Improving your profit-ability
Every company should have a profit plan with built-in incentives for continuous improvement of the bottom line.
Businesses today have processes and plans for just about everything. They have strategic plans and marketing plans and product-development plans they can show to bankers. They have processes in place for monitoring prices in the marketplace, for tracking inventory, for approving credit, for paying suppliers. They plot trends in sales with the dedication of monastic scribes and are cheered with every upward spike in revenues. When we ask managers of some companies whether they have a plan for increasing profits, however, they look at us as if we're crazy.
Like other types of companies, closely held family businesses often give more attention to growth in revenues than to profits. Relieved of the need to show quarterly sales results, the leaders sometimes lose track of the bottom line. Every company should have a profit plan with built-in incentives for continuous improvement of the bottom line. Traditional profit projections, based on a previous quarter's or the previous year's performance, are very limiting. When the company or its salespeople reach those budgeted goals or exceed them slightly, they may sit back and do no more. (Jack Welch, CEO of General Electric, believes that budgets are an exercise in minimalization of profits, because everyone negotiates to get the lowest possible revenue target.)
With today's tricky economy making it very difficult for companies to simply grow their way to bigger profits, there's much to be gained from learning how to be more profitable without getting bigger. Our firm is devoted to helping firms locate the many opportunities for profits that they have ignored—what we call profit “fumbles”—as well as search out new opportunities for profit. To come up with new profit ideas for clients, we examine each of the five areas that drive a family business: sales and marketing, personnel, financial matters, operations, and organization. It is not unusual to find hidden profit potential in all areas. But most companies are strong in some areas, weak in others. Our objective is to build up the weak areas, so that instead of dragging down profits they contribute to the bottom line and even become profit centers.
We encourage management to conduct a profit audit that examines potential opportunities for maximizing profitable sales and controlling costs. The audit includes a survey of employees on their understanding of the company's profit strategy and what they see as the most promising areas for increased profit. At a one- or two-day retreat, department heads are organized into a profit team to get them working together on improving the whole company's bottom line rather than focusing narrowly on each department's results. This top-management team discusses strategies for enhancing profits in specific areas, and appoints profit champions to implement those strategies. Most often these strategies don't involve major restructuring, just improving what we call “profit-ability”—the skills needed to identify financial opportunities and the ability to turn ideas into bottom-line results.
Focusing your family business on profit creates a whole new way of thinking and working that doesn't interfere with the long-term goals and objectives of the company, but produces a never-ending stream of new ideas from management. We'll show you some typical strategies that have worked for our family business clients and can work for you.
Laying off work instead of people
A second-generation family business, a brick–and–block manufacturer, complained of flat sales. In reviewing its operations, as part of a profit audit, we noted that the drivers who were routinely delivering building materials to customers on construction sites were never given a key profit role to play. Since they were out there every day seeing what was going on in the construction business, we proposed making them new-business scouts.
Each driver now goes out with a lead/opportunity pad on which he can record signs going up for new construction sites, such as excavations or the appearance of earth-moving equipment. If the company's salespeople end up getting new business from these leads, a percentage commission goes to the driver who came up with them.
The incentive paid off. Sales increased 15 percent as a result of having “profit scouts.” The company added to its bottom line by improving the profit-ability of its employees.
An obvious way to save money and quickly boost profits is to lay off employees. We find that layoffs are rarely necessary, however. With most companies, the problem is not too many people, but too much work—often unnecessary work. One of our favorite rules of thumb is: “There's nothing more unprofitable than doing unnecessary work more efficiently.”
The use of corporate credit cards for purchasing is increasing, for example, because they have been proven to minimize paperwork. Well-run companies have traditionally used a purchase-order system to establish purchasing controls. By using a corporate credit card for purchasing, the company eliminates unnecessary paperwork and reduces costs significantly. It also frees up purchasing agents to spend more time on buying strategies. Smart companies have established new purchasing policies that permit the use of corporate procurement credit cards for amounts below predetermined limits. Purchases in excess of the limited amount are typically handled by a purchase-order system.
Remember the Paredo 20/80 rule? Twenty percent of the variables produce 80 percent of the results. In most cases, 20 percent of the items purchased represent 80 percent of what the company spends but only 20 percent of the cost associated with processing the paperwork. Using the procurement credit card for 80 percent of the smaller purchases will save 80 percent of the cost of processing the paperwork. Of course, the purchasing department must develop procedures for using the card, develop financial reports to assure that compliance and reporting are adequate, and establish an internal control procedure before putting this program in place.
Our clients who benchmark their purchasing costs report that their average purchase order costs from $30 to $300 in administrative expenses. Using this procedure, these costs can be reduced 80 to 90 percent, and the savings go directly to the bottom line.
Sales feed egos, but profits feed families
We advise profit teams to look at the bottom line of the income statement as they plan new sales initiatives. A company is very fortunate if it has a 10 percent net income. To earn $100,000 of additional profit, in other words, a company may have to increase sales by $1 million. So the question is: What if you cut costs by 10 percent instead? Let's check out the hypothetical (and admittedly overly simple) example in the following table:
Profit from cost-cutting versus new sales
|Cost of sales|
As you can see, cutting costs by 10 percent almost doubles the net profit in this example. On the other hand, to increase profits to $3,800,000 without the 10 percent cost cutting, sales would have to increase to $38 million. Imagine the effort and cost associated with a sales increase of $18 million!
Many companies cannot afford to do business at nearly twice their existing volume, simply because they don't have enough cash to finance the increase. A sale made at the beginning of the month, for example, might not produce cash for 60 days, perhaps longer. In fact, sales might have to be greater than the $38 million in this example, because the costs to finance the increased sales could be substantial.
While economies of scale can be associated with greater volume, realistically, this doesn't apply across the board. Significant sales growth puts substantial strains on equipment and personnel, so profits might be minimized. Consider sales increases balanced with expense controls. This balance can provide the greatest bottom–line benefit to your business.
Barbara Walters questions
One of our most effective techniques for discovering hidden profit opportunities is to ask a series of what we call “Barbara Walters questions.” They are questions that are tough to dodge and force you to be honest with yourself, such as:
- What does the company do best? If no one knows, there's an obvious problem. Working toward a good answer, though, usually results in strategies that boost the company's core operations and thus increases profits.
- What products or services should we eliminate? Everyone in management has an answer to this, but usually no one asks for it. When the tough answers come out, unprofitable activities are eliminated and profits jump.
- Exactly who are our customers? Often money is wasted on efforts to reach the wrong people in the customer's company...or the wrong prospect altogether. Analyzing customers in terms of profitability is a powerful way to cut marketing waste.
Customers will pay you what they think your product or service is worth, not a penny more. Traditionally, many businesses have priced their goods and services based on cost. But cost is irrelevant in the buying decision of the purchaser. Understanding financial matters is essential to determining the real profit opportunities in your business. Your organization's gross margin potential is illustrated using the following model:
Potential sales = Units sold x Customer's perceived value per unit
Cost of sales = Accurately determined direct and indirect costs of product/services sold
Gross margin potential = The dollars left to pay all other expenses as well as generate profits
Unless your customers perceive that your product is truly unique, you have to remain competitive in pricing your goods and services. Even what customers are willing to pay for uniqueness has limits, however. Make sure you know your competitors, what they sell, and what they charge. In today's low-inflation economy, many companies are complaining of their inability to boost profits by raising prices. But often there are ways to do this if a company knows which products or services its customers value most. To find out, the company can hire a third party to do in-depth research. In our experience, these surveys often result in adding or dropping products or services as well as in re-pricing them.
For example, we were able to help a third-generation family business, a wine-and-spirits wholesaler, pinpoint a pricing opportunity with a special California wine. The wine was in strong demand, and it could easily justify a much higher markup than the standard markup the distributor applied to its entire inventory. Result: an added $350,000 of recurring profits.
Pricing decisions must work in concert with other strategic business decisions. Think about your sales goals, corporate image, marketing strategies, competitor goals, and various other related business objectives. Put those business objectives in writing and share that information with your profit team. Profit team members will then be more informed when making critical price decisions.
During the profit audit for a computer-software training company, a father-son business, it soon became clear that there were severe weaknesses in sales and marketing. The managers didn't know how to change the way the department was doing business in order to achieve their sales objectives. We learned from the managers that sales were posted at the end of the month, but salespeople had no idea how they were performing during the rest of the month. There were no benchmarks, so everyone was like a hiker trudging along a trail with no end in sight.
We coached the profit team on setting up a system for posting daily sales figures. Everyone on the sales staff can now see at a glance how their sales compare with targets set for specific points of time during the current and future months. The numbers immediately illustrate how individuals and the group are performing. There are no surprises anymore. Everyone can track their progress and make adjustments to their game plan before it is too late to reach their goals.
A distribution company incorporated the same concept and added an additional twist—a tracking system for lost accounts that pinpoints drops in customer activity. The system alerts profit managers of customer accounts that have a reduction in frequency of transactions. Now the company can more quickly discover problem accounts. They immediately determine what is causing the customer to change its buying patterns. The company now retains a significantly higher percentage of potentially lost business. This project has the potential to provide an extra $250,000 of profit annually.
Sell all your products all of the time
Could you charge for something you are currently providing free?
A company selling supplies and equipment to the physically challenged asked us to help them increase their sales. A manager at the profit retreat mentioned that she had been told by a customer who was bringing in a wheelchair for repairs about four new wheelchairs he had just bought. She asked her customer why his firm hadn't bought them from her company. Surprised, the customer replied that he didn't know wheelchairs were included in her company's product line. This organization's selling price per wheelchair ranges from several hundred to several thousand dollars. Can you imagine how many dollars of lost sales occur per year in your organization because customers don't know what you sell?
The profit team of departmental managers promptly appointed a profit champion and committee to address this problem. Now whenever customers enter the showroom, they are given a brochure that shows the complete product line. On a tour of the company's impressive facility, they are introduced to its major products and services. Whenever one of them mentions a need, customer-service reps steer him or her to the right department. The profit team has established simple procedures to recover “fumbles” and maximize sales and services.
Another profit opportunity was suggested by an employee who is herself physically challenged. The company published a free monthly newsletter on news and products of interest to the physically challenged. She asked why this publication was free to subscribers when it provided such valuable information. No one had an answer. Three months later, the company began selling subscriptions. This initiative earned the company $200,000 in the first year, with little additional effort or expense.
Hidden profits in one company
A manufacturing company challenged many aspects of its operating procedures and found millions of dollars in hidden profits. All of these ideas came out of the first profit retreat attended by key managers.
This manufacturer sells to the giant hardware store chains. The profit team determined that one of their greatest profit fumbles was in delivering partial loads on their trucks. They set up some real financial incentives to encourage their customers to buy full loads or share the delivery with other stores. By saving on delivery expenses, this initiative added $116,000 to the bottom line.
The top-management profit team identified a weakness in their customer service department: The receptionist and other telephone-answering staff were not really trained to answer questions about the company's products. Nor did they know who else might answer each question. “That's not my job,” they would say as they handed the call on to the next uninformed employee. A profit project team was appointed to determine what major questions were coming in from customers. This team set up a program to train operators who could answer each kind of question about issues and products.
In addition, the company had no sales-tracking database. The profit team put one in and generated an extra $425,000 in profit the first year.
Our client had not trained customer-service representatives to cross-sell their products. The company sold certain products to some customers, and different products to others. Another profit project team developed a new sales program in which all the company's products were featured in customer promotional materials. Cross-selling brought in an extra $300,000 in profit the first year.
A third profit-project team examined the pricing on company inventories. They looked at the pricing for their products based on availability and quality. Accordingly, they raised some prices and lowered others, and developed close-out procedures for excess inventory. These initiatives created $1.8 million in extra profit the first year.
There was no formal preventative maintenance plan for the company's equipment. We all know that preventative maintenance prolongs the life of equipment and keeps people working instead of waiting for equipment to be repaired. By establishing a plan for preventative maintenance of equipment, the profit team potentially saved the company about $260,000 in excess repair costs, wasted time, and orders lost because they could not be filled promptly.
Every business has hidden opportunities such as these throughout its operations. As the leader of a family business, your job is to focus the attention of managers and employees on improving the bottom line, no matter what their jobs. Everyone who receives a paycheck should be responsible for developing and implementing ideas that benefit the bottom line. A company that takes time to create a profit plan, manages it continuously, and teaches its people profit-ability skills will add real value to the bottom line.
Barry R. Schimel and Gary R. Kravitz are co-founders of The Profit Advisors Inc., a consulting firm in Rockville, MD. This article is adapted from, The Profit Game: How to Play—How to Win (Capital Books, 1998). They also have developed software, “The Profit Playbook,” with strategies for improving profits (see www.weprofit.com).
Ideas for increasing your profits
1. If your business is seasonal, ask your biggest vendors to let you stock up now but pay when customers buy. Also, re-negotiate your leases to pay only those 8, 9, or 10 months out of the year when you experience the greatest number of sales. See how well your cash flow improves.
2. For the next two weeks, have your customer service personnel keep a list of products your customers would have bought had you stocked them. Then calculate how much revenue you would have earned by stocking the three most requested items.
3. Ask your employees to make a list of 10 ways that they would like to be rewarded for a job well done. Figure out how much you would have made by awarding these perks instead of giving cash bonuses based on the subjective judgments of supervisors.
4. Ask your production foreman to estimate how much you spent in the last six months on lost production, manufacturing errors, injuries, and re-works. Then calculate how much extra you would have made by paying your manufacturing crews a small percentage of the materials waste reduction and hourly pay required to fix mistakes.
5. Tell your plant foreman to give you a list of any equipment that is idle most of the time. Then calculate how much you would save in insurance, property taxes, income taxes, maintenance, storage space, and carrying charges by getting rid of it.
6. Ask anyone who performs day-to-day work in your business—secretaries, delivery people, janitors, customer-service personnel, shipping clerks, production workers—to write down five ways your company can become more profitable. You may be surprised by how many great ideas you receive.
7. Start sending letters to customers who discontinue doing business with you, thanking them for their past patronage. See how many call you to reinstate their account.
8. Ask your accounting department to rank your customers by dollars they spend. Calculate how much more money you'd make by transferring your time and dollars from servicing the lowest producing 80 percent to “wowing” the top 20 percent of your customers.
9. Ask your accounting department to tell you how much you spent last year on overnight priority packages and shipping. Then calculate how much you would have saved if just 75 percent of those were sent so they would get to the recipient the following afternoon, or in two days.
10. Ask your payroll manager to give you a list of employees who were paid overtime last year. Initiate a bonus to those departments who get their work done responsibly without incurring any overtime.
11. If you currently bill customers a fixed amount every month, calculate how much you'll save in monthly mailing costs, and how much you'll increase cash flow, by billing in advance every two months instead.
12. Calculate how much you spent last year for products and services that were shipped to customers but not authorized by them. Set up a system to get customers' approval in advance and avoid this wasted expense.
13. Calculate how much more you'd earn if you improved your net pre-tax by just 10 percent.
14. Make a list of all the things you would do with that money. It will motivate you to do even more to enhance your company's bottom line.
-- B. R. S., G. R. K.