The Profit Gene by Liz Lynch

Are You Asking the Right Questions?

Many companies struggling with developing a cohesive strategy often lack the ability to get answers to very basic questions.  They are short staffed in the analytical areas that can help them uncover what is missing in their business models.

Some companies I’ve worked with are afraid to ask certain questions because of where the answer may lead.  For example, asking “Where can we cut costs?” may lead to funding cuts on someone’s pet project.  That gets uncomfortable.  So the question doesn’t get asked and the company doesn’t reach the next level.  When this happens I guarantee that someday someone will ask, “Why didn’t we do something sooner?”

Constant questioning is key to making giant leaps.  An article in Time magazine on Google, for example, highlights that the company is run “by questions, not by answers.” Questions like, “What do we do with our cash? How can we better monetize our products? What are the next big breakthroughs?” stimulate conversation. 

Google says if you’re not talking, you’re not innovating.  Judging by their success in by passing more established companies, perhaps their model of constant questioning should be something you should do without question.

Attracting New Customers With New Pricing Models

It’s been a while since I’ve loved enough songs on an album to buy the whole CD, so consequently, my music collection has been stuck in the 80s and 90s. But selecting songs a la carte at iTunes’ has me buying music again. I’ve probably spent more money on music this year than I have in the last five years combined.

A different pricing model can attract customers who have left or never consumed in the first place.  It could also steal unsatisfied customers away competitors.  Take this example from Inc. Magazine “Goodbye, Retainers: Pay as You Go with Results-Based PR.”

Traditional pricing models for public relations services involve a monthly retainer where PR firms get a monthly fee to pitch on your behalf to media outlets, regardless of whether those pitches result in successful placements.  You’re paying for the hours they work rather than the results they get. In other words, your interests aren’t aligned.

The article describes a new model of pay-for-placement arrangements where “companies pay only when their PR rep lands them mentions in the press.”  This can be an appealing model not just for public relations, but for any service firm, to win new business provided that you keep some key things in mind:

You have to price the pay-for-performance fee so that it compares favorably to a retainer in the eyes of the client. For example, if you hit a home run, you should be entitled to just as much or more than what the client would have paid you under a retainer arrangement. But for anything short of that, the client will expect to pay less than the retainer.

You have to understand your delivery costs and processes well enough to be sure that you can still make money. Pay-for-performance is best for work that you’ve done many times before so you know exactly what it will take to do the work you’re required to do.

You have to be pickier in selecting your clients.  You need to work with the strongest clients so you’ll have the high probability for success. If you aren’t confident you can deliver, you’ll be tying up resources for no payout.

While pay-for-performance isn’t right for every company to offer or to buy for that matter, it’s certainly worth evaluating.

Uncovering Opportunities to Improve the Bottom Line

Unleashing your company’s profit potential requires your ongoing ability to analyze financial performance and identify high impact opportunities to raise revenues, lower costs and improve your mix of products and customers.  Managed well, you’ll have the financial flexibility to pursue higher goals and increase your company’s value.  Ignore it for too long, however, and you’ll stifle growth.

The following lessons, excerpted from my Profit Lessons Mini-Course, can help increase your odds for success:

Focus on profits sooner rather than later.  Profits aren’t a luxury in business; they’re a necessity.  To fuel future growth, you must take the right actions today to ensure that capital and other resources will be available.  If you wait until you have more time, money, or people to make profitability a priority, you’ll never get there. 

Identify the most effective combination of profit improvement options.  Chapter 1 of Accelerating Profitability describes 11 different ways to increase margins.  Choosing which are right for you and the order in which to implement them will be a function of your timeframe and resources. 

Spread the responsibility for improving profits.  Sustained profitability is a team effort.  Leverage the experience, creativity and perspective of all employees and take the full burden off your shoulders.  How can you make profit improvement a part of everyone’s job?

Want to learn more?  Check out the Profit Lessons Mini-Course.

Checking Your Vitals

It’s earnings reporting season again and, WestJet, Canada’s leading low-fare airline, recently announced a return to first-quarter profitability, going from a net loss of $9.6MM in Q1 2005, to a profit of $12.9MM in Q1 2006. 

I always enjoy reading these reports not necessarily to learn about the actual results themselves, but to learn how companies measure their progress. What are they looking at?  Are they focusing on macro factors like revenue, cash flow, and net income, or are they digging into detailed metrics to try to understand more?

When monitoring a patient, a doctor doesn’t just check to see that he is breathing, but also keeps tabs on other vital signs such as heart rate and blood pressure, and orders appropriate xrays and tests to find out other key stats in order to make decisions on a course of action.

The WestJet earnings release was filled with great stats that explained what happened in their business. I did some consulting work for several major airlines a while back, so the terms were familiar to me – ASMs (available seat miles), RPMs (revenue passenger miles), load factor, yield, etc.

When a business has such a good handle on their key business metrics, it’s much easier to monitor the business on a constant basis.  More importantly, it helps management understand how to influence those metrics. Clive Beddoe, WestJet’s CEO commented: “Our record load factors are a reflection of the significant investment we have put into our marketing efforts in recent months.”

What are the key metrics for your business?  How do you know you’re on track? If you’re focused just on the basic financial statement line items, you really don’t have the full picture of your company’s health, and more importantly, you’ll have no idea what decisions to make to improve that picture.

Be Okay With Walking Away

A client of mine recently lost a sale to a prospect who told him that while his work was the most impressive of all the companies bidding for the business, her point system for judging eliminated him because of the weight placed on costs.

Instead of being upset, however, my client was happy to lose the business.  “We offer more value for the kind of work we do than the cheaper vendors who win on price alone,” he told me.  “And we wouldn’t have made any money at the price level they needed us to be.”

Unless your business model allows you to compete effectively as a low cost provider – meaning that your cost structure actually is very low – you should never feel pressured to compete on price.  When you offer a highly customized product like my client does, you need to compete on value and stand behind it.  In other words, be okay with walking away.

This particular prospect saw the value my client offered but wasn’t willing to pay for it.  And my client wasn’t willing to offer the same value he provides to other clients, but at a lower price.  Why should he?  All that would do is erode his margins.  When you have finite capacity, as most businesses do, whether it’s people, time or equipment, you want to be sure that capacity is being used to service your highest margin accounts. 

Don’t dwell on unprofitable business that you lost.  Move quickly to finding that next great client who values quality as much as you do.

Let’s Get Fiscal

Though strains of the Olivia Newton-John hit from the early 80s may come to mind, I’m actually talking about getting your bottom line in shape, not your bottom. 

Last week, analysts lauded semi-conductor testing and packaging company Amkor Technology’s fourth-quarter margin improvements which stem from a commitment to fiscal discipline that is bringing operating expenses down.  They’re also saying no to low-margin business.  Wall Street rewarded the company with a 19% increase in share price right after the earnings announcement.  As of this blog posting, the stock was still on the way up.

SmartMoney magazine reported that “the company lacked discipline in the past but it has demonstrated over the past two quarters that it is serious about improving profitability going forward.” 

Managing costs and improving margins is not difficult IF you make it a part of everyone’s job, not just the CFO’s.  Companies tend to start watching the outflow only when the inflow isn’t so good, but just as you’d never be able to improve your fitness without deliberate effort and possibly help from others, planning for profitability will give you a much greater chance for success than simply hoping for it.

Check Your Fit Before You Sell

Ever buy a jacket that just didn’t fit right?  Maybe it was too tight in certain places, too loose in others, too long or too short.  It probably bothered you all day and made you self-conscious, and when you got home, you couldn’t wait to take it off.

Trying to service customers that don’t fit you well can be just as nagging and uncomfortable.  This month’s issue of Fast Company features the story of Snapper CEO Jim Wier, who pulled his business from Wal-Mart because it just didn’t fit:

Read more: The Man Who Said No to Wal-Mart

Your vision for what you want your company to be and how you want your customers to feel have to be consistent with where you are selling, how you are selling and what you are selling.  In general, your best customers will:

• Fit with your values:  Do you stand for excellence and quality, or speed and convenience?  You can’t be a white table cloth restaurant at a truck stop. 
• Fit with your market positioning:  Are you a Beetle or a BMW?  Both cars will get you from point A to point B, but the person who chooses the BMW to get them there is fundamentally different from the one who picks the Beetle.  Take a look at the messaging and imagery on their websites to see the difference. 
• Fit with your strategy:  Are you making a play based on differentiation or volume?   If the former, are you differentiated on dimensions that customers care about?  If it’s the latter, can you be in enough places for lots of customers to find you? 

If you target customers who don’t fit, no amount of clever marketing, coercion, or discounting will make that sale a good one for either of you.  On the other hand, with a good fit, gimmicks and price will matter a lot less.

In the Race for Profits, Does Size Matter?

Sometimes.  A look at IT companies in India showed that operating profits were clearly correlated  to size as measured by revenues.  Larger companies had higher margins and were more profitable on an absolute basis than mid-sized firms.  Why?  They enjoyed significantly higher pricing power, lower cost of sales (due to their scale) and similar employee costs. 

Does this spell doom for smaller companies?  Not if you change your game and run a different race.   First, focus – on an industry, a specific competency or expertise.  If you’re known as one of the few rather than one of the many, you’ll command higher prices for the services you offer.

Second, stop obsessing over top-line growth.  As I say time and again, it’s not what you make that matters, it’s what you keep.  Profits matter more than revenues.  Say it with me:  “Profits matter more than revenues.”

Turn away business that doesn’t meet a minimum gross margin hurdle.  If you can’t adjust your pricing or your costs to meet that hurdle, walk away.  Don’t tie up resources, including your own valuable management time, on clients that can’t or won’t pay what you deserve.

Read more: 

Breaking Out of the Middle

Stop Fumbling in the Dark With Your Pricing

Pricing matters.  A lot.  In the '90s, McKinsey & Co. published a study in the Harvard Business Review on the drivers of profitability.  They studied 2,600 companies in different industries with different economics and found some interesting things:  On average, a 1% improvement in volume increased operating profits by 3.3%.  While a 1% improvement in price, increased operating profits by 11.1%. 

What this is saying is that improvements in price typically have 3-4 times the effect on profitability as proportionate increases in volume.  Why might this be? 

When you sell more of something you have more revenue, but you also have more cost.  You have to make that additional widget and there’s a cost in materials and labor.  Or if you’re in a service business, you have the cost of the person doing the job, either yourself or one of your employees.  Not every extra dollar you bring in will fall to the bottom line.

When you bring in additional revenues through higher prices, all of that usually does fall to the bottom line.  Some companies in the McKinsey study were able to increase profits by 35% with just a modest 3% increase in price.  But it’s knowing how to increase the price that’s important.

Now, the reverse also holds true.  A 1% decrease in price, would destroy 11.1% of a company’s operating profits.  So, with such extreme profit leverage, pricing is something a company can always improve, and should strive to improve.

Measuring Customer Profitability

Getting business at any cost will cost you.

Robert Kaplan, Harvard Business School professor and author of The Balanced Scorecard explains why “some companies lose sight of the ultimate objective: to make a profit from selling products and services. In their zeal to delight customers, these companies actually lose money with them. They become customer-obsessed rather than customer-focused. When the customer says 'jump,' they ask 'how high?' They offer additional product features and services to their customers, but fail to receive prices that cover the costs for these additional features and services."

Read more:

A BALANCED SCORECARD APPROACH TO MEASURE CUSTOMER PROFITABILITY