Profit Pool Analysis

Profit Pool Analysis: An Insight Into Todays Consumer Cotton Apparel Market Olivia Lau August 18, 2009

Profit Pool Analysis Purpose of a Profit Pool Analysis In todays competitive marketplace, it has become increasingly harder for organizations to succeed in any type of business in any given industry. In order to remain competitive and/or gain competitive advantage, organizations are no longer just focusing their strategies based on its revenue pools but are also looking into the profit pools of the industry that they are in. A profit pool is defined as the total profits earned in an industry at all points along the industrys value chain.(Gadiesh & Gilbert, 1998, 140) Profit pool mapping reveals the location and size of profit concentrations within an industry and sheds light on how those concentrations might shift.(Gadiesh & Gilbert, 1998, 160) With knowledge of how the distribution of profits are allocated along the whole value chain will allow managers to better gauge and formulate strategies to sustain and enhance profitability and may even open doors within their industry and gain competitive advantage over their competitors.

Profit Pool Elements in the Consumer Cotton Apparel Industry For the purpose of obtaining a big picture of the consumer cotton apparel industry in the US, 5 major profit pool elements (vertical sectors) have been identified and are shown in table 1-1.

Cotton Farming
Inputs: Inputs: Inputs: Inputs: Inputs: Pesticides/Herbicides Producers Fertilizer Producers Seed Producers Cotton Growers Landowners

Table 1-1 Profit Pool Elements

Apparel Knitting Mills

Textile & Fabric Finishing Mills

Profit Pool Elements in the consumer cotton apparel industry from growing of the cotton to selling the finished clothing to the consumer

Apparel Manufacturer

Retailer

Sources of Revenue

In the Cotton Farming industry, it comprises of businesses that primarily engage in the growing of cotton. Cotton is grown as an annual crop from annual seed planting. The main activities that this industry engages in are: Cotton farming Field and seed production Cottonseed growing

The main source of revenue would be the proceeds of selling cotton lint and cotton seed. According to the National Cotton Council of America, about 57% of cotton produced is used for clothing, 36.9% is used for home furnishings textiles (such as sheets, linens and towels), 3.5% is used for oil seed processors, and 2.5% for other industries (ie: using cottonseed and selling it to food and animal feed manufacturers). In 2008, the cotton farming industry generated $4.6 billion dollars in revenues. (IBIS World Inc, 2009, 9) In the apparel knitting mills industry, businesses in this industry primarily engaged in knitting, manufacturing threads, fabrics, yarns, carpets and curtains. The major source of revenues from this industry is the knitted fabrics, knitted shirts, nightwear, underwear, sweaters, knitted shirts, outwear, contract knitting and finishing, knit gloves and mitts. In the textile & fabric finishing mills industry; it is made up of operations that finish fabrics, yarns, textiles, thread and apparel. This would also include industries that convert fabric goods and finish them such as bleaching, dyeing, printing, stonewashing, shrinking, sponging, mercerizing, napping, cleaning and preparing natural fibers and raw stock. The major sources of revenue from this industry would be sales from broad woven fabric (cotton, manmade fiber and silk), knitted fabric, yarn and narrow fabric finishing, other fabric finishing, and finishing of warp

and weft knit fabrics. According to IBIS World Inc, this industry is projected to create revenues of $6.17 billion in 2009. (IBIS World Inc, 2009, 13) In the US apparel manufacturing industry, there are approximately 10,000 companies in this industry which have combined revenues of $20 billion dollars. This industry is largely fragmented with 50 of the largest companies holding less than 40% of the market share.(Hoovers First Research Industry Profile, 2009). In this industry, the major sources of revenue would be the sale of the finished pieced of apparel (ie: cut and sewn mens and womens apparel, blouses, jackets, shirts, pants, dress, skirts, coats, trousers). In the US clothing retail industry, there are approximately 100,000 stores with combined revenue of $150 billion dollars. This industry is very concentrated with the 50 largest companies in this industry taking 65% of the market share in generated revenues.(Hoovers First Research Industry, 2009). The major source of revenue would be the finished product to the consumer.

Sources of Major Cost

Table 1-2 Cost Structure Textile & Fabric Finishing Millls Purchases Wages Depreciation Rent Utilities Other Profit 54.10% 19.40% 3.50% 2.20% 0.90% 8.50% 11.20%

Cotton Farming Purchases Ginning Wages Repairs & Maintenance Depreciation Utilities Other Profit 38% 9% 8% 8% 7% 3% 15% 12%

Apparel Knitting Purchases Wages Depreciation Rent Utilities Other Profit

Apparel Manufacturer Purchases Wages Contract Work Depreciation Rent Utilities Other Tax Profit Women 49% 14% 12% 2% 2% 1% 13% 0% 8% 100% Men's 49% 21% 10% 3% 2% 2% 5% 2% 7% 100.00%

54.10% 12.80% 2.50% 1.20% 1.10% 16.10% 12.10%

100% Source: IBIS World Industry Report 2009

100%

100%

Table 1-2A Clothing Retail Store

Women Purchases Wages Rent Depreciation Advertising Other Profit 59% 12% 6% 2% 2% 14% 4%

Men's 55% 13% 5% 5% 1% 18% 3%

100%

100.00%

Source: IBIS World Industry Report 2009

In Tables 1-2 and 1-2A, it illustrates the cost segmentation for each sector. In the cotton farming industry, 38% of the industrys revenue is allocated to purchases, which include purchases for chemicals and fertilizers (18.5%), seeds represent 4.5% and fuels and lubricants account for 9.7%. In the apparel knitting mills industry, the largest component of a companys expenses is purchases, 54.1% of the industrys revenues. This comprises of purchases of fibers, yarns, and packaging materials. Major Assets Required for Each Sector
Major Assets Required Textile & Fabric Finishing Mills

Cotton Farming

Apparel Knitting Mills

Apparel Manufacture Equipment & Machinery A/R Cash Land Building/Storage Facility Trucks/Automobile

Retail Store

Land Building Machinery Harvesting Machinery Tractors Storage facilities A/R Cash

Building/Real Estate Looms Knitting Machines Yarn Spinning Machines Equipment Inventory A/R Cash

Looms Equipment & Machinery Land Building/Storage Facility Inventory A/R Cash

Inventory Cash Store Fixtures Computer Land

Porters Five Forces

Table 1-3 Porter's Five Forces

Suppliers Buyers Substitute Products or Services Industry Competitors
Medium - raw cotton is homogeneous and prices are determined according to the commodities market, thus cotton growers can lower their costs of production will enable them to increase their profitability and increase their competitive position Medium - raw cotton competes with alternative natural fibers (ie: silk, wool and other synthetic fibers)

Barriers to Entry

Cotton Farming

Low - there is low ownership, many smaller farms have shut down and the industry has moved towards large-scale production

Medium

Medium - depending on the trends, ie: if polyester is in, there may be a lesser demand for cotton thus affecting cotton growers. There are other substitutes such was wool, silk and synthetic fibers.

Low - Inputs are readily available however there are high capital investment requirements and there is often restricted access to water

Apparel Knitting

Medium

High remain competitive in pricing or else buyers will go else where to buy their fabrics

Medium

High - need to be "price" competitive, as at times importing clothing/fabrics from other countries High - US is known for their strong brand development, good quality of textiles, strong technological competence Medium - due to economic pressures and need to try to keep costs downs and spread it to the buyers to remain competitive Medium advancements in manufacturing techniques and product design will give the firm a competitive advantage Medium - maximize efficiency and productivity and ensuring the factory is at full capacity will add to competitive advantage

Medium - new firms will find it harder to enter the market as there are already a high number of competitors in the market place already similar products Medium - high start up costs, high advertising costs to promote the product

Textile and Fabric Finishing Mills

Low

High remain competitive in pricing or else buyers may go else where to buy their fabrics

Medium - depending on the trends, ie: if polyester is in, there may be a lesser demand for cotton thus affecting cotton growers. There are other substitutes such was wool, silk and synthetic fibers.

Medium - have a difficulty establishing their place in the marketplace due to the high number of

Apparel Manufacture

Low - Many suppliers out in the marketplace, have a higher bargaining power

Medium

Medium - could have sew contractors do to the work

High - could have cheaper apparel for similar quality from factories abroad (ie India, China, Asia)

Medium - Could outsource to other countries for same quality at a lower prices

competitors in the market place. Medium downstream of loyalty of products may cause difficulty in attracting sales to other manufacturers and mills Medium - High costs of establishing brand recognition Medium - have a difficulty establishing their place in the marketplace due to the high number of competitors in the market place. Medium - access to distribution channels could be hard to trickle down to the retail sector Low - capital costs associated with opening a retail store is manageable Low brand recognition and brand awareness will take time Low - high costs and long term nature of establishing your place in the market may be difficult

Retail

Medium - there are many suppliers out in the market the buyer may have higher buying power

Medium - There are may consumers out in the market place

Medium - consumers could go to another retail store that sells a similar style piece of clothing for a lower price or higher quality

High - brand awareness, fashion trends = retailers needs to be on top of what is in and what is not High - need to offer customers merchandise that fits their target market

Source: IBIS World Industry Report 2009

Managing Risk

In the cotton farming industry, as the farmers do rely heavily on the success of their crops, with rising input costs and labor costs, subsidies provided by the government may not be enough to help sustain the success of farms. To mitigate this risk, farms may want to outsource certain labor or capital intensive tasks. Cotton is often marketed in advance, thus farmers need to effectively manage their price and exchange rate risks, thus hedging would be of help to farmers. In the apparel knitting mills industry and textile & fabric finishing mills industry, there has been a steady decline in demand from American apparel makers and imports of textile products have increased about 25% from 2003 to 2008 and the industry has seen a 50% increase of imports from China. (Hoovers First Research Industry, 2009) To mitigate this is to form strategic alliances with the buyers to try to keep business transactions local. To lower costs, some mills may want to invest money into advancements into its current technological capabilities of its machinery, thus it could lead to great efficiencies and productivity, and in the long run lower cost and this can to carry down to the customer. In the apparel manufacturing industry, they have been losing to foreign production factories overseas as it is cheaper to have apparel produced overseas. We are seeing many American manufacturers trying to consolidate and restructure their operations to cut costs. A way to mitigate this is to form strategic alliances other firms and try to amalgamate operations to cut costs. In the retail store industry, it has become very competitive, demands depend on the economy and fashion trends drive demand, the internet has taken sales away from stores. To mitigate this, retails stores could add an internet section to their store thus they can compete with other internet sites. By adding an internet section to their business, they can try out new styles and sizes to test the market before they purchase a whole lot.

References Gadiesh, O., & Gilbert, J. L. (1998, May). Profit pools: A fresh look at strategy. Harvard Business Review, 76(3), 139-147. Gadiesh, O., & Gilbert, J. L. (1998, May-June). How to map your industry's profit pool. Havard Business Review, , 149-162. Hoovers First Research Industry (2009). First research industry profile - texile manufacturing. Retrieved August 15, 2009, from http://univeristyofphoenix.firstsearchlearn.com.ezproxy.apollolibrary.com/industry.aspx Hoovers First Research Industry (2009, July 20). Industry profile - clothing stores. Retrieved August 15, 2009, from http://universityofphoenix.firstsearchlearn.com.ezproxy.apollolibrary.com/industry.aspx Hoovers First Research Industry Profile (2009, July 20). Industry profile - apparel manufacture. Retrieved August 15, 2009, from http://univesrityofphoenix.firstreearchlearn.com/ezproxy.apollolibrary.com/industry.aspx IBIS World Inc (2009, April 18). IBIS world industry report - cotton farming in the US. IBIS World Industry Report, , 1-36. IBIS World Inc (2009, June 2). Textile & Fabric Finishing Mills in the US. IBIS World Industry Report, , 1-39.