{"id":336119,"date":"2024-05-23T12:44:39","date_gmt":"2024-05-23T16:44:39","guid":{"rendered":"https:\/\/chiefexecutive.net\/?p=336119"},"modified":"2024-05-23T12:44:41","modified_gmt":"2024-05-23T16:44:41","slug":"how-to-avoid-3-common-profit-drains","status":"publish","type":"post","link":"https:\/\/chiefexecutive.net\/how-to-avoid-3-common-profit-drains\/","title":{"rendered":"How To Avoid 3 Common Profit Drains"},"content":{"rendered":"\n<p><em>Editor\u2019s note: Longtime&nbsp;<\/em>Chief Executive&nbsp;<em>columnist Jonathan Byrnes&nbsp;<\/em><a href=\"https:\/\/www.legacy.com\/us\/obituaries\/bostonglobe\/name\/jonathan-byrnes-obituary?id=55050959&amp;fhid=8784\"><em>passed away<\/em><\/a><em>&nbsp;on May 7 at age 75 after a long and valiant fight against cancer. The MIT professor, consultant and cofounder of Profit Isle was a brilliant mind, thoughtful businessperson\u2014and kind man. We will miss him. This column is one of several that he submitted to us before his passing.<\/em><\/p>\n\n\n\n<p>***<\/p>\n\n\n\n<p>When I talk to managers about profit generation, I\u2019m often asked about profit pitfalls\u2014logic traps that lead to major profitability drains. Here are three big offenders:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><em>Marginal contribution.<\/em> Why shouldn\u2019t we take business that contributes to overhead, even if it doesn\u2019t cover full cost?<br><br><\/li>\n<\/ul>\n\n\n\n<ul class=\"wp-block-list\">\n<li><em>Full product line. <\/em>\u00a0Why shouldn\u2019t we carry products that lose money if they are part of a product line that makes money overall?<br><br><\/li>\n<\/ul>\n\n\n\n<ul class=\"wp-block-list\">\n<li><em>Traffic drivers. <\/em>\u00a0Why shouldn\u2019t we carry money-losing \u201closs-leader\u201d products if they attract customers who then buy very lucrative products?<\/li>\n<\/ul>\n\n\n\n<p><\/p>\n\n\n\n<p>Each of these questions seems to have a perfectly logical answer that leads to the conclusion that it is all right to carry money-losing business.<\/p>\n\n\n\n<p>Let\u2019s analyze each question carefully.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\">Marginal contribution<\/h4>\n\n\n\n<p>The question of contribution is one I hear in almost every talk and meeting. After all, the question goes, if our warehouses and trucks are not full, isn\u2019t it better to take some business that helps cover the cost, than to leave them partly empty? This sounds sensible.<\/p>\n\n\n\n<p>There are two big problems with this logic.<\/p>\n\n\n\n<p>First, if a company takes business that doesn\u2019t pay full freight, it also needs a strict \u201csunset\u201d mechanism to divest that business (or reprice it) when full-freight business becomes available. In fact, companies almost never do this.<\/p>\n\n\n\n<p>Instead they keep the marginal business because it provides so-called \u201cvolume.\u201d When new business moves them beyond capacity, they simply build more capacity. The logic always is that the marginal business provides a contribution. Over time they wind up with a warehouse full of mixed business\u2014some paying its way, most not.&nbsp;<\/p>\n\n\n\n<p>The second problem is much more insidious. If there is full-freight business available that has not been sold, the company is implicitly letting the sales reps \u201coff the hook\u201d by allowing them to fill their quota with marginal business. The false logic of taking business that covers variable cost but doesn\u2019t pay for full cost removes the pressure on sales reps to do what they need to do: Continue to sell until they bring in lucrative business.<\/p>\n\n\n\n<p>The net effect is a few Profit Peaks surrounded by a host of Profit Drains, and no one knows where the Profit Drains came from.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\">Full product line<\/h4>\n\n\n\n<p>The second profit pitfall also seems to have an unassailable logic. Since some customers want a supplier with a full product line, it seems obvious that a company has to have some losing products in order to make money on the overall product line.<\/p>\n\n\n\n<p>This seems completely logical. But think carefully about it.<\/p>\n\n\n\n<p>If this logic is true, than the company is essentially making an investment. It is investing in carrying money-losing products in order to generate<em> incremental<\/em> sales in other products that not only are profitable, but importantly, also cover the losses on the portion of the product line that is underwater.<\/p>\n\n\n\n<p>This seems like a sound thought process\u2014but it only makes sense if the company calculates the return on this investment, and shows that it is a good investment.<\/p>\n\n\n\n<p>The counter argument is that it appears to be impossible to do this calculation. However, with an Enterprise Profit Management solution (EPM), a SaaS system that shows the net profitability of every product in every account every time it is purchased\u2014and every account\u2019s buying pattern\u2014you can quickly make this determination. Remember, however, that if a minor, money-losing product is important to a number of your high-revenue, high-profit Profit Peak customers, it may well be a great investment. &nbsp;<\/p>\n\n\n\n<p>Here is a companion reason why product line logic is a profit pitfall. It assumes that you have to be a full-line supplier. In fact, a quick look around business over the past few decades shows that many very successful companies like Walmart do very well by positioning themselves selectively in key product categories, and competing on low costs and price. It goes without saying that the rock-bottom low costs and prices are generated by streamlining the supply chain and eliminating the extraneous, money-losing products.<\/p>\n\n\n\n<p>Instead, all too many companies simply assume that they have to provide rapid service for a full product line at prices that are competitive with narrow-line competitors.<\/p>\n\n\n\n<p>There is a way to do this, however. If you keep your steadily-consumed, fast-moving products in local distribution centers, and your other products in consolidated national or regional facilities\u2014and you eliminate overly-frequent ordering\u2014you can lower your cost to serve on the slower-moving products so you can carry a full line and make money on all or most of it.<\/p>\n\n\n\n<p>Of course, your customers will have to agree to a slight delay\u2014a longer service interval. But here\u2019s the leverage point: You can keep enough local stock of slow-moving products for the customers who really are buying a full product line and for your Profit Peak customers\u2014if you have an Enterprise Profit Management system that enables you to identify them.<\/p>\n\n\n\n<p>For the customers that are cherry-picking you, they either can wait a little, or pay an expediting fee, or broaden their purchases to move into your most-favored customer category.<\/p>\n\n\n\n<p>(Note that Apple, a high-end company, has maintained a compressed product line in order to simplify their customers\u2019 choice, and reduce their manufacturing and supply chain cost.)<\/p>\n\n\n\n<h4 class=\"wp-block-heading\">Traffic drivers<\/h4>\n\n\n\n<p>The third profit pitfall, traffic drivers, is very common. Here\u2019s the apparent logic.<\/p>\n\n\n\n<p>Your marketing strategy centers on attracting customers with a \u201closs leader\u201d\u2014a product or category that is priced low in order to develop further high-margin sales.<\/p>\n\n\n\n<p>Today, many auto parts retailers view their fluids as a loss leader category. When customers come in to buy brake or window washing fluid, the logic goes, the customer will shop for higher-margin products, making the overall visit profitable.<\/p>\n\n\n\n<p>Most companies have business that looks like this.<\/p>\n\n\n\n<p>The logic underlying this product strategy is similar to the product line logic analyzed in the prior section. Essentially, the company is making an investment in pricing a traffic driver below full cost in order to generate high-margin sales elsewhere. But few companies actually track this in order to determine the real return on investment.<\/p>\n\n\n\n<p>In fact, one auto parts retailer used Enterprise Profit Management to quickly calculate the payoff for its loss leaders based on the profitability of each customer <em>basket<\/em>. They found that overall, this strategy lost money, but for certain identifiable high-volume, do-it-yourself customers, it was a big winner. When they saw this, they changed their promotion strategy from offering loss leaders to everyone, to sending fluid-discount coupons only to their target customers.<\/p>\n\n\n\n<p>As in the case of product line profitability, Enterprise Profit Management will quickly show which customers, <em>over time<\/em>, produce a threshold return on investment on the traffic drivers they consume. Armed with this knowledge, the company can build a smart set of incentives and linkages to move customers to the desired buyer behavior.<\/p>\n\n\n\n<p>Where a customer is simply cherry-picking the traffic driver, the company can develop appropriate measures to minimize the losses.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\">Profit logic<\/h4>\n\n\n\n<p>What these three common profit pitfalls have in common is that each seems so logical.<\/p>\n\n\n\n<p>After all, why shouldn\u2019t you take business that helps pay for the overhead? Why shouldn\u2019t you carry some losing products in order to make money on the whole line? Why shouldn\u2019t you offer some loss leaders, or traffic drivers, to draw in customers who will buy high-margin products?<\/p>\n\n\n\n<p>The truth is that each of these profit pitfalls does indeed have a reasonable-sounding logic. The really big issue, however, is determining <em>where the apparent logic produces real results<\/em>.<\/p>\n\n\n\n<p>The problem is that in most companies, the policy that follows from the logic is applied indiscriminately, rather than targeted specifically at customers and situations where it makes sense\u2014and not where it doesn\u2019t fit. The power of Enterprise Profit Management is that it allows you to draw a line in the sand, and make this precise distinction\u2014building your Profit Peaks while you reduce your Profit Drains.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>These pitfalls may seem logical, but examine them carefully to improve your bottom line.<\/p>\n","protected":false},"author":9492,"featured_media":336122,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_oasis_is_in_workflow":0,"_oasis_original":0,"_relevanssi_hide_post":"","_relevanssi_hide_content":"","_relevanssi_pin_for_all":"","_relevanssi_pin_keywords":"","_relevanssi_unpin_keywords":"","_relevanssi_related_keywords":"","_relevanssi_related_include_ids":"","_relevanssi_related_exclude_ids":"","_relevanssi_related_no_append":"","_relevanssi_related_not_related":"","_relevanssi_related_posts":"206,208,210,212,214,216","_relevanssi_noindex_reason":"","footnotes":"","_links_to":"","_links_to_target":""},"categories":[905,9,879],"tags":[],"class_list":["post-336119","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-finance","category-operations","category-strategy-2"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin 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