Just how do companies increase profits?
They can address their Profit Levers.
What are the Profit Levers?
- Price – selling prices of their products (goods or services).
- Direct Costs – these are the costs that are directly involved in bringing their products to the market.
- Volumes – the number of products sold.
- Overheads – the costs associated with running the business; rent, salaries, etc.
But there is sometimes a problem. It is focusing on the wrong profit lever.
Research based on average of 2463 companies showed the following:
A 1% improvement in each of the items below without changing any of the others created the following profit improvements:
Direct Costs 7.8%
If you look at the Income Statement of the average company it is easy to see why the above percentages apply. The biggest number on the Income Statement will be Sales (if it isn’t the company is in trouble) and the numbers following sales will be less than sales so it follows that reducing them will have less impact on profits than an increase in the sales figure.
Sadly in business down turns the first target always seem to be headcount. While this may sometimes be necessary the impact on remaining staff is negative and even good staff may seek employment elsewhere as a result. If any retrenchment receives widespread attention in the media it may be difficult when an upturn is experienced to attract good staff.
Naturally the effectiveness of every Rand spent on overhead items need to be examined to see that it is necessary and providing value.
So what can companies do?
There have been a few Captains of Industry who have continuously grown their businesses and profits through constant innovation. But real growth will come about through a swarm approach to innovation.
What about the body of managers in companies who, together with their teams, make things happen on a day-to-day basis? It is seldom that they have to time or budgets available to actively engage in innovation. Added to this is the fear factor. What if their new ideas are met with resistance – or even ridicule? What if innovations they do implement meet with failure and result in being career limiting?
I have found that given insights and guidance regarding certain key areas managers and senior staff in many companies are able to come up with valuable ideas and implement them. Though, in this regard, workshops on ‘innovation’ are not sufficient.
I have discovered this in the process of adding to my Finance for Non-Financial Managers workshops a Profit Improvement Project (PIP). The advantages of following my workshop with a PIP were that the managers involved were able to use the insights and understanding of costs, cost behaviour and what causes profit productively while undertaking the PIP. The causes of profit are introduced while exploring the Profit Triangle during my workshop.
The Profit Improvement Projects required that the managers propose, together with detailed explanations what they would do to improve the profits of their company. This could be done by increasing sales and/or reducing costs. A specific target in rand terms was given to them to achieve. The target had to be achievable within the following 12 months.
On receipt of the projects I reviewed them and then set up times for the managers to present them to their senior managers.
One team from a small hotel within a large hotel group had been set a profit improvement target of R400,000. The idea behind the project and target is to introduce a way of thinking about the business that would be continued into the future. This particular group came up suggestions that totalled a profit improvement of R1,2 million. On presentation to senior management this amount was reduced to around R800,000. Not because any suggestions they had made would not work but because the senior managers felt that these may diminish what they termed the ‘guest experience’ which was a valid point.
At another PIP presentation at a large company where its CEO was present it was gratifying for the managers and me when he told the group that he had learned things about the company’s operations the he had not been aware of before.
I believe that in addition to the benefits to the companies involved in these projects the sense of achievement and the visibility it gave to the managers involved was very motivating for them.