Maximizing Profit From Diversified Product Lines
Using a Portfolio Approach to Managing Overall Profit Margins

Hamilton Consultants White Paper

Managers of companies under margin pressure may need to look at their Portfolio of Margins for ways to bring their overall margins back in line.

A common problem in highly competitive businesses is that the core product lines of all the major competitors go through continual rounds of cost and price reductions - with all parties claiming “no one is making money in this business!” In high volume, highly advertised lines -- such as consumer long distance service -- the pace of downward pressure on margins can be breathtaking. From an economic standpoint, one could easily assume that only the truly low cost producer could survive in such an environment.

But wait. Companies with both high and low margin product lines can optimize their overall margins by managing their overall "margin yield." Supermarkets make almost no margin on bread and milk (high volume, highly advertised lines), they make reasonable margins on canned and frozen foods, and even better margins on flowers, ethnic food lines, freshly baked goods and items at the checkout counter. Local access telephone companies attempt to accomplish the same goal by pairing their core local access service with high value-added optional services such as call waiting, caller ID, and voice mail.

One tool that we encourage clients to use when trying to maximize margins is the Margin Portfolio Matrix (below) of goods and services.

Companies can usually split their product lines among four categories according to their sales volumes, and how much they are promoted against competition. Management can optimize overall business margins by first understanding where in this matrix their product resides, then tackle margin improvement in each quadrant individually by:

• Raising prices
• Building volumes (especially in the left hand quadrants),or
• Reducing costs

Simply put, where management may have thought it had just three ways to aid overall margins, it really has three ways in each of four quadrants, for a total of twelve ways to improve margins.

Example: Computer Original Equipment Manufacturers (OEMs)

The computer manufacturing industry offers a good example of how this matrix can help optimize overall margins, despite cutthroat competition. Personal Computer (PC) Original Equipment Manufacturers (OEMs) have found themselves under increasing competitive pressure for most of the last decade due to rampant margin erosion caused by fast-paced technological obsolescence and increasing industry supply. Successful PC OEM’s have followed the Margin Portfolio Matrix - offering products in each of the four quadrants.

Highly Competitive

The core features and functionality that all personal computers must have to function reside in the "Highly Competitive" quadrant of the matrix. In a sense, this is the lowest common denominator. This includes reasonable (but not the fastest available) CPUs, a standard amount of memory, and a basic hard drive. OEM's produce little margin from these "boxes," because they are viewed as undifferentiated commodities -- often serving as loss leaders to entice customers to start the buying process.

Staple

Bigger hard-drives, faster CPUs, and more memory are frequently requested by customers to tailor their PCs. The vast majority of customers never upgrade these components once the product is configured. These items rarely draw consumers to an OEM, and so they are rarely, if ever, promoted. These items can be sold at higher margins and fall within the "Staple" quadrant of the Margin Portfolio Matrix. Successful companies may garner the same amount of revenue from this quadrant as the Highly Competitive quadrant but may make a much greater percentage of their margin dollars here.

Specialty

The "Specialty" quadrant of the matrix is increasingly dominated by service offerings ranging from maintenance and support to Internet access and web hosting. In an increasingly commoditized industry, OEMs have scrambled to differentiate their products. This can take the form of very specialized, powerful systems, or systems focused on niche applications such as digital movie making.

Recently there has been an industry-wide shift towards developing high-quality service offerings that can serve as key competitive differentiators. An aggressive example can be found in Gateway's promotion of personal delivery, installation, and on-site training for their products. Another intriguing example is provided by Dell’s foray into providing application hosting and focused small and medium business support.

Convenience

Finally, odds and ends such as printers, premium video and sound cards, Zip drives, and certain software items, fall within the "Convenience" quadrant. Consumers can obtain these items relatively easily from competitors, but, largely for the sake of convenience, customers will often purchase these items from the OEM. These peripheral items often represent a significant upselling opportunity for the OEM, yielding much higher margins and helping to subsidize the lower margins in the "Highly Competitive" quadrant.

Maximizing Revenues and Margins

Optimizing revenues and profits using this matrix necessitates a proactive approach. First one must categorize a company’s product line into the revenue/margin quadrants detailed above. Systematic approaches must be put in place to harvest higher yields by attempting to move more of a customer’s purchase into higher yield quadrants, and selectively reducing costs or raising prices on certain lines. Some of the ways to accomplish this goal involve “smart” computer systems that support and/or automate up-selling, creating specialized offerings that are compelling for the needs of specific customer segments, and exploring high revenue/margin opportunities that are natural outgrowths of the existing product portfolio.

In the example below, a margin of 27% is achieved by a Portfolio of Margins approach - substantially higher then the Highly Competitive core business, which delivers 10% margin.

	Volume(%)	GM(%)		Overall Gross Margin 27%
Highly Competitive	30	10
Staple	40	25
Specialty	20	40
Convenience/Upselling	10	60

The computer OEM market is just one of many industries that is recognizing the need to protect shrinking core market margins by extending or diversifying product lines. In fact, the "Margin Portfolio Matrix" can be applied to diverse industries ranging from apparel and shoe retailing, to automotive marketing, or even telecommunications and energy marketing.

The key for management is to recognize when margins on the core product are souring to the point that a business based on just these products is no longer attractive. Then it is time to lay in staples, specialty, and convenience product lines with higher margins. The strategic combination of these offerings creates a far more compelling business model.

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