Manage profitability

If you are in business, then you want to make money and you want to make more of it. But wouldn’t it be great to get it from your existing customers and not have to start all sorts of new costly initiatives or programs?

I read a book a few years ago that allowed me to do just that. The book “Islands of Profit in a Sea of Red Ink” was written by Jonathan L. S. Byrnes. Much of the book is geared toward manufacturing and distribution companies, but there is plenty that applies to service companies and other green-industry businesses.

It has stuck with me over time and helped me to look at my business, my service offerings and my customers in a more critical manner. It helped raise our profitability. While doing that it helped me realize several common myths in business:

• If everyone does his or her job well, the company will prosper
• All customers should get the same great service
• Revenues are good, costs are bad

In the book Byrnes asks a key question: “Who is managing the profitability of your company?” In most companies everyone may pay attention to profitability, but no one really has a process for managing the profits on a day-to-day basis. In fact, many companies may have systems and incentives in place, but they are out of alignment, and undermine the firm’s overall profitability.

Optimizing the parts of a process does not guarantee that you will optimize the whole process. That is how everyone can be making or even exceeding their individual goals, but the company is not.

Is your sales team selling the most profitable item or are they just meeting revenue goals with whatever they can get? Are their sales building density or causing increased windshield time? Is your operation able to take advantage of more efficient equipment or is it laid out in a way that prevents this?

Byrnes says that nearly 40% of the average company is unprofitable, but 20% to 30% is so profitable that it provides all the earnings and subsidizes the other losses. The key to increased profitability is to identify which work is profitable and which is not, which clients purchase the profitable work, and what you can do to get more of each.

One of the first steps to managing your firm’s profitability is to understand the profitability of each service and product you offer. The best way to get this information is to develop a profitability database. The database is something that can easily be developed with a few key people from both sales and operations in something as simple as an Excel spreadsheet. There is no need to over-analyze or to let the development of the database become the project — it need only have about a 70% accuracy to be effective. You can refine it over time as needed. Major errors that pop out can be adjusted by the team as they are discovered.

To build the database, the team will take a set of invoices (you can use last year’s sales) and look at them at the line item level. For each item, identify/estimate several numbers: the actual revenue, the direct costs and the indirect costs. Use available data, estimates and basic rules of thumb to develop the detail. Once done, the database will let you see the actual profitability of each item/service studied.

After completing the database, you can use the information to build profit profiles for each of your existing customers. By applying the numbers in the database to each customer’s past purchases you can rank your customers by profitability, not just revenue. I know at our company this list was quite surprising and made us look at certain customers in a different light. All customers are not equal. It helped us prioritize customers and put them in tiers. We then determined how to serve each tier effectively and maximize profitability.

We also used the database to find profitability killers in our existing operations. Reviewing the numbers let us focus on those issues that would have the greatest impact on our profitability. These issues were further investigated, and we would look for ways to eliminate them.

We now know what to sell to whom and how to serve them. When you can answer these questions effectively you will be able to dramatically increase your profitability.