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Profit Pitfalls By Jonathan Byrnes, author of Islands of Profit in a Sea of Red Ink logic traps that lead to major profitabil- ity drains. Here are three big offenders: W • 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 overall? • Traffic 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 part- ly empty? Sounds sensible, however, 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, companies almost never do this. Instead, they keep the marginal busi- ness because it provides "volume." When new business moves them beyond capacity, they simply build more capacity. The logic always is that the marginal business provides a contribu- tion. Over time they wind up with a warehouse full of mixed business— 64 FEDA News & Views hen I talk to managers about profit generation, I'm often asked about profit pitfalls— some paying 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 the sales reps "off the hook" by allowing them to fill their quota with marginal business. The false logic of taking business that covers variable cost but doesn't pay for full cost removes the pressure on sales reps to do what they need to do: con- tinue to sell until they bring in lucrative business. Product line The second profit pitfall also seems to have an unassailable logic. Since cus- tomers want a supplier with a full prod- uct line, it seems obvious that a compa- ny has to have some losing products in order to make money on the product line overall. This seems completely logi- cal. But think about it carefully. If this logic is true, then the company is essen- tially making an investment. It is invest- ing in carrying money-losing products in order to generate incremental sales in other products that not only are prof- itable, but importantly, also cover the losses on the portion of the product line that is underwater. I can understand this thought process–but it only makes sense if the company calculates the return on this investment and shows that it is a good investment. How many companies do this? The counter argument is that it is impossible to do this calculation. However, with a profit map, showing the net profitability of every product in every account – and every account's buying pattern – you can quickly make this determination. (I explain how to build a profit map in my book, Islands of Profit in a Sea of Red Ink.) Here is a companion reason why product line logic is a profit 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 com- panies like Wal-Mart do very well by positioning themselves selectively in key product categories and competing on price. It goes without saying that the 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. There is a way to do this, however. If you keep your steadily-con- sumed, fast-moving products in the warehouse, and your other products in consolidated national or regional facili- ties, 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. Of course, your customers will have to agree to a slight delay. But here's the leverage point. You can keep enough local stock of slow-moving products for the customers who really are buying a full product line—if you have a profit map that enables you to identify them. For the customers that are cherry-pick- ing you, they either can wait a little, or pay an expediting fee, or broaden their purchases to move into your favored customer category. This is the power of profit mapping in action. Traffic drivers The third profit pitfall, traffic drivers, is very common. Here's the apparent logic. Your product strategy centers on attracting customers with a "loss leader, " a product or category that is priced lower in order to develop further high- margin sales. Think about consumer electronics. The new DVDs and CDs hit the shelves on a certain day, and con- sumer interest, plus attractive pricing, generates a lot of business. The retailer