The Bottom Line

In his book Islands of Profit in a Sea of Red Ink, Jonathan Byrnes states that by any measure of a business (dimension), 40% of a company is unprofitable. We have also seen this in the 300+ clients that we have analyzed, many times even more skewed. In fact, for some companies, the most profitable customers (Top 20%) generate 300% of a company’s net profits, the middle 60% is basically break even and the bottom 20% loses 200% of net profits. And the numbers are more skewed the more detailed the analysis; transaction analysis would be more skewed than customer analysis.

In a 2010 survey by CFO Magazine and Duke University, ‘maintaining margins’ and ‘the ability to forecast results’ were the Top 2 issues facing CFOs. In the 2010 Gartner FEI Study, the ability to measure customer and product profitability was the top concern for C-level executives. And yet, virtually every time I meet executives to discuss our ability to deliver customer, product, and every other dimension profitability, the most common response I get is “we’re already doing that”.

Our regular readers have probably noticed the not-so-subtle transformation of our blog.  I'm pretty excited about it because we're hoping to expand the discussion a bit and add additional perspective.  As always, the goal will remain the same: provide you with meaningful ways to improve your company or organizational profitability in language that's easy to understand.  Many ideas are simple, but that's what makes them so effective.  We'll continue to reference emerging and established best practices that we think are worth your time exploring.

A colleague and I were having a conversation the other day about the remarkable success many of our clients have achieved with their profitability analytics.   While not all of them have achieved the same degree of success, many success stories are significant enough to make you wonder why more companies don’t improve their capabilities to achieve similar results.   My colleague and I wondered about the key difference makers and whether they were the strategies employed by their leaders, certain capabilities that they needed to have or a combination of the two.  In the end we decided that it had to be a combination of the two, but that senior leadership had to recognize the impact their profitability analytical capabilities had on their strategy to be able to exploit them to their advantage. We both recognized that many executives today face a dizzying array of choices that all promise dramatic results and that it’s very difficult to identify the key difference makers.  So I asked my colleague what one question an executive should ask about their capabilities that captures the essence of these difference makers. 

I recently attended a Harvard Business Review webcast featuring Reuben Slone and Paul Dittmann, authors of The New Supply Chain Agenda.  Their presentation was interesting for several reasons.  First, they measured success using economic profit, which they referred to as the generic version of Stern Stewart & Co’s  Economic Value Add (EVA).  Economic profit is the difference between the net profit after tax and the opportunity cost of invested capital, which calculated using weighted average cost of capital (WACC) and the amount of capital employed.  Second, they the focused on the opportunity to collaborate, both internally and externally, to drive improvement which was measured in terms of economic profit.  Finally, they stated that a critical success factor was adapting systems thinking to supply chain.  Reuben’s success at OfficeMax is not unlike the success experienced by many of our clients.  Let’s take a closer look at some of the key capabilities required to achieve this type of success on a sustainable basis.

I picked up a tweet by a friend who was attending an event featuring Robert Kaplan sponsored by one of our partners in Dublin that said “No such thing as a fixed cost…Kaplan”.  Before the hair starts bristling on the back of your neck, allow me to explain the context.  These remarks were made in the context of a larger discussion about how to structure a company so it’s recession-proof.   One of the challenges that many companies face today is a highly dynamic business climate into which they have very little visibility.  This makes it very difficult to predict what they can expect quarter to quarter and almost impossible to anticipate 6, 12 or even 18 months down the road. In the context of this volatility, many companies are struggling to get a handle on their costs, particularly those that they can control as business volumes fluctuate.

Over the last 30 years or so, all sorts of management strategies, methodologies and practices have evolved and some are actually quite effective.  It can be a bit intimidating to the uninitiated and this creates a problem that I think (with my process guy hat on) needs to be addressed.  This might surprise you coming from a technology guy, but I really do believe the simplest ideas often turn out to be the best ideas.   Consider Apple’s iPod.  Do you know anyone who doesn’t own one?  As an early adopter of many things technical, I really appreciate its simplicity because I owned another early MP3 player.   The other aspect that is also not lost on me is the interoperability with the rest of my life that makes it an indispensible device for me.  I’ve managed to consolidate my extensive collection of CDs into a device the size of my mobile phone, I’ve got headphones for my trips, a built-in adaptor for my car/boat and my iTunes library is accessible in my home theater setup where it scrolls through my rather large photo album in high definition on the big screen.  Not bad for such a small device.   I feel the same way about agile development practices (Agile), lean management practices (Lean), SCOR and Time-Driven Activity-Based Costing (TDABC). 

Imagery is a powerful thing and I’m counting on it to work for me here.  You’ve probably seen (or at least heard) about the movie Titanic.  It had a star studded cast and a mega-million dollar budget.  At the time it was being made, it was projected to be one of the most expensive movies ever produced.  The movie has lots of drama and this makes it easy to forget about the real story line of a ship called Titanic.  A variety of factors contributed to the sinking of the Titanic, including failure to recognize that weather conditions made it difficult to identify icebergs, an insufficient number of lifeboats, inappropriate use of construction materials and the reluctance of many passengers to actually board the lifeboats.  In many ways, these factors are similar to the factors that many businesses faced during the current economic downturn.

It’s actually quite simple and it’s much closer to the original concept behind Activity-Based Costing as envisioned by Robert Kaplan.  The main idea behind ABC was to provide management with a decision support capability that was more relevant to the way the business actually worked than previous management accounting systems (which originated back in the 1920s).  By focusing on the processes (or activities) that took place in relation to your customers and products, you could begin to make more intelligent decisions about their value to your organization.   This translated into a number of approaches that were ultimately very similar in that they ended up defining a method of allocating costs in a rather static (top-down) manner.  As systems evolved, the ability to more dynamically allocate costs was added using a concept of driver-based allocations.  This captured some of the variability, but many of the systems still relied upon an initial top-down allocations for much of the overhead costs.

I was speaking with one of my colleagues the other day and he referenced an analogy about the difference between using a crayon vs. a mechanical pencil.  What I liked about the analogy was the powerful visual I started thinking about.  When you think about crayons, your mind probably wanders back to grade school and your box of Crayola crayons that were in every child’s desk in grade school.  Crayons were used primarily for drawing and served as an easy-to-use tool for learning how to draw. However, most would attribute any drawing done with crayon to a child and immediately lower their expectations.