Editor's note: For many years chief executive officer Columnist Jonathan Burns died He passed away on May 7th at the age of 75 after a long and courageous battle with cancer. The MIT professor, consultant, and co-founder of Profit Isle was a brilliant mind, a thoughtful businessman, and a kind person. We will miss him. This column is one of several he submitted to us before he passed away.
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When I talk to managers about profit generation, I'm often asked about profit traps — logic traps that lead to significant revenue drain. There are three big offenders:
- Marginal contribution. Why shouldn’t we take away business that contributes to overhead costs, even if it doesn’t cover the full amount?
- complete product line. Why should you have a product that is causing a loss when it is part of a product line that is profitable overall?
- traffic driver. If you're going to attract customers who buy a very profitable product, why not carry a loss-making “loss leader” product?
Each of these questions seems to have a perfectly logical answer that leads to the conclusion that it’s OK to operate at a loss.
Let's analyze each question carefully.
Marginal Contribution
The question about contributions is a question asked at almost every talk and conference. After all, if the warehouses and trucks are not full, the question arises, is it not better to take advantage of the business that covers the costs, rather than leaving some empty? This seems wise.
There are two big problems with this logic.
First, if a company does business that does not pay full-freight rates, they also need a strict “sunsetting” mechanism to sell (or re-price) that business when full-freight business becomes available – something that in practice companies rarely do.
Instead, it maintains a marginal business that provides so-called “volume.” When new business exceeds capacity, they simply increase capacity. There is always a logic that marginal business contributes. Over time, the warehouse is filled with various businesses, some of which are profitable, but most are not.
The second problem is even more troubling: if unsold full-freight business is available, the company is implicitly “freeing” its salespeople by allowing them to meet their quotas with marginal business. The flawed logic of covering variable costs but not paying them in full takes the pressure off the salespeople to keep doing what they should be doing: selling until they bring in a profitable deal.
The end result is a few profit peaks surrounded by many profit drains, and no one knows where the profit drains came from.
complete product line
The second profit trap also seems to have an unassailable logic: some customers want suppliers with a complete product line, so it seems obvious that a company must have some loss-making products in order to be profitable across its entire product line.
This seems perfectly logical. But think about it.
If this logic is correct, the company is essentially investing. They invest in selling products at a loss in order to make a profit. incremental Sales of other products not only generate profits but, importantly, also cover losses in the parts of the product line that are submerged.
While this seems like a sound thought process, it only makes sense if the company calculates the return on this investment and shows that it is a good investment.
The counterargument is that this calculation seems impossible to make, although an Enterprise Profit Management solution (EPM) can make this determination quickly with a SaaS system that shows you the net profitability of every product for every account every time you buy, and the buying patterns of every account. But remember, a minor, loss-making product can be a great investment if it's important to many of your high-revenue, high-profit Profit Peak customers.
Here's another reason why product line logic is a profit trap: It assumes you're a full-line supplier. In fact, if you look at business over the past few decades, you'll see that many of the most successful companies, like Walmart, have done very well by selectively positioning themselves in key product categories and competing on low cost and price. Needless to say, rock-bottom low costs and prices are created by streamlining supply chains and eliminating irrelevant, loss-making products.
Instead, too many companies simply think they need to provide quick service for their entire product line at competitive prices with narrow-line competitors.
However, there are ways to achieve this. Deliver slow-moving products by storing consistently consumed, fast-moving products in local distribution centers and other products in national or regional consolidation facilities, eliminating overly frequent orders. You can reduce costs, have a full line, and make a profit on all or most of them.
Of course, your customers will have to accept some delays, extended service intervals, but the advantage here is that if you have an Enterprise Profit Management system that can distinguish between customers who buy the full product line and Profit Peak customers, you can have enough local inventory of slow-moving products.
Customers who are selective about your company can either wait a little longer, pay an expedited fee, or expand their purchasing range to be in your company's most preferred customer category.
(Keep in mind that Apple, a high-end company, maintains a condensed product line to simplify customer choices and reduce manufacturing and supply chain costs).
Traffic Driver
The third profit pitfall, traffic drivers, is very common. Its obvious logic is:
Your marketing strategy is focused on attracting customers with “loss leaders” — products or categories sold at a low price to drive more high-margin sales.
Currently, many auto parts retailers consider their fluids to be a loss leader category: if a customer comes into the store to buy brake fluid or window washing fluid, the entire visit becomes profitable because the customer is purchasing higher margin products.
Most companies do business like this.
The logic behind this product strategy is similar to that of the product lines analyzed in the previous section: essentially, companies are pricing their traffic drivers below total cost to invest in generating high-margin sales elsewhere, but few companies track this to determine the actual return on investment.
In fact, an auto parts retailer used Enterprise Profit Management to quickly calculate returns to loss leaders based on each customer's profitability. basketOverall, this strategy was a loss, but it was a big win for certain identifiable bulk buying DIY customers. Seeing this, they changed their promotion strategy from offering roasters to everyone to sending liquid discount coupons only to their targeted customers.
As with product line profitability, Enterprise Profit Management determines which customers over time, yields a constant return on investment for the traffic drivers it consumes. Armed with this knowledge, companies can build smart sets of incentives and incentives to drive customers toward desired purchasing behaviors.
If customers are just cherry-picking traffic drivers, businesses can take appropriate measures to minimize losses.
profit logic
What these three profit pitfalls have in common is that each seems very logical.
After all, shouldn't you take on business that helps pay your overhead? Why not carry a few loss-making products in order to make a profit across your product line? Why not offer a few loss-making leaders or traffic drivers to attract customers to buy your higher-margin products?
The truth is that each of these profit pitfalls has a logic that certainly sounds reasonable. But the really big problem is: When apparent logic produces real results.
The problem is that in most companies, policies based on logic are applied indiscriminately, rather than specifically targeting customers or situations where it makes sense, and not being applied where it doesn't make sense. is. The power of Enterprise Profit Management is that it allows you to draw lines in the sand, make precise distinctions, and build peak profits while reducing profit outflows.
