iStock-magnifyTo many managers, a demand for profit improvement simply means cutting costs or raising prices across the business. Everyone is asked to take their share of the pain, almost regardless of the value they deliver. The changes tend to deliver short-term gain, not sustainable, longer-term improvements, and within a year many of the ‘cut’ costs have returned.

You don’t have to work that way. At one manufacturing client of mine, for instance, we grew profits by nearly 20% by focusing on improvements in the price, margin and service support of just a handful of customers. After undertaking some simple analysis, we realised that these customers were bringing down the overall profits of the business. What’s more, the changes and profit improvements have stuck without impacting on the rest of the business.

Here are the five steps we followed and which can help you to identify the areas of your business with the potential for rapid profit improvement:

  1. Break down your business into discrete business segments. Your business is not a single, homogenous entity, but is made up of several businesses. You need to shine a torch on all of your business activities, and, this way, you will get a handle of the performance – at a financial, organisational, competitive and market level – of your entire business, and will avoid success in one area concealing weaknesses elsewhere. As you do this work, you may be surprised how many business segments you really operate. At my manufacturing client we identified 14 different segments, much to the chief executive’s surprise!
  2. Identify sales for each segment over the past three years. This step enables you to understand the relative importance of each segment. A three-year view enables you to start to identify performance trends, rather than recent one-off events, but is a short enough period of time that allows most management teams to collect reasonably robust data.
  3. Identify the costs for each business segment for the past three years. You need divide the costs into three types: (1) Costs of Sale (these are the costs required to manufacture the product or deliver the service, including the costs of bought-in materials and production), (2) Sales, Marketing, Development and Distribution Costs, and (3) General and Administrative Costs. The purpose of collecting this information is to allocate the costs across your discrete business segments. Most businesses are able to allocate the cost of raw and bought-in materials, and even track costs of production by different product groups. It is less common to allocate sales, marketing and administrative costs directly across your business segments. As a result, the process will involve some estimates and high-level judgements. For example, my manufacturing client split the cost of its sales team by the estimated time devoted to the product ranges in each segment, while it allocated the costs of senior management according to each segment’s sales.
  4. Calculate the profitability of each segment. Simply subtract the costs of each business segment from its sales. You can then also determine the operating margin % by dividing each segment’s profit by its sales, enabling you to understand the variation in profitability from each segment.
  5. Identify specific profit improvement opportunities. The final stage is to review the data and identify the insights that will help you dramatically improve the performance of your business. At my manufacturing client, we found three segments with low profitability. The management team already understood the issues in two of the segments, but the third segment was a surprise. Subsequent analysis revealed that a handful of customers in this business segment were driving down the overall profitability and so management took the rapid action necessary to address the issue and deliver the £1 million profit improvements.

How well do you really understand the different business segments your organisation operates, where you’re making and losing money, and where you have you specific opportunities for rapid, sustainable profit growth?

© Stuart Cross 2015. All rights reserved.