Profit As Altruism
George Gilder has written extensively about entrepreneurism. Recently I read a piece by George where he called ‘profit an index of altruism’.
Often profit unfortunately in our society is automatically associated with greed. There is no doubt that there has been (unfortunately) cases of excessive profits and greed that has been espoused by some sectors of the business community.
This should not mean that profit gets a bad name as a result. It would be crazy to replace a flawed system with a failed system. The profit motive may be a flawed system but everything else are failed systems.
Profit is what is necessary to feed the spirit of entrepreneurism the world over. It is only through small-medium businesses that are willing to a risk and to explore the mysteries of business that society as a whole is better off.
It is only through the profit motive that inspires entrepreneurs to have a go that employment increases, general welfare of our society increases and we as consumers are served with better products and services for our enjoyment.
Altruism is considered to be inspired by something other than profit. But as George Gilder states profit is an index of altruism. Through profit society is better off.
Profit is good – don’t demonize it. Profit motivates positive society change benefiting all. We must be careful of regulation that would in any way stifle the entrepreneurial spirit that will lead to a better world for all.
Stop Chasing Profits
In business we are always told to focus on the bottom line. For instance – ‘the bottom line is all that matters’ etc
I believe that this focus is wrong.
The persistent focus on the bottom line can lead to poor decisions being made. Activity for the sake of activity could be happening, inefficiencies could be allowed to continue, unprofitable services/products/or customers could still be provided, but the bottom line still be healthy. Focusing on profit does not tell us the story about what is happening to cashflow, customers, or employees.
It is not uncommon to hear “We have been profitable, but I don’t know where the cash is.” All of these comments and issues are symptoms on the focus being purely on the profit. Obviously we can’t ignore profit, but we need to stop being primarily focused on the bottom line.
At the end of the day the profit and loss statement is a history statement, it is a statement of decisions made by the business and by its customers in the past. There is a story to be told, the numbers do talk. But it is a story of what has gone on in the past.
Also connected to this is what period and how soon after the end of the period are we looking at, when we are looking at profit? That is if the profit and loss statement is for the year ended 31 Dec and we are looking at in February then it is late and the somewhat irrelevant.
The profit and loss statement is only of use if we are looking at it very soon after the end of the period. It will soon become ancient data and decisions made on the basis of the profit could well be wrong based on where the customer has moved to.
We need to be collecting information that informs us as to where the future of the business is going. This is through the use of ‘lead indicators’ or ‘metrics’, indicators that illustrate the value being built or that is driving the current performance of the business.
Chasing profits can lead to poor decisions. Stop chasing profits.
How are you keeping the score?
In Brisbane we have enjoyed the Brisbane International Tennis Tournament. It is part of the world tennis circuit and is one of the lead up tournaments to the Australian Open held in Melbourne this week.
We went to the tennis arena to watch some of the matches which was most enjoyable. The thing that is quite obvious though (in watching any sporting match, but lets just for the minute focus on the tennis) is the use of a scoreboard. The tennis scoring system dates back to when the date when the game was founded and has some little quirks, but anybody new to the game after a short explanation will understand how each game is scored; from 15, to 30, to 40, potentially ‘deuce’, to ‘game’. Then the first to 6 games (subject to tiebreak situation) wins a set. The matches are best of 3 or 5 sets. (Obviously there are many nuances in the scoring of tennis which I wont go into.
My point is that the scoreboard clearly shows the progress of the match. It is very clear to all, the players, the spectators what the score is and what has happened.
Is this the case in your business?
Do you have a scorecard that is simple to understand? A scoreboard that after a short explanation everybody can understand? Can everybody understand how the business makes money?
There would not be many variables that the scoreboard would measure. It must be easily understood and relevant. There may be separate scoreboards for separate divisions or areas of the business.
FedEx use a system whereby they have what they call a ‘Hierarchy of Horrors’. These are all the things that could go wrong in dealing with their customers. All parcels are tracked to determine how their service ranked against this hierarchy of horrors and an index which they call a ‘Service Quality Index’ is kept. Every morning this service quality index is emailed out to every office. Everybody knows from this index how FedEx is going.
Yes, they have quite a sophisticated IT solution and for any small business, they could not hope to emulate the same sort of scoreboard, but the point is that they have considered what actually matters to the customer and developed a scoreboard around that. It is something that everybody in the business has input into and I believe that a system of a scoreboard that everybody understands is important to manage the business.
There are other things to lead the business, but from the management view point, we need to (like the tennis) have a scoreboard that is simple and relevant for all.
Picture – Richard Fisher
Margin and Markup – Does your team know the difference?
There is a lot of focus in business on net profit, ebit, roi, or other similar measures. However before all that a business needs margin. It is imperative that all in the team understand margin and what affects margin.
Margin is the sale price of the good or service less the costs incurred directly in making/purchasing the goods or services available for sale(also known as variable costs). Margin is also known as gross profit. This gross profit is what covers overheads, fixed costs and hopefully there is net profit.
Each type of business will have different norms for what variable costs and gross margin are. For example in a retail business it could be as follows:-
Sales 100
Variable Costs 70
Gross Profit 30
Overheads / Fixed Costs 25
Net Profit 5
In a retail business the majority of the variable costs are usually tied up in stock / inventory. Other sectors would have different standards.
From this we need to explore margin and markup which are often confused. Markup is the sum applied to the cost of goods sold to determine the sales price. Margin is the sales less cost of goods sold. In percentage terms margin can only be between 1 to 100% whereas markup range from 1 to over 5000% percent. At 50% margin the markup is 100% but after this as margin increase the markup increase exponentially.
One of the biggest item that impacts on margin is discounting. This seems to be the first tool to increase volume of sales. But before any discounting is entered we must consider the impact of the discount on the margin and calculate exactly much extra sales the business will need to recover the discount. Volume sales is not the only way to make profit. Smaller volume sold at a better margin can lead to more profit.
Another issue is adjusting prices to reflect the change in the cost of goods. When you import goods the currency changes can significantly affect the margin. So if the costs have increased and the margin is declined by 10% points, how much does the prices need to increase? No the answer is not 10%. If you put the prices up 10% then you would only increase margin by 9% points not 10. Now if you were turning over $30 million per annum then this could cost the business $300,000 in profit.
In setting the price of goods ensure that you know whether the software you are using is using markup or margin. If you put 30% into the program and it is set as markup when you wanted 30% margin then you have just lost 6.9% of your profit. If the desired margin was 80% and instead the goods were priced at 80% markup this would mean you have lost 22.8% profit.
Now none of this is necessarily sophisticated analysis but does your team understand these issues. What happens if the sales person in negotiating with a buyer applies 40% markup instead of 40% margin which the business wants. The buyer would have got a bargain. This message is applicable to a small business as it is a large business. GM in the States went under because it could not sell enough cars at high enough margin.
Photo courtesy of agentakit
The Three most important things to measure in any business.
“The three most important things to measure in any business are customer satisfaction, employee satisfaction and cash-flow” Jack Welch former ceo of GE.
I don’t agree with all that Jack says or did in his tenure at GE however on this point I am in total agreement.
Customers who are not happy will buy elsewhere. Employees who don’t enjoy working for your business will move on and work for your competitors and the replacement employee will be costly to replace. Lastly if a business does not completely understand its cashflow and is totally in control of it then the business growth can suffer.
Measuring customer satisfaction is more than just a quick survey from a call centre. We need to understand whether the customer is truly satifised with the complete experience in dealing with the business. We need to ask the right questions in the right manner. Customer surveys can work if carefully desgined. However there may be other ways to measure customer satisfaction eg in a professional service firm it would be appropriate to measure the number of referrals. A customer will only refer if they are happy. Singapore Airlines measure the number of complaints to the number of compliments ratio to address this issue. Whatever the measure everybody needs to understand it and then it must be tracked consistently.
Employee satisfaction can also be measured by a carefully executed survey. Unfortunately many of these surveys are not properly designed or carefully executed. Also there are other measurements that can be useful eg staff turnover rate (this needs to be tailored for each level of the organisation). Again whatever the final tool, everybody must understand the metric and then it must be consistently measured and reviewed.
Lastly a business must understand the cash-flow cycle. There are a number of operational and capital impacts on cashflow. To manage a business it is necessary that this is understood. Accounts receivable, accounts payable, new equipment, new loans, repaying loans and other finance obligations, owners drawings and contributions are only part of the equation. The complete cashflow of the business must be managed at a minimum each week if not daily.
Also some of the component parts need constant measurement eg debtors and creditors days. Recently in a business they had not previously being measuring debtors days. When I started it was 43 days. Purely because they started measuring it and the accounts staff and the owner were suddenly aware they took action and now the debtors days stand at 29. This has lead to a significant improvement in cash-flow.
What systems to you have to measure customer satisfaction, employee satisfaction and cash-flow?
Rules of Thumb – Are they good or bad?
Often in business there are industry rules of thumbs for profits, costs and valuation. There are many examples of these however to illustrate professional service firms often use the one third rule which is 33% wages, 33% operating expenses and 33% profit. Commercial cleaning business try to only have wages as 55% of income. There are plenty of examples but are these useful.
My belief is that these rules of thumbs can be useful if they are used as a guide only. If we rely on them to make significant decisions they we can be led astray. The rules of thumbs can trap you into certain assumptions about the industry. These assumptions may become self limiting. To take the business to the next level it is important to think about business lessons from outside the industry that could significantly accelerate the business.
Before Fedex came into the delivery business it was considered normal to have a delivery rate of 95%. Fedex changed this. They were not happy with the industry norm. Now the delivery rate of Fedex and also the other companies is 99.95%. This does not sound a lot until you realise the number of parcels that are freighted each year. This difference has meant that millions more parcels are getting to where it is meant to.
In Australia financial planning firms have an industry rule of valuation of about 3 times recurring revenue. Financial planning firms are still being sold for these figures. This is despite the fact that there is significant regulatory changes coming to the industry which may significantly affect the recurring revenue. Also this is despite that this method of valuation gives no regard to what the business is actually earning. So the rule of thumb could be a starting guide but then we need to consider the hard facts.
The next area of rules of thumbs is those that a business creates over time for internally use. I have seen businesses where they have determined rules of thumbs for when they are pricing a quote. Again these rules are useful but we need to be constantly reviewing these rules against the hard facts. So for example when the quote is accepted we need then to examine the resulting job profitability and determine whether that pricing rules are still relevant.
So I see rules of thumbs like fire. In its place fire can be extremely useful but if it gets out of control it can destroy all. Use rules of thumbs as a guide but always check the hard facts on a regular basis.
Do you know exactly the cost of your product or service?
Recently I have seen businesses where the management have not have an exact handle of how much their service / product is costing to create and then deliver to the customer. They were only able to give me an estimate of what they thought the cost was.
This has set me thinking. I just took it as a given that business would know and then keep monitoring what it costs to deliver the product or service. So why do I see it important?
Only by knowing these numbers will the business be able to react to the market. For instance if for one of your product or service lines there becomes some significant market competition then how do you react?
Knowing the cost regularly allows management to look at whether there are any efficiency issues that could be addressed. One business had measured the cost over two years prior but had no idea whether there had been any change (positive or negative) in the business since.
Knowing the cost will also enable the management to determine whether you should alter the product or service mix. Some of the products or services may be cut out or only sold on a certain basis. Also closely aligned to this there may be issues if the order size is above or below a certain level. Another related issue is the costing could be affected by when,where how the product or service is delivered.
These are some of the reasons why which could be summarised by saying that to make better decisions you need better information.
Do not get trapped by the fact that the monthly management accounts show the business is profitable. One the businesses I mention above is just experiencing the situation where another competitor with a good quality product is 40% cheaper than they are. Now the pressure is on to determine how to react. The management accounts showed healthy profit which has lead to complancey. We need to drill down further to get the exact detail on the cost of your product or service.
If you would like more details on determining the exact cost of your product or service please contact me – steve (at) majorfocusgroup.com
Engaging the employees – a key to success.
Staff Engagement
I was reading a recent article on Business Week website about employee engagement. I recommend the complete article to you.
The article quotes some research undertaken by Gallup which determined that less than 30% of the workforce is truly engaged
To quote from the article – “That’s less than 30% of employees who work with passion and feel a profound connection to their companies. Yet employee engagement leads to increased customer engagement, which leads to real revenues…”
The article goes on to give an of a store in the electronics retail chain Best Buy. The store management measured employee engagement and realised the store was not going well. This affected morale, employee turnover and profits. Using this information they instituted a number of changes which had the results of increased employee engagement, substantially lowered employee turnover and increased profits. Taking this it was translated across the chain. It was determined that for every one-tenth-of-a-point increase in employee engagement, each Best Buy store increased profits by $100,000 a year.
This highlights the fact that there is a huge profit motive to ensure management engages with the team.
As I have previously written on this blog we must tell the team exactly what is expected of them and then let them go to achieve this. We can get what we want if they know what we want. Employee engagement is one of the keys of business success. Ignore it at your business peril.
Best Motivation Video
Recently I saw this video and was reminded again to ” Follow your dreams”
If you have not failed you have not tried.
Fear of the cashflow hampers business.
Business owners particularly in these uncertain times get very concerned about the cashflow that I believe affects their decision making. We need to be on top of cashflow, it needs to be properly managed but by focusing on this alone we affect the long term performance of the business.
This short term focus makes us assume all clients are good if they have a cheque book. But we can’t be all things to all people and if we take on unprofitable clients or try to provide services to people that whilst profitable but not to the level of our main services then all we have done s added to the management drama of the business.
This short term focus can make us not devote the time and resources necessary to improve systems, services etc. But it is only by investing in these areas will we have a more enjoyable and more profitable business.
This short term focus can lead to poor customer service. By trying to do everything, serve as many as possible and manage the team the result will be a decrease in the priority given to making the customer service fantastic.
So remember the focus on the systems, client selection and client service are not urgent but they are extremely important to the long term development of an enjoyable business. Stop chasing the profits and todays cashflow, focus on the customer and deliver a great experience.
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