Today’s complex business environment—with its multitude of regulations, global economies, competitive factors, and series of technological and product innovations—presents the customer with ever-hanging offerings to replace, substitute for, or act as alternative to your business’ market offerings. Too often this translates to an increasing “thin” profit margin for your business. This thin profit margin is what stands between the business as it presently is and the events it must weather in the future. It is also the means by which it pursues growth in existing markets and operations and funds the pursuit of new opportunities and markets.
The Thinner the Profit, the Greater the Limitations
How far an organization can grow is a function of its ability to make the necessary funds available for that purpose. It is a simple fact of business: Growth requires cash. Without profit, a business rarely has the ability to generate cash. Growth typically is driven from two primary sources: existing markets, products, customers, operations; and new markets, products, customers, and operations. The ability to enter new markets is funded by the success (profits) in our existing markets. Knowing how much profit you have, and from where your profits originate are the keys to an enterprise’s ability to grow. This knowledge also tells us what we are good (or not-so-good) at, and gives the information needed to direct the business. It also tells us our limitations and the areas for improvement and impact.
Thin Translates to a Fine Line
The thinner your profit margin, the more critical it is to know who and what contributes to the bottom line, and who and what consumes those resources. Every decision impacts that fine line between profitability and just covering costs or falling below the line into losing money. Every expenditure, investment, reduction in price, change in credit terms: Everything makes an impact on profit.
Need to Know Basis
It isn’t enough to believe that a customer, product line, or market is profitable. You need to know for certain, not just at the level of direct costs (the costs of the “goods”) but the total cost of doing business with the customer: creating, managing, selling, promoting, and delivering the product. Some customers, for instance, have higher costs associated with customer service, credit terms, or any number of “support services.” Those costs matter; they cut into profits. Other times, it is important to understand that certain product lines have extra costs associated with regulations, consumer impact and perspective, import/export issues, and so on. For the business to get a true picture of its profitability and to understand to get the most out of its market potential—profits, sustainability and growth—it must fully understand its financials.
Total Cost of the Business
When you think about the cost of doing business with any one customer or developing any single product, the costs associated with the underlying business the aspects of the business that are in place for “doing” business (the “overhead” and “general and administrative” expenses, as well as the costs of setting up the initial enterprise) are frequently viewed as costs that are “not ours.” The typical argument made by product managers, business unit managers, and even sales managers stems from the belief that if they can’t control those costs (or if those costs have already been incurred by decisions made at other levels or in previous periods) they have no place in the performance being measured now, which is their performance.
Reality Check: Yesterday Is in Today’s Returns
The reality is: Those costs incurred “yesterday” to create the infrastructure and provide services, market the business, account for the business, setup operations, acquire resources, etc. are part of the cost structure today. Today’s business analyzes how the returns from those investments are being generated and how the payoffs are being achieved. How well the business is doing depends upon how well today’s managers and team members are using those resources, combined with resources that are being acquired today.
In other words, the full cost for the business includes the infrastructure costs of the investments being made today and a share of the costs invested in prior periods. Furthermore, everyone in the organization is using the resources, so they have a share of the responsibility for making a return on those investments. How the responsibility is shared depends upon the roles in the organization and translates into the metrics that are established for each role.
For example, if you are part of the sales organization, the performance impact you can have ranges from the amount of sales to the quality and timing of the sales. It isn’t enough to generate sales dollars; you have to have profitable sales and be able to collect the payments. A sale is only as good as the payments that are made. Late payments, long terms, and defaulted customers cut into the profitability of the business. Those are important aspects of the business to measure, understand, and manage, not just in the accounting department but with the sales team who are out there looking for customers and deals. The sales team needs to understand how payment terms fit into the cost and profit equation of the business.
Being profitable is good. Thin profits can be improved by examining the total business, from improving the ability to generate more sales, to improving pricing strategy and cost structures. Even in industries and markets that are viewed as high competition, commodity, or declining, there will always be opportunities and ability for the savvy business to be profitable, improve performance, and grow. Sustainability is possible under the most adverse circumstances and market conditions. It simply takes an ability to connect with the market, hone the product offering, and do things differently than the competition.
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