By Jean-François Fontaine, B. Eng. M..Sc.A. Profit Maker & Speaker at Vision Profit (www.visionprofit.ca)
Over my 30+ years of experiences, I’ve seen profit expectations not met as per leaders were anticipated. In fact, results were going both ways, where expectations were above or under real results. Do you ever wonder how our management process not being able to better predict results while we know in every detail from the bank account, the cost of everything?
People from finance would say “it is because of the mix-products”. But nevertheless, how an accurate profit cannot be forecasted, if we have all the required data; nothing should be matter of guesses.
May be the financial statement process is not so appropriate to predict the future but rather accurate to describe the past!
In facts, it relies more from the perspective we take to project the situation. What if we decide to look at our company as a “MONEY MAKING MACHINE”, rather than as a “GROSS MARGIN MACHINE” that generates profit?
That perspective could change the way we make decisions at managing our business. In fact it could make a huge difference between making and losing money.
The most important aspect to be considered are the revenue streams that feed the money making machine. Let’s define what it is?
A revenue stream is based on the internal path of the material (or service) that goes to the market and its end-user that acquire the products or services.
The Revenue Streams make the profits not the gross margin of the products!
Based on the market served and its users, there is a multitude of revenue streams that brings $ to the company.
For a same product that has the same cost, the selling price is deeply related to the market. As a matter of fact, the price will change depending on the market the products are sold. Thus, it is reasonable to acknowledge the negotiated price changes from one market to the other.
Now, let’s consider the costs that must be really assumed if we sell or not a product:
For sure the material cost is directly linked to the sales. If the sale takes place, the material is spent to “manufacture” the end-products.
Thus it is the same for all real direct cost such as representative’s commission, the freight charges, sub-contractors, or any other activities that must take place because the sales occurred.
A generally accepted hypothesis everywhere company I’ve worked for, is to make variable the production labor cost based on the sale activities.
Nothing is more wrong than that!
Back in 19th century where people were paid based on parts produced, the reasoning was accurate, but now the workforce is scarce and costly to replace. Thus we tend to keep it stable to minimize costs. Our product cost system does not reflect this situation.
Then, how could we be really sure we meet our profit goals?
Acknowledging that the labor cost not dependant of the sales means we might are wrong with our pricing policy!
With the above taken into account, it means the revenue streams generated contributions based on the selling dollars less the real variable cost.
The contributions are the foundation of the profit!
We need to manage our business to insure we generate as much as possible of these contributions from the revenue streams while minimising our efforts at “producing” it. It becomes a matter of targeting the selling of the revenue streams that have the potential of generating the highest contributions. Our analysis perspective goes from the product makes the profit to the acknowledgement that contributions are the driver of the business profits.
The pricing decision process must be based on contributions from the revenue streams rather than product profit
The management of companies must be updated to the 21st century where change paces are increasing. The ones who will make those changes first will seize the opportunity to a competitive advantage against the others that have not yet acknowledged the shift.
This profit prediction matter is a vast subject and could not be entirely discussed here and will be subject to other articles, but there is important thing to remember, it is the revenue streams that are the foundation of profit, not the product profit.
The revenue streams are based on internal capacities but also based on served markets. Acknowledging that the market dictates the selling price, every revenue stream does not contribute the same way to the profit. Sorting the revenue stream by potential will prioritize the sales efforts to maximize profits.