Patrick Stewart, CIRA
Anybody who has owned or operated a business in the last few years would probably agree with the old adage that “the only constant is change.” While change can be good, it can also spell trouble, and it often hits us when we least expect it.
The recession and sluggish recovery cast a wide shadow over the business community. Perhaps most obvious is the change in the retail landscape, which has been punctuated with high profile bankruptcies like RadioShack and JC Penney’s continuing struggles. But the fallout is apparent in other industries, too. New forms of lending are being introduced into traditional banking, social media is infiltrating all aspects of marketing, and technology is creeping into every facet of commerce. Today’s on-demand consumers are more knowledgeable, more price sensitive, expect higher standards and actively explore more new shopping platforms than ever before.
So what’s a company supposed to do? After all, it’s not what you see coming that hurts, it’s what you don’t that can bring a business to its knees.
The answers are really all around us. Everything in a business tells you something, and sometimes what you aren’t seeing reveals just as much. Protecting your company starts with a detailed understanding of what’s going on in the business:
- Which customers comprise 80% of profits, and is that customer base large enough so the loss of any one customer won’t hurt too much?
- How do you know when something isn’t working? What metrics do you look at to know when a project is off track or a department isn’t getting it done?
- What systems do you have in place to monitor internal and external change? Do you regularly and systematically measure what’s going on in the marketplace?
- What risks can you quantify, and what can you do about them?
Answers to these key questions will identify potential red flags. The next step is to make clear what levers you can pull in the event of unforeseen events. Here we need to take a deeper look, beyond the basic P&L, to determine what you can actually control. We may not be able to control the market chaos around us, but there are steps we can take to put internal controls in place:
Profit Analysis Beyond the Margins
Analyze true customer profitability by looking beyond gross margin. In most cases, our clients discover that their profitability is tied to fewer customers than expected, which means they are carrying more marginal, and sometimes unprofitable, customers than they thought. At that point they must choose between improving profits on certain customers or jettisoning them to improve the overall bottom line.
Bigger is Not Always Better
While bigger customers may appear profitable, sometimes they aren’t quite what they seem. Are you jumping through hoops to satisfy them by cutting margins, adding to the cost of goods sold for customization, extending payment terms or holding inventory? If push comes to shove, shrinking the business can actually make it more profitable. You can learn a great deal from monitoring levels of product returns, spikes in warranty claims, and reviewing feedback from sales and customer service representatives.
Feeding the 800 Pound Gorilla
Failure to monitor true customer profitability can hurt your business in several ways. The amount of time you spend on under-performing customers is inversely proportionate to the profits they provide. In essence, as the time you spend on unproductive customers grows, your overall company profit margin falls. There is also a diminishing returns concept in play here as you find yourself spending more company resources only to achieve less profit. We tell our clients that you can’t make an 800 pound gorilla bigger, but you can find a baby gorilla to nurture and grow with. In the end, focusing on the wrong customers simply because you don’t have the right information leads the business towards reduced profits, which in and of itself will eventually lead to insolvency. It also makes the business more susceptible to the unforeseen shocks that can really hurt.
A Good Offense is the Best Defense
On the surface, hiccups along the way may seem like a small deal, but when a company is operating from a weak position, that small problem can suddenly become a very big deal. Probably the most volatile issue is cash management to cover a distressed situation. For smaller companies, the unexpected could be as simple as a few large invoices hitting on the same day or in the same week, and if that happens to be a payroll week, you could find yourself unable to make ends meet. It’s standard procedure to be prepared to cover a few weeks of obvious expenditures such as payroll and recurring bills. But it’s worth the exercise to map out inflows and outflows to uncover the nonrecurring expenses so you can create a more realistic and predictive cash flow model.
Mining Your Data
Data is one key to winning in today’s business climate, but managing that data can be a challenge for even the largest companies. In my middle market world, a client was generating more than a million records of sales transactions annually that provided crucial customer information – how much, how often and what product. However, our client wasn’t paying sufficient attention to the information. Instead, they chose to put into their stores what they thought the consumer wanted. The impacts of their subjective approach were far reaching including excess and obsolete inventory, disengaged customers and even rifts within the management team. Our solution was to compile all three million records and put them into a usable form that highlighted underperforming products and categories, which were then re-priced or eliminated. Anything we got rid of was sent back to the vendor for much needed cash and credits on future orders. The result of capturing the customer input and analyzing the data was higher revenue on lower inventory levels.
Without the right operating metrics, most companies become proficient at fighting fires and many assume that’s just the way it will always be. A lot of service companies assume they don’t need metrics, but time is a mirror of cost. So, if your marketing campaign or architectural design work is taking longer than expected, then you are hurting your profits by running over budget. One of the best ways to determine the right metrics for your industry is to identify what key information you could analyze that would trigger corrective action. For instance, monitoring inventory levels, hours billed, or parts produced per hour all provide valuable data points that enable you to see red flags looming on the horizon. We always look at three types of metrics: throughput, effectiveness (errors) and utilization.
Throughput denotes the number of widgets processed through the system (boxes shipped, proposals developed, building plans finished).
Effectiveness metrics reflect the number of errors or changes that were required to conclude a particular process. These metrics are typically represented by a ratio that compares the number of changes to the number of items processed.
Utilization quantifies how time is used during a process. In manufacturing you see this as “up time” compared to “down time”. In professional services it shows up as “hours billed”. As an aside, I think industry benchmarks can be dangerous in this context as every business is different. In my opinion it’s better to understand the company’s metrics and work to improve them. As an example, I was at an apparel distributor’s warehouse that processed 350 lines per person per day. If we had chosen this as a benchmark for another client that distributed school supplies we would never hit the goal because of product differences. The result would be a self-defeating goal that would damage morale and do more damage than good.
The Only Constant is Change
Pay attention to the world around you. Business history is littered with companies that failed to see the change around them (Kodak, Research in Motion, RadioShack). It’s critical to understand how your customers shop and the psychology behind it. Mobile technology has leveled the playing field in many ways leading to impatient consumers that expect goods wherever and whenever they want. Retailers struggle to compete across multiple platforms and juggle pricing, stock and delivery pressures. Paying attention to consumer habits can reveal simple solutions such as arranging your distribution center or a store layout to drive ultimate efficiency and profitability. Commit resources to your front line by providing customer service training, and listen to your employees’ valuable feedback.
It’s easy to be lulled into complacency when everything appears to be going fine, but in a blink of an eye, unexpected changes can put your business into turmoil. The key is to anticipate change and manage it by truly understanding the key factors that impact your business. If you stay attuned to clues and cues all around you and thoroughly understand what’s happening on the inside, it will make reacting to the outside that much easier.
Patrick Stewart is a partner with Momentum Advisors in Media, Pa. He specializes in operational improvements, financial restructuring and interim management. www.mo-adv.com