Most successful men have not achieved their distinction by having some new talent or opportunity presented to them. They have developed the opportunity that was at hand.
—BRUCE BARTON
There is a truism that 50 percent of advertising is wasted, but no one ever knows for sure which 50 percent it is. As a result, advertising budgets always seem higher than necessary. This problem persists in many areas of many businesses today. Money is being wasted, but no one is exactly sure where and how it is happening.
Many companies today are earning low profits or no profits because their costs of doing business are not coordinated with their sales. Many products and services are priced by people who are completely unaware of the real costs involved in bringing those products or services to the market. These mistakes in pricing are then buried in the overall operations and general revenues of the business.
You’ve heard the saying, “We lose money on every sale, but we make it up on the volume.”
In many cases, this is not a joke. It is common for companies to have too many products or services at too many price points, aimed at too many markets and sold in too many different ways. Many of these companies are losing money on the sales of certain products, or making far less than they could be if they knew the true costs of bringing those products or services to market.
One of the most important parts of the Turbostrategy process is for you to conduct a complete profit analysis on each product or service you sell. Very few companies have ever done this. But when you begin applying profit analysis in your company, you can often increase your profits dramatically.
You begin the process of profit analysis by applying the 80/20 Rule to every part of your business. You determine which 20 percent of your products or services account for 80 percent of your sales. Then you determine which products or services account for 80 percent of your profits. You will be surprised to learn that the answers to these two questions are not necessarily the same.
You then analyze your costs and determine the 20 percent of activities that account for 80 percent of your expenses of doing business. You analyze your customers to determine the 20 percent who represent 80 percent of your sales.
As you examine these numbers, you will find that, in many cases, your biggest customers are not your most profitable customers, and your biggest selling products or services are not your most profitable ones either. You may find that your costs of doing business with some customers and with some products are so high that it is hardly worth the investment of people and resources. This can only be determined by taking a hard look at the numbers.
When a turnaround specialist takes over a company in trouble, she immediately conducts a profit analysis. She analyzes every product or service to determine quickly which ones are the most profitable, which are the second most profitable, and which are the least profitable.
Once this analysis is complete, the turnaround specialist moves quickly to discontinue, sell off, and close down unprofitable elements of the business. Her sole focus is on cash flow, which comes largely from selling something and getting paid for it quickly.
You need to be your own turnaround specialist all the time, and most especially when business slows for any reason. To pump up your profits, you do a complete profit analysis on your business and move immediately to focus the energies of the company on those areas that represent the very best sources of net cash. This process requires that you continuously analyze your business so that you know exactly the profitability of every product and service you sell in comparison with every other product or service you sell, right down to the penny.
Many companies, as they grow, fall into the habit of including more and more expenses such as salaries, rent, telephones, travel, and even advertising under the category of “General and Administrative.” Only costs that can be directly attributed to a specific product or service are used for costing purposes. As a result, many costs get “buried” in the bookkeeping, and even the person in charge is not aware of the exact sources and uses of cash.
The fact is that, with a little effort, every single product or service can be organized on a scale from the most profitable to the least profitable, both on a per item or per hour basis, and in net dollar amounts. There is always one that is more profitable than any other. There is a second that follows closely behind the first. There is a third and a fourth, and so on. Your job is to determine exactly what they are and in which order.
You begin your profit analysis by determining the exact gross sales revenues that you receive from a product or service after all subtractions for defects, returns, breakage, loss, wastage, and bad debts. Take every single deduction so that your gross dollar amount is completely accurate, and you are crystal-clear about the exact amount you are netting from sales.
Once you have an accurate top-line figure, the next step is for you to determine 100 percent of the costs of providing that product or service to the customer. These include the direct costs of producing and delivering the product or service, plus the indirect, variable, semivariable, and fixed costs that must be allocated to get an accurate number. You must be absolutely, brutally honest with yourself in determining these costs.
You must calculate and deduct a percentage of the labor costs of every person in the organization who has anything to do with the product or service. You should deduct a portion of the rent, the electricity, the telephones, the utilities, and all general administration costs. These are real costs of doing business that must be included for you to get an accurate assessment of that product’s profitability.
Now, if you haven’t done it already, you deduct a percentage of all costs of advertising, promotion, marketing, labor, commissions, and, especially, your own time investment, and the time investment of other executives, based on your and their hourly rates from each unit of product or service sold.
People are often confused about the subject of hourly rate. The fact is that it costs a company three to six times a person’s salary to keep him or her employed. The additional costs are included in benefits provided, the costs of the offices and other facilities a person needs to do his or her job, vacations, pension plan contributions, and the cost of other managers and staff to supervise or support him.
Using a simple calculation, you can divide your annual income by 2,000 hours, the average American work year, to get your hourly rate. For example, if you earn $100,000 per year, divided by 2,000, your hourly rate is equal to $50 per hour. Therefore, every hour you spend on a product or project is costing your company that amount in direct salary cost, plus at least twice that amount in associated or “indirect costs.” This is the real figure that must be included to calculate the true profits that the company earns from a product or a customer.
Many small-business owners and managers forget that their labor has a real “opportunity” cost. If it were applied to another task, it could be generating $50, $100, and more per hour. If you spend one hour working on a sale, you must add one hour of your time to the cost of making that sale or deduct the cost of one hour from the profit the company made from that sale.
Many companies find that, because of the demands that some customers place on their executives and staff, the company is actually losing money every time it does business with that particular customer. We call this a “high maintenance” customer. The more time you spend with “high maintenance” customers, the less time you have to spend with other customers who may be more profitable in terms of net dollars to your business.
Now you are ready for the next step, ranking all your products or services, from the most profitable to the least profitable, on a list. What is your number-one, most profitable product, after you have deducted all your possible costs, both direct and indirect?
Often there is little or no relationship between the amount of time and money you spend creating and selling a product and the amount of profit you earn on that product after all costs are deducted. Sometimes your most profitable products, activities, or customers are taken for granted or go unnoticed.
Identify your most profitable and your least profitable customers. What are the common characteristics of each type? How could you structure your business so that you attract and keep more of those customers that represent the most profit for what you sell?
You will probably find that fully half of your product and service offerings are generating very little profit or even causing you to lose money with every sale. A turnaround specialist would immediately either raise the prices of the low-profit items or discontinue them altogether. You must do the same.
You can often transform your results and increase your profitability quickly by applying a rigid profit analysis to everything you sell. You could probably discontinue 80 percent of your product or service lines without any great loss. You could then commit 100 percent of your people and resources to the 20 percent of products or services that account for 80 percent of your profits today. Think about what a difference that would make!
Take a long-term perspective on your business. Think about your best and most profitable products of today. Then think about your best and most profitable products of yesterday. Based on the trends in your business, what are likely to be your most profitable products and services of tomorrow? Remember: “The best way to predict the future is to create it.”
Finally, look at yourself as a business as well. Identify the few things you do that make the greatest contribution to your organization. What activities pay you the highest hourly rate? What are the opportunities of tomorrow for you? What additional skills and competencies could you acquire that would make you even more valuable in the months and years ahead? Whatever they are, the time to start learning them is now. There is no time to waste.