04 Oct On Driving Profitability
Want to freak out one of your employees? Ask them in the elevator or at the coffee pot sometime: “Do you know how we make money?” As a business owner, do you know how you make money? Which of your customers are most profitable…really? Which of your products and services are most profitable…really? And, to get really dimensional – which of your products or services to which of your customers are most profitable…really?
When you’re in growth mode, when margin and cash is king, understanding your margins by product and customer is critical. Sure there are loss-leaders and deliberate investments, but eventually the margin you make (sales less cost of sales) must make a positive contribution to your overhead (fixed costs like rent) and profit in order for you win.
It’s not that hard. Pull your historical selling prices (net of discounts, etc.) by product. Subtract your variable costs to produce those products or services. What are variable costs? Those costs that you wouldn’t have if you didn’t sell that product or service. The difference is your gross margin. You would really like that difference to be a positive number for each product. Sort the margin dollars and percentage from high to low and calculate the overall average. Those products below the average are clear opportunities to improve profits. Think very hard about continuing to sell anything with negative margin.
Now look at the products and services you sell each customer and do the same exercise…sorting high to low and computing the average. Think also about the costs to service those customers but don’t get trapped in over-analysis of allocating overhead and fixed costs. Those customers who contribute less to overhead and profit are clear opportunities for you. Focus on your product or service mix, reducing your costs to produce or serve and your selling prices. At the extreme, don’t be afraid to walk away from an unprofitable customer (or raise prices and see if they walk away from you). Think about how you pay your sales organization. Simply based on sales dollars or on contribution to overhead and profit?
With some relatively simple analytics and alignment of objectives you may find a significant improvement in your bottom line. Try this. It works!