For better or for worse, our beliefs often drive our actions. But when those beliefs persist long enough, they can fall out of sync with the broader world and be at odds with a new reality.
Consider some of the business disciplines that are often held above reproach: revenues are good, costs are bad; give the customer what they want; don’t mess with a good thing; and supply chain integration is always a benefit.
Those beliefs have passed their expiration, according to Jonathan Byrnes, a consultant and senior lecturer at MIT. According to Byrnes, some of those disciplines are merely myths and could very well undermine profitability and business success.
In his latest book, Islands of Profit in a Sea of Red Ink, Byrnes posits that only about a quarter of most company’s efforts actually prove to be profitable. The rest of the business, meanwhile, bleeds their organizations dry. According to Byrnes, 40 percent of most businesses are unprofitable by any measure.
That’s a staggering number. But also one that serves as both a wake-up call and an opportunity to better understand the main drivers of profit.
“There’s an assumption that more revenues equal more profits,” says Byrnes. “It’s a belief that if everybody beats budget, the company is in great shape. But that misses the boat completely. A company can still have a latent 50 to 60 percent profit improvement and nobody sees it.”
Part of the trouble is that traditional accounting categories are too broad to identify which accounts and products are profitable, and which ones are not.
Byrnes recommends developing what he calls a profit map, which estimates the profitability of every order line for each customer, using transactions over a representative period, such as three to four months.
These maps don’t necessarily have to be precisely accurate. In fact, Byrnes believes that reaching 70 percent accuracy can reveal a company’s prime profit trends.
After identifying those “islands of profitability,” Byrnes says companies can then set about protecting and cultivating those lines of business. In other words, organizations have to maximize their sweet spot.
“Typically, the best customers are being overpriced and under-served,” he says. “The key is to focus your resources on your islands of profitability and find ways to make these customers more profitable.”
To do that, companies need to be the best at something, he says, whether that be developing a product or providing an innovative service that raises the customer’s profitability and the organization’s sales.
Among the companies that have instituted these strategies are Procter & Gamble, Pepsi, and Chiquita.
“What you’re seeing is a change in the basic paradigm of business,” says Byrnes. “We have all grown up in what I call the Age of Mass Markets, where companies are trying to get more and more volume to create lower costs through economies of scale. What’s happened in the last 30 years though is companies are forming very different relationships with different customers, with different cost structures and different pricing.”
With the explosion of information, real-time visibility, and different pricing for different products, companies are faced with a world of mass customization and globalization, and of increasingly complex relationships.
“The way we teach business in business school and the tools we use to measure and manage businesses comes from the old age mass markets and they haven’t been transitioned to what’s going on today,” says Byrnes. “Today, the essence of great management is to create a foundation with the right information, the right priorities, the right processes, and the right compensation. The process isn’t painful, but it’s a different way of managing. And you’d be surprised how a company’s performance will improve surprisingly quickly.”