How to Improve Your Profitability

I believe that better profitability is an overlooked tool for improving a business owner’s life. Higher profits allow people to send their kids to better schools, take better vacations, and save more for retirement. Profits also produce the cash needed to make better investments in the business and higher pay for the employees.

It’s nice to say that you are for more profits, but just how do you make that happen? I have found three major approaches to achieving higher profitability:

· Have a written business plan that is reviewed and updated regularly

· Invest in your pricing system

· Control your overhead costs through better processes

Writing a business plan forces you to do the critical thinking. Conflicting goals become more obvious. The reality that you don’t really understand your own strengths and weaknesses suddenly becomes clear. Addressing these problems in your planning is what makes it more likely that good decision making will result.

A typical business owner hates to have a prospect reject a quote and as a result we tend to leave a lot of money on the table. A good pricing system will allow you to constantly experiment with how you present the value of your service or product to get that higher sales dollar. Increasing your sales prices by just a few percentage points can often double your net profits.

It took me a lot of years to discover the key to controlling overhead costs. Controlling the processes that consume the overhead is the only thing that works. Rather than demanding that a company save money by buying fewer paperclips, change the processes so that fewer paperclips are required.

Why Doesn’t Management Implement Consulting Advice?

This has mystified me since my first consulting gig. The client pays for advice, doesn’t complain that the advice is bad, but never implements.

An interview with Chad Syverson, an economist with the Federal Reserve Bank of Richmond, provides an interesting answer to this in an interview in June of 2018.

EF: Regarding management prac­tices, it seems a little puzzling that lagging firms wouldn't have done more to replicate what more suc­cessful firms have done. You could imagine possible stories about why that may be the case, but it seems like an important question to answer.

Syverson: I agree, and there is some evidence we can look at from work done by Bloom and some colleagues. I'll call it the India experiments📷. They did a randomized controlled trial with textile producers in India. They provided management consulting practices to 28 plants — a small sam­ple but still useful — and asked the management of every plant why they hadn't previously instituted some of the management practices that the consultants recommended. Basically, there were three classes of explana­tions. First, there was, I didn't know about them. The second was, I knew about them, but they're just not going to work here. The third was, they might work here, but I didn't have the time to put them into place. And then they tracked the plants over time and asked those who still had not adopted those practices why they hadn't. Obviously, plants are unlikely to still give the first answer, but you still had a lot giving answer two or three.

Now, maybe there's something special or unusual about the setting of that experiment. But I do think the fact that management is often just mistaken is a nontriv­ial factor. There is evidence coming out of this body of work that suggests companies don't know where they are in the distribution — they don't know whether they are well-managed or not. You can't fix yourself until you know you have a problem.

Also, I think even if you know you have a problem, a lot of firms can't simply say, well, we see this competing company over there has an inventory management track­ing system that seems really useful, so we'll install it on our computers and our problems will be solved. That's not how it works. The firm that has adopted this practice has people trained in how to do it. It has changed its system, so that there's an interaction and a feedback loop between what the system is recording and recommending and what you do. If you just say, OK, we're going to start collecting these data now and then do nothing else, you're not going to get the productivity benefits that the company with the complements is getting. I just think this stuff is way more complex than people might initially think.

An example I talk about in class a lot is when many mainline carriers in the United States tried to copy Southwest and created little carriers offering low-cost service. For instance, United had Ted and Delta had Song. They failed because they copied a few superficial elements of Southwest's operations, but there was a lot of underlying stuff that Southwest did differently that they didn't replicate. I think that presents a more general lesson: You need a lot of pieces working together to get the benefits, and a lot of companies can't manage to do that. It also typically requires you to continue doing what you have been doing while you are changing your capital and people to do things differently. That's hard.

Read the whole interview at https://www.richmondfed.org/publications/research/econ_focus/2018/q2/interview?cc_view=mobile

When it comes to small businesses, the “I didn’t know about it” is not relevant. Business owner of course no about all consulting engagements since they are usually the only ones that can initiate them.

The number two explanation of “it won’t work here” probably has some relevance, but then why don’t we hear direct complaints about the advice being not workable? Some of it could be because they are complaining, but we are not listening. But this does not likely explain why so much of the consulting advice is not implemented.

Then there is the third explanation of “I don’t have the time to implement” which probably explains most of it. In the end, we all know of lots of things that we wish our businesses were doing better. It’s just hard to implement anything that is extensive and takes a long time to implement.

My takeaway is that if I want my consulting engagements to be more effective, I have to include an incremental approach to implementation.

Business Planning Words of Wisdom (principally from Peter Drucker)

1. Play to your strengths - this requires serious thought to understand what your strengths and weaknesses really are. Consider reviewing the SWOT analysis monthly and update it as you discover new things.

2. Be different from your competition. A company that looks like all the others can only compete on price.

3. Effectiveness is much more important than efficiency. Efficiency is all about minimizing the input vs. output. Effectiveness is all about producing the most valuable output.

4. All profit comes from risks taken. The Drucker outline of risks: From <http://www.druckerinstitute.com/2012/05/the-risk-one-cannot-afford/>

1. The risk one must accept, the risk that is built into the nature of the business

2. The risk one can afford to take

3. The risk one cannot afford to take

4. The risk one cannot afford not to take

5. Keep it simple. Business planning is a communication tool used to explain the goals and the reasoning behind them.

6. Sunk Costs don't count. This is one of the most powerful emotions that contaminates your thinking. The idea that because you have already invested X dollars in time and money into something, you must continue with that something. Planning should be about the future, not justifying the past. This is an incredibly hard thing to do.

7. Planning is worthless unless put into action. Do not wait for the perfect plan - implement and adjust.

8. Business planning is never done. You need to review it monthly and update it as you discover what works and doesn't work.