Issue link: https://www.e-digitaleditions.com/i/799779
36 FEDA News & Views W hen I talk to managers about profi t generation, I'm often asked about profi t pitfalls— logic traps that lead to major profi t- ability drains. Here are three big offend- ers: Contribution (Why shouldn't we take business that contributes to over- head, even if it doesn't cover full cost?); Product line (Why shouldn't we carry products that lose money if they are part of a product line that makes money over- all?); and Traffi c drivers (Why shouldn't we carry money-losing products if they attract customers who then buy very lucrative products so we make money overall?) Each of these questions seems to have a perfectly logical answer that leads to the suggestion that it is OK to carry money-losing business. Maybe the Sea of Red Ink is not so bad after all, but think about each question carefully. Contribution The question of contribution is one I hear in almost every talk and meeting. After all, the question goes, if our ware- houses and trucks are not full, isn't it better to take some business that helps cover the cost than to leave them partly empty? Sounds sensible but there are two big problems with this logic. First, if a company takes business that doesn't pay full freight, it also needs a strict "sunset" mechanism to throw out that business (or reprice it) when full-freight business becomes available. In fact, com- panies almost never do this. Instead, they keep the marginal business because it provides "volume." W profi t generation, I'm often W hen I talk to managers about When new business moves them beyond capacity, they simply build more capacity. The logic always is that the mar- ginal business provides a contribution. Over time, they wind up with a ware- house full of mixed business—some pay- ing its way, some not. This is the source of the Sea of Red Ink. The second problem is much more insidious. If there is full-freight business available that has not been sold, the company is implicitly letting sales reps "off the hook" by allowing them to fi ll their quota with marginal business. The false logic of taking business that cov- ers variable cost but doesn't pay for full cost removes the pressure on sales reps to do what they need to do: Continue to sell until they bring in lucrative business. The net effect: Islands of Profi t in a Sea of Red Ink. And no one knows where it came from. Product Line The second profi t pitfall also seems to have an unassailable logic. Since custom- ers want a supplier with a full product line, it seems obvious that a company has to have some losing products in order to make money on the product line overall. This seems completely logi- cal. But if this logic is true, then the com- pany is essentially making an investment. It is investing in carrying money-losing products in order to generate incremen- tal sales in other products that not only are profi table, but more importantly, also cover the losses on the portion of the product line that is underwater. IS IT EVER OK TO CARRY MONEY-LOSING BUSINESS? Not Without Calculating the Cost of These Three Profi t Pitfalls, says the author of Islands of Profi t in a Sea of Red Ink By Jonathan Byrnes I can understand this thought pro- cess—but it only makes sense if a com- pany calculates the return on this invest- ment and shows that it is a good invest- ment. How many companies do this? The counter argument is that it is impossible to do this calculation. Not true. With a profi t map, showing the net profi tability of every product in every account — and every account's buying pattern, you can quickly make this deter- mination. (I explain how to build a profi t map in my book Islands of Profi t in a Sea of Red Ink.) Here is a companion reason why prod- uct-line logic is a profi t pitfall. It assumes that you have to be a full-line supplier. In fact, a quick look around business over the past decade or two shows that many very successful companies like Wal-Mart do very well by positioning themselves selectively in key product categories, and competing on price. It goes without saying that rock-bottom low prices are generated by streamlining the supply chain and eliminating the extraneous products. Instead, too many companies simply assume that they have to provide rapid service for a full product line at prices that are competitive with narrow- line competitors. On the other hand, if you keep your steadily-consumed, fast- moving products in local distribution centers and your other products in con- solidated national or regional facilities, you can lower your cost to serve on the slower-moving products so you can carry a full line and make money on all or most of it.