Written by Eric van der Meulen
Do you know where most of your money is actually made? The answer may surprise you. Making money has to do with profitability and cash generation, so your activities – and at a higher level your strategy – should be geared towards maximizing these gains and minimizing cost.
Get the numbers right
While it’s great to enjoy customer demand for your products, does the segment with the highest sales numbers also yield the highest returns? Gross margin numbers – sales less cost of sales – per product or product line may be readily available, but does this tell the whole story? It is easy to understand that it costs more to set up and run short batches on a special piece of equipment for a single customer that needs a lot of hand-holding, than to let an efficient process run for days or weeks, cranking out product for a substantial customer base which does not require much attention. There are pros and cons to various ways of overhead allocation, like volume based, volume adjusted, and activity based. How do you prevent high volume products from subsidizing special orders? The bottom line is that you need accurate numbers to make strategic decisions, and the accounting methods are available.
Listen to the market
To answer the profit question, some analysis is required, with primary focus on the market. Since the market is always right, segmenting your business by competitive segments is the shortest way to a strategy you can actionize. A competitive segment is a part of the business with a unique competitor or unique competitive dynamics. Ask yourself the following questions to arrive at those segments: “Does this part of my business face a different competitor compared to the rest of it?” and “Do I have the same ratio of sales or market share as my competitor in this area?” Generally profitability will be determined by competitive dynamics, and the goal is to maximize profits.
Capitalize on the winners
Once the segments have been identified, the analysis can be done by listing percentage of sales and percentage of profits for each segment in descending order of return on sales or profitability (profit divided by sales). By now you may have recognized a dramatically skewed distribution, with a minority of your segments bringing in the majority of the profits. In order to complete the diagnosis for each segment, analyze market attractiveness and how well you are positioned in each segment.
The result of this analysis is a good starting point for a strategy session. Now that you know where profits are made, how do you maximize the opportunities for more?
Back “in the day”, the early days of Domino’s Pizza, late ’60′s, they (we) made the decision to “follow the profit” and bypass the difficult to manage campus stores to open the very profitable, and much easier to manage, neighborhood stores. From all angles, this seemed the right decision. The campws shops would make a lot of money when school was in and then lose much of it back in the summer and other times school was out. Scheduling help and maintaining cars was a nightmare. Virtually everyone that had tried to manage one of those campus Goliath-ons agreed, “neighborhood shops is the way to go”. Consistant business week to week, easy scheduling, easy to track inventory and labor costs.
Disaster ensued. Anyone want hazard a guess what went wrong?
Need grammar ck as well as spell ck. “Neighborhood shops ARE the way to go”.