Breaking down the top 10 reasons for NOT managing profitability

Our persistently weak economy is driving small businesses into two camps – the few that are growing fast and the many that are struggling.

For most, staying in place is sliding towards failure, so effective profitability management makes all the difference.

A few days ago I discussed my new book Islands of Profit in a Sea of Red Ink with an officer of an industry association with many small business members.

Her questions reflected discussions I’ve had with small business owners and managers over the years.

These were the top 10 concerns:

1. I’m already doing it

There is a huge difference between managing budgets and managing profitability.

Virtually every company I’ve seen – large and small in more than a dozen industries – is 30-40% unprofitable by any measure and 20-30% of the business provides all reported profits and subsidizes losses, even the industry leaders. Why?

Because they make three big mistakes:

(1) Assuming that more revenue means more profit.
(2) Failing to identify and focus on their profitable core of business.
(3) Failing to develop appropriate information and processes to manage profitability.

2. It’s a big company thing

Wrong. It’s really important for a big company but it is life or death for a small business.

In this economy companies that focus on their profitable core of business are making big gains in market share and profits.

I’m familiar with a small company that worked with an important customer on a new business process that really improved the customer’s productivity – its sales rose from $10,000 to more than $1 million in a year.

3. I don’t know how

There are four building blocks:

(1) The right information – granular (specific products in specific customers) not aggregated.
(2) The right priorities – first secure and grow the profitable business, then improve marginal business, then reprice the money-losers.
(3) The right processes – mostly co-ordinating sales, marketing and operations to get things right.
(4) The right compensation, especially for sales – matching compensation to real profitability, not just revenue.

4. I’m too busy selling

This is a common concern because many small business owners are also chief customer officers.

The real problem is that the sales force is not focusing on securing and growing the profitable core, so their efforts are dissipated over a lot of unprofitable business, much of which can be turned around with a few focused measures.

5. I’m too busy cutting costs

This is a big problem. If all revenue is viewed as good all costs are viewed as bad.

That leads to the big mistake of across-the-board cuts at a time when the company should invest in growing its profitable core of business and generate cash by turning around its marginal business.

The most successful companies today are making big gains in market share by working with their best customers to create joint supply chain and marketing efficiencies.

That increases the customers’ profitability – driving huge sales increases while lowering the supplier’s costs.

6. My CFO is really stretched

Islands explains “profit mapping” – how to develop much more granular information than that which is produced by accounting systems.

You have to look at the profitability of specific products in specific customers.

The book gives examples of how even profitable customers have 30-40% unprofitable business, which can be reversed with surprisingly simple measures.

How long does it take? A couple of capable managers can develop a profit map in four-to-six weeks using standard desktop tools. Even a busy CFO can easily oversee the process.

7. My customers are hammering me on price

When you make your best customers more profitable you are no longer a commodity provider. Price pressure simply disappears.

Remember that your first priority is to secure and grow your profitable business before your competitors attack it. This is the biggest danger – and opportunity – you face.

8. We can’t afford expensive new software

No need – see 6 above.

9. We’re all making budget

Budgets are developed and performance is judged relative to history, not potential. If a company is 30-40% unprofitable and its budget aims for a 10% improvement the company will still have a huge amount of embedded unprofitability.

10. I don’t know where to start

Great question. Many managers simply assume that leading a profitability turnaround requires a big, one-time, disruptive reorganization. That is a huge mistake.

The most effective turnarounds are more like getting healthy by eating good food and getting regular exercise.

The process is not particularly difficult or painful but it is a very different way of managing. I wrote Islands of Profit in a Sea of Red Ink to guide you step-by-step through that process.

What’s the first step? Develop a profit map – you’ll be amazed at what you’ll see.

Jonathan Byrnes is Senior Lecturer at MIT, and author of Islands of Profit in a Sea of Red Ink (Portfolio, 2010). He is an acknowledged authority on profit generation and profitability management. He holds a doctorate from Harvard University.