The Profit Cycle: A Tale of One Business's Turnaround

"Watch out for the bump in the road," Grace blurted out.

Mike glanced down at the newly patched pothole, and braked his bicycle to a stop. Grace stopped beside him. Mike turned to her, "You know, I could take that two ways."

Grace smiled. Mike had been her bicycling partner since college. In the distance, the Cambridge Reservoir presented a lovely early morning tableau. The maple trees were just turning blood red and yellow, and there was a slight mist rising from the water. "I thought your company was growing."

Mike paused. "That's the problem. Our revenues are rising, and our profits are falling. I'm working really hard, but it feels like I'm falling further and further behind."

Grace visualized the changes she had managed over the past year as president of her distribution company. She understood Mike's challenge--managing his fast-growing software company.

"I went through this last year, Mike. The good news is that you can grow your revenues and boost profitability at the same time."

"I'd really like to hear about it. I'm pretty good at product development and selling. I thought we'd be profitable if I nailed these. I don't know what else to do."

Grace and Mike cycled over to a bench by the water, and Grace began to tell Mike about how she led her company's profitability turnaround. Here's her story:

Grace's story

It all started about a year and a half ago. Grace was president of a $30 million distribution company that had the problem Mike's company now faced: revenues were rising, and profits were falling. She was puzzled, so she went to a talk at MIT on profitability management.

The speaker outlined a four-step process for managing a profitability turnaround: (1) develop the right information, (2) institute the right priorities, (3) create the right processes, and (4) establish the right compensation.

Grace was surprised. The process seemed very straightforward and logical, but different from the way that she managed day-to-day operations and growth. She was also surprised that so many managers she met at the talk had the same problem--and reaction.

After the talk, Grace kept thinking about the speaker's words at end of the lecture. The first step is to develop the right information, which he called a "profit map," which two managers could create in a month or two using standard desktop tools. "You'll be amazed at what you see."

A few weeks later, Grace reviewed her quarterly results and became concerned. The tough economy had slowed her sales, and profitability was plunging quickly. The next morning, she decided to develop a profit map.

The right information

The process was straightforward. She tapped an experienced marketing manager, who was open-minded and analytically inclined, and a rising senior finance analyst. They created a database of every order line over the past three months. Their objective was to develop an "income statement" for each order line.

Each order line already had information on the product, customer, price, and product cost. They developed a few tables to add other important cost elements, like whether the customer was near to or far from the warehouse, whether the product was fast, medium, or slow moving, and whether the customer was served by the web, by telesales, or by a sales rep. There were other cost factors as well.

They were careful to heed the MIT speaker's advice to work at "70% accuracy," and they were amazed at how fast the process went compared to activity-based costing.

Once the database was complete, they used a standard database program to hunt for profits. They were astounded by what they saw. The MIT speaker had said that virtually every company was 30-40% unprofitable by any measure, and 20-30% of the business provided all of the reported profits and subsidized the losses. That's exactly what they saw.

They were surprised that many of their best accounts were only marginally profitable, even though they had good gross margins. They also saw that even large, profitable customers had 20-30% unprofitable products, and that these could be made profitable with some surprisingly simple changes.

When the team showed this information to the company's management committee, they were asked to check some specific customers. They double-checked, and found that they were right the first time.