How to Build a Profit Culture

Norm Smallwood and Dixon Thayer

 

 

Overview

 

In our recent book, Why the Bottom Line Isn’t: How to Build Value through People and Organization, Dave Ulrich and Norm Smallwood describe how leaders can increase the market value of their business by making intangibles more tangible. These intangibles include industry growth, quality of earnings, product brands, technical competencies, and organization capabilities. On average, these intangibles account for half of the market value of publicly traded firms. One surprising implication of intangibles is that companies with the same earnings in the same industry can have very different market valuations. A striking example is Southwest Airlines that currently has much smaller revenues but three times the combined market value of its’ “big five” competitors- United, Delta, Northwest, Continental and American. Any customer of Southwest can quickly attest that not only does it have lower prices but that it has many other appealing characteristics such as a culture that encourages flight attendants and pilots to have fun with customers before, during and after a flight.

 

Leaders build market value through intangibles by paying attention to the “architecture for intangibles.” This architecture for intangibles consists of four levels:

 

1.      Predictable and “reinvestable” earnings;

2.      Articulating a clear growth strategy;

3.      Allocating resources consistent with the growth strategy;

4.      Building organization capabilities consistent with the growth strategy.

 

In this article we describe practical ideas for building a profit culture that ensures that the first level, consistent and predictable earnings, can be achieved.   

 

What Entrepreneurs Know that they Don’t Teach at Business School

 

Business schools teach accounting and finance. They don’t teach people how to make money. People learn how to make money when they are responsible for profit and loss. In many large companies this occurs when a supervisor or manager becomes a general manager. This often does not happen for several years. On the other hand, entrepreneurs have to learn how to make money very quickly or they go out of business very quickly. Most entrepreneurs have more experience at making money than most business people below the rank of general manager. This is crazy.

 

For the last few years, we have been working hard at helping leaders and professionals at every level learn how to make money for their business and if they are not general managers we help them learn how the business makes money so that they can contribute to it.  Profit cultures emerge as people throughout the business gain financial literacy and are provided with no risk experiences in learning how the business actually makes money.

 

The Profit Master

 

A business with a profit culture achieves reinvestable profits for strategic growth. Creating these conditions is usually realistic with hard work. Building a profit culture involves four steps:

 

1.      Shared & simplified financial language;

2.      Analytic tools that go beyond traditional financial reporting;

3.      Common financial processes and incentives;

4.      Investment in leader / manager education and “war gaming” to accelerate hands on experience

 

Shared financial language:

 

Most companies are clear about their financial objectives and measures. Despite this clarity, our experience is that not enough people really know what these objectives and measures really mean, why they are important and how to impact them in a positive way. The impact of this ignorance is higher costs, lost opportunities and other chronic profitability problems. We often hear senior executives, finance and accounting people and general managers complain about this state of ignorance.

 

An example of building a simple & shared language is to remind employees that there are only four ways that operators can make more money:

 

 

The challenge is that knowledge of this is not enough to assure success!

 

Analytic tools that go beyond traditional financial reporting

 

Learning a language is not enough. Leaders also need tools. We find that five common financial tools contain principles that can be tailored to fit virtually any industry:

 

  1. Profit Peel: Where are the best opportunities to increase sales and profit? Who are the big hitters and big losers? Who are the best prospects?
  2. Price Staircase: What activities are draining price realization? How do I reduce or eliminate invisible price drains? What are our actual costs? What can I do for price realization without increasing list costs?
  3. MixMax: Are we selling the right stuff to the right people? What is my most profitable product/service mix? What products, services, customers, sales areas.. are best targets for profit improvement?
  4. Penetration Bingo: who’s buying our products (or services) and which ones? Where to focus sales effort to increase volume? When deployed properly it also aligns Marketing in very tangible and tactical ways.
  5. Outliers and Outlaws: Which customers or products are outliers (most profitable, least profitable)? What’s the value of shifting least profitable customers inside the band or dropping them?

 

 

Common financial processes and incentives:

 

Language and tools are still not enough. Leaders also need processes and incentives to facilitate systematic application of these levers of profit on an ongoing basis. Financial processes help leaders learn how to ask the right questions that dig deeper to uncover potential sources of profitability. For example, let’s say that a manager is responsible for three products that have profitability targets of 20%. Assume Product A has a 23% margin, Product B has a 17% margin and Product C has a 26% margin. It would be easy for a busy manager to quickly determine that she needs to increase the margin on Product B by at least 3% and Products A and C are fine. However, this also might leave lots of untapped money on the table if Product C should really have a 40% margin. Leaders must provide processes as well as incentives that encourage this busy manager to take the time to find out.

 

 

Investment in operator education and “war gaming” to accelerate experience- The Profit Master

 

We have created a new online simulation called Profit Master, based on over ten years of experience with a paper and pencil version that allows leaders and professionals to gain experience in learning a common language, practice using financial tools and trying out processes to uncover profitability opportunities. They do this first in a tutorial and then for their own business by tailoring the simulation to a specific business. Participants play “The Profit Master” to see if they can improve their scores. As they play the Profit Master, he uncovers his “secrets” to help participants learn how to improve. The Profit Master has been initially programmed by experienced operating leaders including Dixon. As players beat the Profit Master, their approaches are adopted by the Profit Master to keep raising the bar for others.

 

Our Challenge

 

Readers of this article are invited to play the Profit Master simulation at no charge as long as they are willing to post their scores, their job title and their industry. This will allow you to compare your scores to Dixon as well as to others in similar as well as in different job areas and industries. To play, go to www.rbl.net, click on the Profit Master icon and get a password. We’ll be looking for your score.