1. ROS/RMS
Author: Gisele Garraway
March 1998

2. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

3. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

4. ROS/RMS Graph
ROS/RMS is a diagnostic tool used to compare a business unit’s actual profitability to its potential profitability.
30%
$150MM
25%
Revenue
20%
Cabot
Normative band
(Predicted potential profitability)
Profitability
15%
10%
Currier 5%
Eliot
Dunster 0%
0.1
0.2
0.5 1 2 5
Relative Market Share

5. Profitability (y-axis)
ROS/RMS Components
There are three main components of an ROS/RMS graph: profitability, relative market share and the normative band.
Profitability (y-axis)
RMS (x-axis)
Normative band
What is measured:
Current profitability
Accumulated experience and strategic position
Range of predicted profitability
How it is measured?
return on capital employed
return on equity
return on assets
return on sales*
Relative market share (RMS)
Plus and minus one standard deviation from regression line
Scale:
Linear
Logarithmic**
* This tool is typically called ROS/RMS since ROS is the most common profitability measure used
**Allows for easy viewing of a doubling in relative market share

6. ROS/RMS Relationship
Companies with higher relative market share tend to have more accumulated experience. Higher accumulated experience gives the potential for lower costs and higher profitability.
Higher accumulated experience is positively correlated with RMS
Higher accumulated experience provides an opportunity for lower costs and higher profits
RMS is a proxy for accumulated experience. RMS is positively correlated with profitability
Accumulated Experience
RMS
Accumulated Experience
Cost per unit
RMS
Profitability

7. Importance of Market Share
Using relative market share as a predictor of profitability is supported by empirical evidence. The PIMS database demonstrates that, on average, across industries, companies with greater market share have higher profitability.
Source: PIMS (Data from 1970 to the present of 3,200 businesses - 66% manufacturing, 20% consumer businesses, 14% services)

8. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

9. Computers & Office Equipment Electric & Power Equipment
Applications
Bain has used ROS/RMS effectively for many clients. Examples of Bain work are:
Computers & Office Equipment
Electric & Power Equipment
Situation:
A major PC manufacturer recently suffered significant operating losses and was experiencing severe cash flow problems
An electric & power equipment company was evaluating a manufacturer of discrete semiconductors for purchase. The client was concerned about industry cyclicality and whether the target’s profit margins were unsustainably high
Result:
Bain used ROS/RMS analysis to examine the PC industry and found that moving the client into the normative band through operational improvements would result in a $174MM profit before tax improvement
RMS/ROS analysis revealed that the target’s margins reflected its market share position and accumulated experience and were therefore sustainable; the target’s high RMS helped drive EBIT margins in excess of 20%

10. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

11. ROS/RMS Steps There are five basic steps involved in ROS/RMS analysis:
Key Success Factors
Define the business
Determine the economic boundaries of the business
Identify relevant competitors
Calculate profitability
Achieve comparability across competitors
Calculate relative market shares
Include any shared experience
If business is local or regional, weight market shares
Draw normative band
Calculate the normative band using regression analysis
Determine action implications
Determine if strategic or operational improvements are required

12. ROS/RMS Steps Key Success Factors
Define the business
Determine the economic boundaries of the business
Identify relevant competitors
Calculate profitability
Calculate relative market shares
Draw normative band
Determine action implications

13. Defining the Business
Effective ROS/RMS analysis depends on correctly defining the economic boundaries of a business. Cost sharing and customer sharing are the primary determinants of business definition.
High
One business with potential for differentiation or niche position (Cross pens and BIC pens)
One business
(charge cards and credit cards)
Separate business with potential for cost leadership
(oil and refinery by-products)
Cost sharing
Separate businesses with potential for bundling (touring quality microphones and speakers)
One business with potential for substitution (milk cartons and glass milk bottles)
Separate businesses
(beer and distilled spirits)
Low
Low
Customer sharing
High

14. Correct Market Share Measure
Determining whether a business is local, regional, or national is also important.
Incorrectly defined business National discount department store
Correctly defined business Regional discount department stores
R-squared:
0.31
0.96
When business definition is correct, there is a meaningful predictive relationship
*Statistical market areas

15. Relevant Competitors - Incorrect Business Definition
An incorrect business definition may exclude relevant competitors from ROS/RMS analysis.
National Textile Laundering
It appears Gibb has three major competitors and is underperforming

16. Relevant Competitors - Correct Business Definition
The correct business definition will ensure that all relevant competitors are considered.
Regional linen laundering
Regional healthcare laundering
Regional industrial laundering
Gibb has six competitors. Gibb is in three separate businesses, all of which are regional.

17. Calculate profitability
ROS/RMS Steps
Key Success Factors
Define the business
Calculate profitability
Achieve comparability across competitors
Calculate relative market shares
Draw normative band
Determine action implications

18. Calculating Profitability
The profitability measure used varies from case to case. The key is to use a measure that will allow for an apples-to-apples comparison across relevant competitors.
ROCE (Return on capital employed)
ROE (Return on equity)
ROA (Return on assets)
ROS (Return on sales)
Advantages:
Best proxy for return on investments
Best proxy for return on shareholders’ investments
Eliminates the effects of how assets are financed
Easy to collect comparable measures across competitors
Disadvantages:
Difficult to make comparable across companies
Difficult to make comparable across companies
Not always clear which asset measures to use (Book value? Before depreciation or after?)
Results are sometimes unclear when some competitors command a large price premium
Calculation:*
Net income after taxes
Net income after taxes
After tax operating profit
Net income after tax
Capital employed
Average equity
Average assets
Sales
Bain example:
Drug store chains
Building products
Retail department stores
Beverage industry
*Pre-tax profitability measures are preferable because they exclude any firm-specific tax issues

19. Calculate relative market shares
ROS/RMS Steps
Key Success Factors
Define the business
Calculate profitability
Calculate relative market shares
Include any shared experience
If business is local or regional, weight market shares
Draw normative band
Determine action implications

20. Calculating Relative Market Share
The relative market share for the market leader is calculated in relation to the #2 player; the RMS for all other players is calculated in relation to the market leader.
Market leader’s units sold
#2 player’s units sold
Leader’s RMS:
Any other player’s RMS:
Other player’s units sold
Market leader’s units sold
It is preferable to use units* instead of revenue since we believe accumulated units of experience drive the potential for higher relative profitability
*Revenues or points of share can be used when units are not available.

21. Shared Experience (1 of 2)
When potential shared experience is ignored, the predictive power of ROS/RMS is limited. In this example, market share in outboard motors does not explain profitability.

22. Shared Experience (2 of 2)
When the benefits of shared experience with lawnmowers and motorcycles is included, a positive correlation appears.
Outboard Motors volume
80%
60%
Yamaha
40%
20%
Pretax Return on Capital 0%
OMC
Mercury
(20%)
Chrysler
(40%)
0.1
0.2
0.3
0.4
0.5
0.7 1
1.5 2 3 4 5 6x
Worldwide Relative Market Share of Outboards, Including Shared Experience With Motorcycles and Lawnmowers

23. ROS/RMS Steps Key Success Factors Define the business
Calculate profitability
Calculate relative market shares
Draw normative band
Calculate the normative normative band using regression analysis
Determine action implications

24. Drawing the Normative Band (1 of 2)
The first step in drawing the normative band is to run a regression on ROS and the log of RMS. We then calculate the best fit, or regression line.
Regression output
(from Excel)
Units (MM)
Competitor
RMS
In (RMS)
ROS
Regression statistics
Cannon
4,960
0.80
-0.22
12.3%
Multiple R
R square
Y = mx + b
ROS = (ln RMS)
Castle
3,400
0.55
-0.60
10.8%
Best Fit Line
Adjusted R square
Holmes
2,178
0.35
-1.05
4.5%
Standard error
Peabody
6,200
1.25
-0.22
10.5%
Observations 5
Whitman
3,182
0.51
-0.67
8.4%
Standard error
T- stat
P- value
Coefficients
Intercept
0.1145
0.0154
7.45
0.005
X-variable 1
0.0465
0.0243
1.1913
0.152
*The Bain Graphics Wizard draws the normative band automatically when the RMS and ROS data points are given. It will not however, calculate an R2

25. Drawing the Normative Band (2 of 2)
The normative band is drawn by applying plus or minus one standard deviation to the best fit line.
Best fit line (regression line)
One standard deviation
=  1
n-1  n
i = 1
(Xi - m)²
Profitability
Where,
n = number of observations
x = observed value
m = mean
RMS

26. Normative Band
The Bain Graphics Wizard will draw a normative band automatically based on the input values of ROS and RMS.

27. Adjusted Normative Band
If we believe that a player has mismanaged its costs and has not gotten the full benefits of its experience, we can exclude it from the calculation of the normative band.* The resulting normative band will be more narrow.
*In the Wizard, go to the “Series” menu and select “remove series from normative band.”

28. Determine action implications
ROS/RMS Steps
Key Success Factors
Define the business
Calculate profitability
Calculate relative market shares
Draw normative band
Determine action implications
Determine if strategic or operational improvements are required

29. Strategic Positioning Operational Improvement
Action Implications
A firm’s position on the ROS/RMS graph helps case teams to determine whether a business should pursue strategic positioning or operational improvements.
Strategic Positioning
Operational Improvement
Examples:
Blandford can improve its profitability if it increases its market share and captures experience benefits
Peabody is below the normative band; its profitability is low given its relative market share
Suggested actions:
Growth strategy
Mergers and acquisitions
Cost reduction strategy

30. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

31. LAGTEL* - Background
Bain used ROS/RMS analysis to develop a strategy for a wireless telecommunications business.
Situation:
LAGTEL is a $6B telecom player. Wireless infrastructure is a $2B business unit of LAGTEL, and it is the only “star” business in LAGTEL’s portfolio. All other business units are dogs.
Complication:
The wireless infrastructure division’s profitability is falling amid rising overcapacity in North America. Management expects that the over-capacity will continue to drive prices downward. Moreover, LAGTEL’s returns are 2% while four competitors earn in excess of 10% operating margins
Question:
How can LAGTEL improve its long-term profitability?
*Disguised client case

32. LAGTEL - Background
The profitability vs. overall scale did not demonstrate or clear normative band.
25%
20%
15%
10% 5% 0%
(5%)
(10%) .1 .2 .3 .5 1
1.5 2 5 10 20
LAGTEL
Callums
E-tel
Lucia
Alliance
$2B
1995 Wireless
Infrastructure revenue
Relative Market Share (Total Telecom)
Operating Profit Margin
Telco
Source: Natwest Securities; CS First Boston; Killen & Associates; Wireless Operating Plan

33. LAGTEL- Wireless RMS
The team “peeled the onion” and found a stronger relationship between wireless only RMS and wireless infrastructure profitability.
25%
$2B
1995 Wireless
Lucia
Infrastructure
Alliance
20%
Revenue
E-tel
15%
R² = 0.52
Telco
10%
Operating Profit Margin
Billtel 5%
LAGTEL
Callums 0%
(5%)
(10%) .1 .2 .3 .5 1
1.5 2 5 10
Relative Market Share (Wireless)
Source: Natwest Securities; CS First Boston; Killen & Associates; Wireless Operating Plan

34. LAGTEL - Technology-Weighted RMS
When RMS was adjusted for the mix of wireless technology, an even stronger relationship appeared. LAGTEL’s profitability was low considering its share, and LAGTEL was considerably behind four key competitors.
20%
15%
10% 5% 0%
(5%)
(10%) .2 .3 .5 1
1.5 2 5 10
Lucia
E-tel
Alliance
Telco
LAGTEL
Callums
Billtel .1
Technology-weighted RMS*
Operating Profit Margin
R² = 0.73
$2B
1995 Wireless Infrastructure Revenue
* Weighted by manufacturer revenue by technology
Source: Natwest Securities; CS First Boston; Killen & Associates; Wireless Operating Plan

35. LAGTEL - Strategic Recommendation
After additional competitor analysis, the team recommended a possible merger with one of the top four players to improve LAGTEL’s profitability.
20%
Lucia
$2B
R² = 0.73
1995 Wireless Infrastructure Revenue
15%
E-tel
LAGTEL
(projected)
Alliance
10%
Billtel
Telco
Operating Profit Margin 5%
LAGTEL
(current) 0%
Callums
(5%)
(10%) .1 .2 .3 .5 1
1.5 2 5 10
Technology-weighted RMS*
*Weighted by manufacturer revenue by technology
Source: Natwest Securities; CS First Boston; Killen & Associates; Wireless Operating Plan

36. LAGTEL - Regression Predicted Synergy Values
The team used the ROS/RMS regression to predict the synergy value of possible competitor combinations. The synergy values ranged from $1.2B to $2.3B.
Source: Bain ROS/RMS Regression Model

37. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

38. Pillz* - Background
Bain used ROS/RMS analysis to understand the profitability potential of a Canadian drug store retail chain.
Situation:
Pillz is a leading retailer of pharmaceuticals in Canada. It participates in the sale of prescriptions and over-the-counter drugs in traditional drug stores. Pillz’s management has asked Bain to assist in repositioning Pillz to become the most profitable drug retailer in North America
Complication:
Pillz’s dominance is being threatened by the entry of non-traditional competitors including food retailers and mass merchants
*Disguised client example

39. Pillz - Industry ROS/RMS
The Bain team identified two normative bands: one for food/drug combos and discount merchandisers and another for traditional drug stores.
Non-traditional channel
Traditional channel 8% 7%
$500M revenue
Loblaws
Pillz Prairies
JC PQ 5% LD
Pillz ON BC
Safeway
Pillz
Atlantic 3% LD
Prairies
Regional ROS 1%
Wal-Mart
Lawtons Atlantic
(1%)
PP ON
(3%)
(5%)
0.2
0.4
1.0
2.0
4.0
10.0
Regional RMS
Source: IMS, Chain Store Guide, annual reports, Pillz internal data

40. Pillz* - Summary
Preliminary ROS/RMS analysis helped the Bain team develop some key insights.
Pillz’s profitability (ROS) is highly correlated with regional RMS
Pillz’s competitors have significant cost advantages
Because the normative band for the non-traditional channel is steeper than for the traditional channel, an increase in relative market share for a non-traditional channel competitor has a greater impact on profitability than the same increase would have for a traditional drug store competitor

41. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

42. Challenges
In some situations, ROS/RMS analysis is difficult to conduct.
It is difficult to define the business
Competition has significant shared experience from other businesses that is difficult to capture in the RMS measure
Market shares must be weighted because the business is local or regional
One or more sizable competitors are not leveraging their accumulated experience to reduce costs

43. Other Bain Tools
Bain uses other tools to estimate potential profitability when RMS or scale is not the profit driver.
Key profit driver
Bain tool
Example industries
Customer loyalty
Retention
Auto insurance
Credit cards
Advertising
Percent of category which is premium priced and relative market share of category
High road/Low road
Consumer goods
toothpaste
ready-to-eat-cereals
Speed of product development and release
Time-to-market
Technology
semi-conductors
Retail fashion
athletic gym shoes

44. Agenda ROS/RMS overview Applications ROS/RMS steps Client examples
wireless infrastructure
drug retailing
Challenges
Key takeaways

45. Key Takeaways (1 of 3) Overview
ROS/RMS is a diagnostic tool used to compare a business unit’s actual profitability to its potential profitability
ROS/RMS suggests that a firm’s profitability should fall within a predicted range based on its relative market share
The ROS/RMS relationship is based on the empirical evidence that high RMS is positively correlated with high profitability
ROS/RMS Components
Profitability is on the y-axis and is plotted on a linear scale
Profitability measures include ROCE, ROE, ROA or ROS. ROS is the most common
Relative market share is on the x-axis and is plotted on a logarithmic scale. RMS is a proxy for accumulated experience
The normative band is the band in which companies should fall based on their RMS. It is drawn by applying plus or minus one standard deviation to the best fit line.

46. Key Takeaways (2 of 3) The leader’s RMS is calculated as follows:
Market leader’s units sold
#2 player’s units sold
The leader’s RMS is calculated as follows:
Any other player’s RMS is calculated as follows:
Other player’s units sold
Market leader’s units sold
Implications of ROS/RMS Analysis
A firm that falls below the normative band requires operational improvements to improve profitability
A firm that lies within the normative band can improve its profitability by improving its strategic position and gaining share
Challenges
In some situations, ROS/RMS analysis is difficult to conduct
it is difficult to define the business
competition has significant shared experience from other businesses that is difficult to capture in the RMS measure
market shares must be weighted because the business is local or regional
one or more sizable competitors are not leveraging their accumulated experience to reduce costs

47. Key Takeaways (3 of 3) Other Tools
When RMS or scale is not a key driver of profitability, ROS/RMS is not an appropriate tool

48. Profitability (y-axis)
Takeaway Slides (1 of 2)
ROS/RMS Graph
ROS/RMS Components
Profitability (y-axis)
RMS (x-axis)
Normative band
What is measured:
Current profitability
Accumulated experience and strategic position
Range of predicted profitability
Normative band
(Predicted potential profitability)
How it is measured?
return on capital employed
return on equity
return on assets
return on sales*
Relative market share (RMS)
Plus and minus one standard deviation from regression line
Relative Market Share
Scale:
Linear
Logarithmic**
ROS/RMS Relationship
ROS/RMS Steps
Key Success Factors
Higher accumulated experience is positively correlated with RMS
Higher accumulated experience provides an opportunity for lower costs and higher profits
RMS is a proxy for accumulated experience. RMS is positively correlated with profitability
Define the business
Determine the economic boundaries of the business
Identify relevant competitors
Calculate profitability
Achieve comparability across competitors
Include any shared experience
If business is local or regional, weight market shares
Calculate relative market shares
RMS
Cost per unit
Profitability
Draw normative band
Calculate the normative band using regression analysis
Accumulated Experience
Accumulated Experience
RMS
Determine action implications
Determine if strategic or operational improvements are required

49. Takeaway Slides (2 of 2) Action Implications Calculating Profitability
Strategic Positioning
Operational Improvement
ROCE (Return on capital employed)
ROE (Return on equity)
ROA (Return on assets)
ROS (Return on sales)
Advantages:
Best proxy for return on investments
Best proxy for return on shareholders’ investments
Eliminates the effects of how assets are financed
Easy to collect comparable measures across competitors
Disadvantages:
Difficult to make comparable across companies
Difficult to make comparable across companies
Not always clear which asset measures to use (Book value? Before depreciation or after?)
Results are sometimes unclear when some competitors command a large price premium
Examples:
Blandford can improve its profitability if it increases its market share and captures experience benefits
Peabody is below the normative band; its profitability is low given its relative market share
Calculation:*
Net income after taxes
Net income after taxes
After tax operating profit
Net income after tax
Capital employed
Average equity
Average assets
Sales
Suggested actions:
Growth strategy
Mergers and acquisitions
Cost reduction strategy
Bain example:
Drug store chains
Building products
Retail department stores
Beverage industry
Calculating RMS
Other Bain Tools
Key profit driver
Bain tool
Example industries
Market leader’s units sold
Leader’s RMS:
#2 player’s units sold
Customer loyalty
Retention
Auto insurance
Credit cards
Advertising
Any other player’s RMS:
Other player’s units sold
Market leader’s units sold
Percent of category which is premium priced and relative market share of category
High road/Low road
Consumer goods
toothpaste
ready-to-eat-cereals
It is preferable to use units instead of revenue since we believe accumulated units of experience drive the potential for higher relative profitability
Speed of product development and release
Time-to-market
Technology
semi-conductors
Retail fashion
athletic gym shoes