Profits tripled in six months – What did we do?
This case study describes a business currently on track to increase year-on-year profits by more than 300%. 80/20 concepts were a significant factor in identifying the focus necessary to drive this turnaround.
This company has a turnover of $30m. It is a long-established wholesaler of its own product range and broker of third party products. A characteristic of this industry is high volume, low margin business. There are eight employees: the owner, a broker, three sales people, and three support people.
The central issue is that the company was under-performing. Whilst it was profitable, the profits were not in line with either the volume of business or the level of business risk. The assignment was to improve business profitability.
The 80/20 view:
A study of the company from an 80/20 perspective identified the key issue was gross margin percentage. In a high volume, low margin business a single percentage point on gross margin can change the quantum of gross profits by 15 – 20%, which in turn falls straight to the bottom line. Thus, there is a huge multiplier effect.
The 80/20 analysis revealed that of the eight employees only two were really critical to the turnaround in the company i.e. that would have a significant impact on the gross margin. That is not to say that the other six employees are not critical to the company – of course they are important, but they are not the drivers to change.
Two key people – who?
The first person we identified was the owner of the business. It is not necessarily always the case that the owner is the key driver, but in this case it was. The reason - he is very hands on with the business and sets the tone. A key function of this role is setting prices, and planning the week.
In this regard he was flying blind as far as reliable information, particularly feedback on how the previous week had gone. It is a feature of this industry that both inwards and outwards prices change constantly. Setting prices is not as simple as it might seem to the causal observer, and there are many permutations.
The second person was the broker, who sells parcels of product in the same way that a sharebroker might act. A client will have a need for certain products – through a network of contacts the broker secures the product and takes a margin. This role is also the eyes and ears of the company in the market.
This role provides market intelligence for pricing, and a wide range of the contacts to secure deals. This role can be differentiated from that of the sales people, who are primarily desk-bound order-takers working from an agreed pricing schedule. This role provided the best avenue to increase the level of business. top
The lessons – what did we do?
The powerful attribute of the owner is his huge experience in the industry. The problem was that he was let down by not having the right information on which to either base decisions, or to review the effect of past decisions. As we find in many businesses, the people at the coal face might not have MBA’s, but they certainly know how to fix problems and attend to issues when those problems are identified. The key is to identify the problem in a meaningful way. In the case of the business owner we developed feed-back loops that provided information to make what were, in some cases, tough pricing decisions.
Another critical role was to act as a mentor to discuss the business and challenge decisions. In a small business such as this, where most of the employees are functional, it is often difficult for owners or senior managers to engage in strategic type discussions. The 80/20 Consulting Company provides a foil to test ideas and challenge decisions.
There were two significant things that we did for the broker. The first was to provide logistics support. Whilst this broker is very good at doing deals he is somewhat remiss with the back-end activities: such things as making sure that transport is arranged, making sure that the order gets shipped on time (often from a third party), making sure the paper-work is in order, and all the administrative tasks that are required.
We provided extra support in this area by hiring a part-time support person, and let the broker focus on that part of his job which had the greatest impact on the company – doing deals.
This is classic 80/20 thinking. The second thing we did was to change his perspective on the profit margin. Many sales- people are focused on ‘the deal’, and go to any lengths to get it – often by discounting the price.
We reviewed sales and profit margins.In the brokering business the paperwork and physical sales effort is almost exactly the same whether the deal is for just 1 unit or 600 units of product. We changed the profit focus from a ‘cents per volume’ basis to ‘dollars profit per transaction’ basis, and reinforced the volume / total profitability formula.
The results of these two strategies has been awesome. The volume of deals is now higher, and each deal is far more profitable. Deals that were previously a cause for celebration are now in the lowest quartile of profitability because of this change in focus. top
The 80/20 bit:
80/20 is not a means in itself; it is a tool to identify where the focus needs to be. In this industry the key issue turns out to be primarily pricing. A small percentage change in price can have a large impact on the gross margin. The 80/20 angle identified that at this stage of the company’s development the focus needed to be on improving the gross margin percentage as compared to, say, the quantum of sales or level of overheads.
Quite simply, when the margin is so low, an increase in sales volume necessary to appreciably increase profits has to be of such a magnitude that it becomes almost impossible to achieve. It is likely that this focus will change over time. Indeed, even after just five months the company is now in a position to grow sales and make a worthwhile profit from doing so.
At the time of writing (August 04) the company is six months into its financial year. The analysis and implementation began shortly after the start of the financial year. The company is currently on budget, which will see it improve year-on-year profits by better than 300%. How can you also achieve these benefits? top
To understand how these ideas might be used to dramatically improve profits in your own business please contact Geoff Vautier, principal of ‘The 80/20 Consulting Company’ Geoff Vautier