. I had no idea that this meant those kinds of players would be extra valuable only on the Oakland A’s baseball team. I didn’t realize, as the demonstrator told us, Billy Bean was building a “pitching team”, not just a cheap on-base team (whatever that means).

This blew my mind. Maybe I just missed this in the book, and the movie. I am not a sports fan so maybe Lewis mentioned it and it wasn’t a detail that stuck out to me (which is actually another important lesson from all of this, but I digress…). Or maybe he didn’t. Maybe Lewis, the consummate story-teller, focused on the point he wanted to make from the story even though the reality, while related, was really determined by something else– the extra large foul zone at the Oakland A’s home stadium.

It reminded me of one of those situations with Warren Buffett. The first time you read Buffett’s biography and learn about his investments, you get the hokey “Just buy good businesses at fair prices!” schtick and you think, “Hey, that sounds simple, makes sense, that’s all there is to it!” Then you learn a few years later that what he was ACTUALLY doing was gaming the tax system, or creating synthetic leverage for himself, or whatever. You find the REAL angle, and it’s a bit more sophisticated and a bit harder for the average Joe to replicate by following the “invert, always invert” mantra of Charlie Munger.

What I took away from this is that people tell the stories they want to tell and you should never, ever take something at face value that involves a story of a person becoming wildly successful, wealthy, etc., just by figuring out some seemingly obvious, simple trick like buying cheap baseball stats.

There’s always an angle, like, he was buying cheap baseball stats that worked especially well in his home stadium.

That’s still genius, no doubt, but there’s less there that anyone operating outside that specific context can learn from it.

 

Notes – The Art Of Profitability: Time Profit (#profitability, #business, @CreditBubbleStocks)

(A multi-part co-blog series with CreditBubbleStocks.com about the book The Art of Profitability, by Adrian Slywotzky)

Chapter 5, Time Profit

Many of guru David Zhao’s profit models come with simple illustrations which capture the essential ingredient of the profit model. The image of the Time Profit model is an X-Y axis with “$/unit” on the Y-axis and “time” on the X-axis. Plotted across this chart is one line, which runs from the top left corner toward the bottom right corner at a 45-degree angle reading “Price”, and another line below that labeled “Cost” at a more mild angle, eventually intersecting with the “Price” line near the right side of the chart and then overtaking it.

The concept is simple: Time Profit is generated by being the first to market a new product or service because over time imitators will compete and eventually drive price toward cost. Time, therefore, is of the essence.

In TAOP, Zhao and Steve discuss Time Profit models in the context of firms without special legal protections (such as patents or copyrights) on their works which serve to shield them from competition. However, whether such legal protections are permanent or limited in duration, the Time Profit model principle is the same– only by being first to market would you even be afforded such legal protections in the first place, so there is an incentive to be first else you finish last.

Zhao and Steve discuss the Time Profit model within the context of an investment bank constantly innovating with new financial products. But this model could also easily apply to pharmaceutical and software development companies (which enjoy legal protections on their products), as well as a tech product manufacturer, such as a smartphone manufacturer, whose core product features are likely not subject to legal protections. Here, the Time Profit model is essential as the first firm to get a product to market with a valuable innovation that creates a consumer craze can capture a premium for their products while competing firms figure out how to duplicate this technology and make it standard in their follow-up product offerings. These “second place” firms are doomed to earn commodity returns on their products, only the first-mover gets to enjoy a profit premium.

Like the Customer Solution Profit model, the Time Profit model is more than just a specific business model, it is something of an essential feature to the competitive conditions of any firm in any industry facing innovative development which, practically speaking, is all firms in all industries. Whether a new product, a new service or a new internal or customer-facing process, all businesses seek to adopt one another’s best practices to save costs and increase profitability. The first firm to innovate something that is eventually imitable by others gets a profit advantage during the period of time between innovation and imitation by others. Time Profit models can be thought of as temporary competitive advantages due to periodic innovation.

As David Zhao teaches, a key component of the Time Profit model that is often overlooked is the role diligence in the innovative process plays:

Tedium is the single greatest challenge for a business that’s built on innovation

The first act of innovation is thinking, the arriving at of a brilliant new idea. The second act, and far more important, is the doing, the translation of an innovative idea into an innovative product, service or process. This part requires the same rigmarole of standard business practice: making phone calls, sending emails, training people, holding meetings, crunching numbers, keeping people on task and pulling in the same direction, etc.

Innovating, idea-making, is sexy and fun. But turning innovative ideas into real profit is often boring, common and time-consuming. The people and firms that are able to apply energy and determination to this part of the process are the ones who can most consistently capture the Time Profit. As innovator Paul Cook says, “What separates the winners and losers in innovation is who can master the drudgery.”

Ancillary Notes

Chapter 5 had a few other points worth mentioning, some of which were connected to carryover discussions from earlier chapters.

The first point concerns the power of critical numerical thinking. When working through a number problem, Zhao advises,

Getting the order of magnitude right is what matters, not the details

This is similar to Buffett and Munger’s “approximately right versus precisely wrong” dictum. Zhao also talks about using the numbers to ask and answer critical questions; the numbers of business (assumptions, projections, actual results, etc.) can tell us a story, but we have to be curious about the numbers. It’s not enough to wonder, “Why are the numbers what they are?” we have to be able to put forth some effort to attempt to answer such questions ourselves. As Zhao says,

Being able to take the measure of the world is one of the most crucial skills we can develop

The second point, which is arrived at in a discussion of business innovation, is the “paradox” Zhao observes in the semiconductor industry, which is that the firms involved “copy each other’s chips, but not each other’s business models.” It is the business model which is responsible for mastering the Time Profit concept and other models discussed in TAOP– why don’t more managements focus on copying successful business models rather than imitating successful products and services?

It brings to mind a question for potential investors, too. Which businesses could see their value dramatically improved by focusing the company’s efforts on copying the leading business model in the industry rather than engaging in the rat race of perpetual product innovation/imitation?

The final point has to do with the nature of learning. Steve the student asks Zhao for a copy of his notes from a previous meeting. Steve wants to see how Zhao solved a problem they both worked on. Zhao suggests,

you’ve got to learn how to solve these problems in your own way

the idea being that true knowledge means being able to solve a problem in your own way, not by imitating somebody else. This is why some firms are innovators while the rest are imitators. Innovators are capable of solving problems their own way; imitators just copy the innovator’s solution. But it’s a lesson that’s important to the budding business analyst, as well. How will you solve problems when there is no guru there to teach you? You have to find your own path and do your own thinking.

Until you can do that, though, as Steve says, copying a few “Picassos” to practice a known master technique can be helpful.

Notes – The Art Of Profitability: Pyramid Profit (#profitability, #business, @CreditBubbleStocks)

(A multi-part co-blog series with CreditBubbleStocks.com about the book The Art of Profitability, by Adrian Slywotzky)

Chapter 2, Pyramid Profit

The Pyramid Profit model consists of multiple quality and price tiers for products, targeted at multiple types of customers (and customer preference), which creates two powerful dynamics for the business:

  1. Protects them from competition from market entrants below (commodity market)
  2. Creates profitable “customer migration” opportunities as loyal customers move up the steps of the pyramid (franchise market)

Why is this model so powerful?

As guru David Zhao teaches,

Your pyramid has to be more than just a collection of different products at different price points. A true pyramid is a system in which the lower-priced products are manufactured and sold with so much efficiency that it’s virtually impossible for a competitor to steal market share by underpricing you. That’s why I call the lowest tier of the pyramid the firewall. But the most important factor is the nature of your customer set. The customers themselves form a hierarchy, with different expectations and different attitudes toward price.

The competitive environment all businesses would prefer to have is that of a franchise, where their product is deemed uniquely valuable and essential such that the business can capture a franchise premium in its margin structure, a premium which is enduring and protected from competition over time by the proverbial “moat.”

Simultaneously, the competitive environment all businesses fear is that of a commodity market, where the only way to distinguish your product from someone else’s and incite the customer to buy is by offering the lowest price. It is a true race to the bottom and the turnover for businesses in commodity markets can be quite high.

As discussed in Clayton Christensen’s classic, The Innovator’s Dilemma, most innovators arrive in a market as low-cost entrants. Incumbent firms see no problem in giving the low-margin business dregs to them as they’re happy to play in the higher-margin markets upstream. The hungry commodity firms are constantly looking above them at the juicy margins available in this other market– can they apply their innovative, low-cost practices to this higher-margin space and move in for the kill? As Christensen details, so often they try and succeed.

This is the genius of the Pyramid Profit model. Incumbent firms are protected from innovative, low-cost competition by offering a low-to-no margin product that creates a competitive “firewall” at the most vulnerable place in the market, the violently dynamic commodity space. Then, they are free to play in the middle and higher margin markets without stress.

There is an additional benefit, as well. By capturing new customers even at the low-margin end of the market, the firm is able to increase customer loyalty and brand familiarity over the customer’s lifecycle. Over time. these (presumably) younger, poorer customers turn into older, richer customers following the circumstances of life.

The value of a Pyramid Profit model depends on the shape of the pyramid. A pyramid with a wide base and a narrow top is relatively inefficient and less valuable as most of the business volume is captured in the low/no-margin mass market whereas the high-margin premium market remains under-promoted. An ideal shape would resemble something more like a skyscraper tower– the same width for all tiers, all the way up, with enough segmentation via price/quality tier to progressively move customers up the pyramid at a rapid pace. The more business that is concentrated at the upper levels of the pyramid, the better the margins and the more profit the firm can earn.

The Pyramid Profit model can be found in many well known businesses, even though it is a rarer circumstance than that of the Customer Solution Profit model discussed in chapter 1. A good example is the automobile industry with its “economy” and “premium” brands (for example, Honda and Acura, or Chevy and Cadillac). Even within each brand, many manufacturers have managed to create a “pyramid” of quality, price and even features/capabilities (for example, Honda has the LX base model, EX, EX with leather and EX-L with navigation; it also has the Civic for the entry buyer, the Accord for the more sophisticated, the Odyssey for the family buyer, etc.). Another example would be the airline industry, such as Virgin Atlantic’s “Economy”, “Premium Economy” and “First Class” seating and service tiers. However, no airline seems to have created separate brands/carriers that focus on one tier of the pyramid over another, instead this segmentation always occurs per aircraft (contrast this to a “single class” carrier such as JetBlue or Southwest Airlines, though notice that even these firms have begun to offer new passenger tiers for additional money such as early boarding, extra luggage capacity, etc.)

Speaking of the auto industry again, one of the most prodigious Pyramid Profit employers has been Toyota. Toyota offers three brands in the United States: Scion, Toyota and Lexus. Scion was a brand developed specifically for the young car buyer, initially offering lower price points, simpler model choices and a “no bargaining” purchase experience that was supposed to capture a first-time buyer and put them into the “Toyota system” for the rest of their automobile-buying lives. Then, there was the mass market, multi-trimmed and multi-segmented Toyota brand, offering cars, vans, SUVs and light trucks to the everyman. And finally, there was Lexus, the flagship brand for wealthy, older, image-conscious and highly-demanding customers.

Toyota’s pyramid is awkwardly shaped, however. It’s base, Scion, is miniscule and definitely low/no-margin. The middle step is enormous and fairly profitable relative to the rest of the industry. And the top is much wider than one would expect it to be, being both relatively high-volume for a luxury market and quite profitable despite ongoing margin erosion in the industry overall. Indeed, Lexus auto dealership franchises are consistently one of the most valuable and sought-after brands in the industry alongside BMW and Audi, commanding high market multiples reflective of their premium value.

The key to a successful and highly profitable pyramid is twofold. First, you must be lucky enough to operate in a market that is conducive to segmentation of customers (especially self-segmentation). Second, you must know your customers well– the Customer Solution Profit at work again! The better you understand your customers and their specific needs, the better you will be able to create custom quality and pricing tiers in your pyramid that will meet their subjective needs.