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 sent us before he passed away.
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When I talk to managers about profit generation, I'm often asked about profit pitfalls, traps in logic that lead to significant revenue drains. There are three serious offenders:
- Marginal contribution. Why shouldn’t you take on business that contributes to overhead costs, even if it doesn’t cover the full cost?
- Complete product line. Why shouldn't you carry a loss-making product if it's part of an overall profitable product line?
- 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 okay to continue operating a business in the red.
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 major problems with this logic.
First, if a company does business that does not pay full-freight, there is a strict “sunset” mechanism to sell (or reprice) that business when full-freight business becomes available. is also required. In fact, companies rarely do this.
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.
full product line
The second profit pitfall also seems to have an irrefutable logic. Some customers want a supplier with a complete product line, so it is clear that a company needs to have some loss-making products in order to make a profit across the 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 also, importantly, cover losses on the parts of the product line that are in the red.
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. However, the Enterprise Profit Management solution (EPM) is a SaaS system that displays the net profit of every product in every account, every time it is purchased, along with purchasing patterns across all accounts, and makes this decision quickly. can do. However, keep in mind that an unprofitable, loss-making product may be a good investment if it is important to some of Profit Peak's highly profitable, high-margin customers. Please keep it.
Another reason product-line logic is a profit trap is because it assumes you have to be a full-line supplier. In fact, a quick look at business over the past few decades shows that many highly successful companies, like Walmart, have done extremely well by selectively positioning themselves in key product categories and competing on low and low prices. Needless to say, extremely low and low prices are achieved by streamlining the supply chain 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, customers will have to accept some delays, i.e. longer intervals between services. However, this is the point of use. Having an enterprise profit management system that can identify customers allows you to have enough local inventory of slow-moving products for customers who are actually looking to buy the entire product line or customers at profit peaks.
Customers who are selective about your company can wait a little longer, pay an expedited fee, or broaden their purchases 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.
Many auto parts retailers currently consider their fluids to be a loss leader category. If a customer comes into the store to buy brake fluid or window cleaning fluid, the entire visit is profitable because the customer buys higher margin products.
Most companies do business like this.
The underlying logic of this product strategy is similar to that of the product lines analyzed in the previous section. Essentially, the company is making investments that bring the price of transportation drivers below full cost in order to generate higher-margin sales elsewhere. However, very few companies actually track this to determine their 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. basket. Overall, this strategy was a loss, but it turned out to be a big winner for a certain large number of his DIY customers. Seeing this, they changed their promotional strategy from offering loss leaders to everyone to sending liquid discount coupons only to their target customers.
As with product line profitability, enterprise profit management focuses on 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 common profit pitfalls have in common is that each seems very logical.
After all, shouldn't you have a business that helps you pay your overhead? Why shouldn't you have a few products that are in the red to make a profit across the line? Why shouldn't you offer loss leaders and 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: Apparent logic produces real results.
The problem is that in most companies, policies that are driven by logic are applied indiscriminately and not where it makes sense, rather than being specifically targeted to customers and situations where it makes sense.The power of Enterprise Profit Management is that it allows you to draw the line and make this clear distinction – reducing profit drains while building profit peaks.
