Focus: The Profit Centres of Your Business

By February 9, 2017Articles

Build a Road to Enhanced Profits

It can be a hard choice to make, but successful companies often have to make the strategic decision to “fix it or exit.”

In other words, any part of the business that doesn’t earn its keep must either be repaired or let go. Many businesses tend to avoid taking the time to identify their key profit centres and eliminate marginal products or services.

During good economic times when sales are booming, problems tend to go unnoticed. But when business turns sour, earnings start to lag, or the economy turns down, weeding out the under-performers can be the key to a company’s success and even survival.

A Case Study

The solution doesn’t always mean selling off operations. Sometimes all it takes is a few simple adjustments. For example, here is how the owner of a large chain of restaurants developed and put the profit mentality to work.

The restaurant’s menu was extensive, the food was delicious and the service excellent. But an analysis of the operation showed that not all the items on the menu turned a profit.

Some dishes were priced at or below the cost of ingredients, while others were so complicated to make that their profits were wiped out by the cost of the labour it took to execute them.

The fixes were fairly simple: Raise prices on the unprofitable items and add mid-range selections that could be priced reasonably and still produce a solid profit margin.

The final, revised menu offered a variety of choices and prices that guaranteed a fair return for the restaurant regardless what the patrons ordered. But for that turnaround to succeed, the owner had to take an objective look at the operation, isolate the sources of profits and losses and make some changes.

Using The Pareto Principle

80-20 pareto ruleIn order to ensure that your company’s bottom line is enhanced by profitable sales, and not hurt by marginal or non-profitable sales, you must know your organisation’s focus. This is where the Pareto Principle can help.

Also known as the 80/20 Rule, the Pareto Principle succinctly states that in anything a few (20 percent) are crucial and many (80 percent) are trivial.

Once you understand the principle, you can start to focus on your enterprise’s profit centres. First, objectively isolate the parts of the organisation that either run perfectly, can be nurtured and fixed, or must be dropped. As a first step, ask these two questions:

  1. Which 20 percent of your business’s products and services contribute the most and the least margin?
  2. Which 20 percent of your customers are responsible for the most high-margin and low-margin sales?

Then, with the answers in hand, sort your products, services, and customers into the following four-quadrant matrix:

sales matrixThe goal is to then develop a strategy that:

  • Maximises the activity in quadrant one.
  • Identifies how low-volume customers in quadrant two can move up to high-volume customers.
  • Determines how low-margin sales in quadrant three can produce higher margins.
  • Creates higher-margin sales and higher-volume customers from the information in quadrant four.

To some degree, this is the easy part. The hard part comes if you are unable to lay out a strategy to move sales and customers up to quadrants two or three from quadrant four.

At that point, you must decide whether to continue selling low-margin products and services to low-volume customers — some of whom may have been with your company for years. You must keep in mind that, ultimately, fewer sales could mean greater profitability.

Part of the success of your business depends on whether it has profit-driven managers and employees who know the road to greater financial performance. Here is a questionnaire that can help you assess the profit mentality at your organisation (click image to enlarge):

questionnaire

Article supplied by: Thomson Reuters
Brought to you by: Advivo Accountants and Advisors

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