It can be a hard choice to make, but successful companies often have to make strategic decisions to “fix it or exit.” In other words, every element of a business must earn its keep, be fixed or let go. Companies must have a growth and profitability mentality that prompts them to maintain their winning profit centers and dump the marginal earners and losers.
Many businesses tend to avoid taking the time to identify their key profit centers and eliminate marginal products or services. During good economic times when sales are booming, problems tend to go unnoticed. But when business turns sour, earnings start to lag, or the economy takes a turn for the worst, weeding out the under-performers can be the key to a company’s success and even survival. The solution doesn’t necessarily mean selling off operations. Sometimes simple adjustments can do the trick. Here’s how the owner of a large chain of Italian restaurants developed and put the profit mentality to work. The restaurant’s menu was extensive, the food was delicious and the service excellent. But an analysis of the business showed that the menu prices weren’t always profitable. Some dishes were priced at or below the cost of their ingredients, while others were so complicated that their profits were wiped out by the cost of the time-consuming labor it took to execute them. The fixes were fairly simple:
- Raise prices on unprofitable dishes.
- Add mid-range selections that could be priced reasonably and still produce a good profit margin.
In the end, the menu offered a variety of choices and prices that ensured the business received a fair return no matter what the patrons ordered. But the turnaround required taking an objective look at the business, and making some changes after isolating the sources of profits and losses. In order to ensure that your company’s bottom line is enhanced by profitable sales, and not hurt by marginal or non-profitable sales, you must know your organization’s focus. This is where the Pareto Principle can help.
Also known as the 80/20 Rule, the Pareto Principle succinctly states that for many events, 80 per cent of the effects come from 20 per cent of the causes. So, for example, 80 per cent of your company’s profitable sales come from 20 per cent of your business’s customers, products or services. Once you understand the principle, you can start to determine the areas of your business that:
- Are running perfectly well.
- Need to be nurtured and fixed.
- Need to exit if profitable adjustments can’t be made.
As a first step toward identifying profit opportunities, set up a sales and customer profit matrix. Using the 80/20 Rule, sort your products, services and customers into a four quadrant matrix after asking:
- Which 20 percent of your business’s products and services contribute the most and the least margin?
- Which 20 per cent of your customers are responsible for the most high-margin and low-margin sales?
|1. High Margin Sales High Volume Customers
|3. Low Margin Sales High Volume Customers
|2. High Margin Sales Low Volume Customers
|4. Low Margin Sales Low Volume Customers
The goal is to then develop a strategy that:
- Maximizes the activity in quadrant one.
- Identifies how low volume customers in quadrant two can move up to high volume customers.
- Determines how low-margin sales in quadrant three can produce higher margins.
- Creates higher margin sales and higher volume customers from the information in quadrant four.
To a certain degree, this is the easy part. The hard part comes if you are unable to lay out a strategy to move sales and customers up to quadrants two or three from quadrant four. At that point, you must decide whether to continue selling low margin products and services to low volume customers — who may have been with your company for years. But bear in mind that in the end, fewer sales could mean greater profitability.
| Hone Your Company’s Profit Mentality Part of the success of your business depends on whether it has profit-driven management and employees who know the road to greater financial performance. To assess the profit mentality at your company, answer the following:
If you and your management team answer “No” to any of these questions, the chances are your company’s profit mentality is not fully developed. Take steps to change all answers to “Yes.”
© Copyright 2016.