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Imagine if you could make your organization more profitable — without the substantial pain that often accompanies significant cost-cutting. Odds are good that you can achieve that goal, according to Jonathan Byrnes, a senior lecturer at the MIT Center for Transportation & Logistics. In his recent book, Islands of Profit in a Sea of Red Ink: Why 40% of Your Business Is Unprofitable and How to Fix It (New York: Portfolio/Penguin Group, 2010), Byrnes argues that in a typical company, 30 to 40% of revenues are actually unprofitable, while another fraction of revenues — often more like 20 to 30% — accounts for most of the organization’s profitability. MIT Sloan Management Review senior editor Martha E. Mangelsdorf asked Byrnes to share some insights about how managers can pinpoint — and increase — their companies’ sources of profitability. Here are some of his tips:
First, create a profit map to identify how profitable — or unprofitable — specific product sales to specific customers are. “Traditional accounting categories are too broad to see which accounts and products are profitable, and which aren’t,” Byrnes explains. His recommended solution? Develop a “profit map” that estimates the profitability of every order line for each customer — using transactions over a representative period, such as three to four months. The key? Don’t get bogged down in trying to create something precisely accurate. Instead, Byrnes recommends striving for “70% accuracy” — a level good enough to discern trends accurately without requiring inordinate investments of time and money. Working at 70% accuracy, “two managers can build a profit map in a month or two using standard desktop tools,” he notes.
Next, identify, protect and grow the “islands of profitability” within your company. Armed with your profit map, you may be tempted to start by addressing the problem of unprofitable customers. But Byrnes maintains that your first priority should instead be to “secure and grow your sweet spot” — those highly profitable customers that are critical to your organization’s financial success. “Typically, the best customers are being overpriced and underserved,” he observes. “The key is to focus your resources on your islands of profitability and find ways to make these customers more profitable.”
Develop innovative services that help you create value for your most profitable customers. Working with your “sweet spot” customers to develop innovative services for them can help raise the customers’ profitability and your company’s sales, according to Byrnes. How can you identify opportunities for new services? “Allow your operations managers to ‘walk in the customer’s shoes’ by spending time within the customer’s organization,” he suggests. Then ask them to work with the customer to create a “channel map” that shows how products or work flow within and between the two organizations — and where costs build up. From that channel map, your operations managers and their counterparts in the customer’s organization will naturally develop ideas for innovative services. Once that happens, Byrnes advises, try out the innovations in an experiment on a small scale — “a limited, low-risk opportunity to learn by doing.”
Look for ways to make marginal customers more profitable — and unprofitable customers profitable. One option Byrnes suggests: Provide differing levels of customer service to different types of customers. “Companies that try to give all customers the same service give the best customers too little service and wind up with reasonable overall service that is much too expensive,” he observes. Instead, Byrnes recommends making different service promises (like order cycle time) for various categories of customer — but always keeping whatever promises you make. Similarly, it can make sense to have different supply chains for different types of products and customers, according to Byrnes.
Incentivize your sales force to reach profit — rather than sales — goals. “Most sales compensation is based on revenues, sometimes gross margin — and rarely profitability,” Byrnes notes. But once you have a more detailed grasp of profitability, you can change that. “Your profit map enables you to align sales compensation with profitability,” he explains.