By Jean-François Fontaine, B. Eng. M.Sc.A. Profit Maker & Speaker at Vision Profit (www.visionprofit.ca)
As a business leader you make decisions on a daily basis that could have tremendous impacts on your profit. But overall, it is not all the decisions you make that impact your profit. Some are irrelevant while others have huge impacts.
In fact, the profit of your organization is based on few decisions that give strong direction to the rest of the organization rather than related to optimizing main sectors such as Sales, Operations or Finances independently.
But there is a more fundamental aspect that also needs to be acknowledged; it is not the product you sell that makes the profit, but rather the sum of all the performed sales that generate the organization’s profit.
So we can no longer afford to manage all sectors, as if they could be optimized independently of one another when we all know that we operate with limited resources.
Your profits are related to 5 pillars that support the financial health of your organization. Taking control of these pillars rather than letting luck deciding otherwise will guaranty your financial successes. These pillars, what are they?
1- First, your COST PER DAY to operate your business defines how you add value to your products and services. It could be identified as the $ you need to spend on a daily basis to open your business, pay your staff, the infrastructure, taxes, etc…. The big difference from how we currently manage is related to the direct labour that is not considered as a variable cost. Think about it, around years 1850, the staff was paid by piece, while today, with all the existing fringe benefits, the staff level is not related anymore to the sales volumes as it was, even 50 years ago. Today, your business operates under a cost per day that defines your competitiveness.
Once you know this cost per day, you know how much money your sales must generate to breakeven your business
2- The second pillar is the sales spread that we are going to call the contributions. These contributions pay for the cost per day and once offset, the surplus become the organization profit. The contribution is based on the following:
CONTRIBUTION = Selling Price – (MTL cost + Freight + Commission)
In other words, it is the real money generated by sales. Higher is the product price, higher will be the contribution generated.
All the generated contributions offset the cost per day and the balance becomes your profit
As you can see, there is no more profit by product but rather the real challenge, which is related to
“Am-I generating enough contributions to offset my cost per day and achieve my profit goals?”
3- The third pillar is your ORGANIZATIONAL CAPACITIES that generate the contributions. To equal contribution, we rather want to sell product that will require less capacity. Our goal is to generate a maximum of contributions while minimizing our efforts.
In other words, we want to sell products that will be quickly ready to be delivered first and if is not, develop an investment plan that will insure, that high demand products are always delivered faster!
The organizational capacities are the source of the contribution speeds and must be in-sync with high market demand.
4- The other pillar that has an impact on your profitability is related to the type of product you are selling. Think about it, do you sell a COMMODITY PRODUCT where the price is the only criteria that matter or a SPECIALTY PRODUCT where the price does not come as the first criteria.
In fact, customers who buy SPECIALTY PRODUCT, buy an answer to their needs. Consequently the price they are ready to pay for is related to the value they attach to your offer. Your price will be based on how you can promote, explain, show benefits of what you are proposing. This differentiation has a tremendous impact on contributions and you have to wonder if you have products that fall into the SPECIALTY PRODUCT?
Specialty products offer higher contributions than commodity products
5- The last, but not the less, is the market potential (overall demand) for each of your product. In fact, your organization is involved in different markets and each of them represents a potential of contributions that could be reached if you properly address their related needs. You must be able to evaluate these needs in perspective with your organization capacities at generating contributions in order to pick the best development strategy that will maximize the contributions in the chosen field.
Market to be developed must be identified in perspective with potential contributions
As you can see, managing a business with the five pillars changes the focus on what is important and what it’s not. As a business leader, you have to manage the essential to get under control the 5 pillars because you do not want to let luck decides which profit level that will be reached.
Product does not make profit, but rather the sum of the product contributions less the cost per day.
Profit is the consequence of the tight 5 pillar management because the organization’s resources are limited and must not be spoiled. The cost per day defines your competitiveness while the contributions pay for it. The generated contributions are characterized by the operation speeds and must be in-synch with the market potentials. Specialty products generate higher contributions and must be subject to specific strategy while commodity products are only price driven. Markets to be developed have to be identified based on contribution potentials to maximize profit in perspective with the organizational capacities.