While other businesses slash prices and downsize, you can actually increase your profits, weather economic downturns and position your company for long-term profitable growth. These five steps will allow you to extract maximum profit from every sales transaction through easy-to-implement profitability management techniques.
By identifying all related revenue and costs per sales transaction, you can leverage that knowledge to reallocate your resources in support of more profitable sales; establish profitable selling prices; turn around your marginal sales transactions; and prune your profit drainers.
To increase the profits you generate from existing customers, follow these five steps:
- Analyze each sales transaction to identify those that generate profit and those that drain it.
- Reallocate resources to protect the high profit segments of your business.
- Apply resources towards getting more profitable business by focusing on high-potential, under-penetrated customers, markets and sales channels.
- Turn around marginal business by altering customer purchasing habits and increasing prices.
- Prune any drainers that remain.
Identify profit generators
It is possible, even probable, that some of the sales transactions or sales channels of an otherwise unprofitable company are profitable. It’s almost certain that there are unprofitable sales channels and sales transactions within an otherwise profitable company. The profitable areas subsidize the losers or, from a different perspective, the losers drain away the profits. Also, within both profitable and unprofitable companies, there are some sales transactions that neither generate nor drain profit. The same is true for customers: some drain away profit; many contribute nothing to your bottom line; while a few generate the majority of your profits.
Your mission is to analyze each of your sales transactions, sales channels, sales reps and customers to identify those that generate profit, those that contribute nothing and those that drain profits away. Start by calculating the revenue you receive and your total cost for each discrete selling unit, such as each individual widget or each insurance policy sold.
Look at individual transactional costs, not just direct acquisition, manufacturing or distribution costs. Allocate all your overhead and indirect costs for things such as obtaining and filling orders and placing orders with vendors. Include operational expenses such as shipping and delivery, invoicing and accounts receivable collection, and other costs to serve your customer. Also apportion costs for intangible items such as customer service and technical support departments.
Each customer, sales transaction, sales rep and sales channel is unique. Assigning ‘rule of thumb’ overhead and indirect costs uniformly across all products, service offerings or sales channels masks the true costs associated with each of these segments. Track actual costs for each discrete selling unit as much as is practical, but don’t go overboard with the details. The objective is not to obtain more precise data, but to obtain more valuable information, so 80-percent accuracy is sufficient.
Enter the data you’ve compiled into a spreadsheet to sort and aggregate it on various dimensions. For example, if you make repeat volume sales, look at individual unit revenue and costs per invoice line item and consolidated unit revenue and costs per customer or sales rep. If the nature of your business is one-time or occasional sales, look at unit revenue and costs per line item and consolidated revenue and costs per sales region, market segment or distribution channel.
By comparing revenue against cost for each line item, you’ll quickly identify which are profit generators and which are drainers. Aggregate line item data by customer or sales channel, and you’ll discover the profitability of each. Using a spreadsheet also lets you view the impact on a sales transaction’s or customer’s profitability as you adjust various cost and pricing drivers.
Once you have identified profit-generators, you must support and protect them or risk losing them to your competitors.
Protect your profit generators
This eye-opening exercise of analyzing and quantifying all your costs may lead you to think across-the-board cost-cutting measures are the only answer. Indiscriminate cuts may seem prudent and expedient in the short-term, but cutting all expenditures across all departments, products and staff (e.g., cutting all staff by 10%) is short-sighted and ineffective. Arbitrarily cutting costs and crippling your capabilities when competitors are actively trying to capture market share is a recipe for disaster. You may not cut enough in some areas, and you may cut too deep in others.
Make cuts with a scalpel rather than an axe so they do not damage your brand or negatively impact current customers. Do not cut costs so deeply or indiscriminately that you can no longer operate your business. It comes down to having the right information about your business and its performance to make educated and sustainable cuts without damaging your overall strategy.
While it is true that you must cut your losers, it is more important to support your winners—be they staff, products or service offerings. To paraphrase management guru Peter Drucker, you achieve success by capitalizing on your strengths, not by trying to fix your weaknesses. Focus your limited resources where they will have the greatest impact on your business, such as customers who are willing to pay for the value they receive and customers with high-potential that are currently under-penetrated.
Get more profitable customers
It is important to differentiate between profitable growth, and growth merely for growth’s sake. Embrace the fact that not all revenue dollars are created equal. Revenue is only good if some portion of it is retained as profit. You can’t always make it up in volume. Having a higher sales volume temporarily strokes your ego; however, having greater profits and the attendant increased cash flow is a great salve for your bruised ego. So be selective of any new business you accept by qualifying it against this profitability management model.
By evaluating the most profitable customers identified by your sales-transaction analysis, you can create an ideal-customer profile for each of your markets or sales channels. Use these profiles to target similar but under-penetrated existing customers and high-potential new customers within those markets and sales channels. Now you can confidently allocate the appropriate level of resources toward booking this business.
Focusing your revenue expansion plans exclusively on high-potential customers and ignoring all others may require cultural changes within your company. It will certainly require behavioral changes. If your goal is to increase profits, as it should be, your sales team must recognize that some customers, product lines and sales channels won’t grow. Instead they should shrink or be eliminated.
Before you change your product or service offerings, examine your business model. When a sufficient volume of profitable sales exists, sales transactions can be adjusted within the context of your business model. Otherwise, when a large portion of your accounts, products, services or transactions are unprofitable within your current business model, it’s the business model that needs to change before you alter your product or service offerings.
Turnaround your marginal sales transactions
Altering your product and service mix can increase the value you offer your customers and dramatically increase your profits at the same time. You may also be able to transform ‘bad’ customers into ‘good’ ones. Altering your product and service mix can also deepen your relationship with your customers and make it difficult for another vendor to displace you.
For any single sales transaction, profit is optimized when the price matches the customer’s perceived value. If the profit generated from a transaction is inadequate, do one or both of the following:
A. Reduce the costs for that transaction without cutting quality or value. Increase short-term profit by reducing overhead and indirect costs. Increase sustained profitability by reducing direct costs. Cost reduction strategies vary depending on industry, company size, the products or services produced, and many other factors, but here are a few ideas: realize cost savings by consolidating purchases with fewer vendors and getting volume discounts, using materials and resources more efficiently and by improving processes and workflow.
When the profits you make on selling your products or services are being drained away by the cost of servicing particular customers or market segments, motivating these customers to alter their buying behavior will improve your profits. The possible changes are only limited by your imagination, but here are several suggestions:
- Migrate the customer to higher margin products or services
- Increase their order size by instituting an up-charge for ordering less than a minimum quantity or dollar amount
- Deliver or ship only on certain days, depending on order size, instead of on-demand
- Suggest scheduled orders based on historical volume as an alternative to on-demand ordering
- Consolidate orders and shipments or institute tiered thresholds for shipping costs versus minimum order quantities
- Only accept orders electronically from certain customers or sales channels instead of sending a sales rep.
- Provide tiered technical support based on product line or business relationship
B. Increase the selling price, and if possible, raise the customer’s perceived value without increasing your costs. A few ways to raise the customer’s perceived value include altering your sales presentation to highlight the intrinsic value of on-time and error-free delivery, supplying training and service materials or bundling services for increased convenience.
Analyze your costs to establish a minimum selling price. Your maximum selling price is limited only by your customer’s perceived value. Either your customer will continue to purchase and you’ll make a profit, or your customer will no longer purchase that product or service and you’ll no longer lose money on the transaction. In either case, your profit has improved.
Remember that your company does not operate in a vacuum; very likely your competitors will react to any change in your prices. Though, by now you’re now savvy enough to keep prices at a level that makes economic sense for your business and avoid engaging in a price war.
Prune the drainers
Sometimes it is prudent to accept marginal business just to cover overhead, knowing that none of this revenue will ever make it to your bottom line. But taking on too much of this business diverts resources that should be focused on garnering profitable business. Set caps on how much overhead-covering business you’ll accept and prune that business as soon as you book full fare transactions.
Even after devoting considerable effort towards turning them around, some profit draining sales transactions remain. When you can’t tip the scales in your favor, have the courage to refuse unprofitable sales transactions. You’ll increase your profits immediately. The customer is always right—sometimes they’re just right for someone else.
Bottom line
Profitability management requires little time, simple spreadsheet and database software and no capital, but can greatly boost profits and cash flow. This tool affords you the opportunity to align sales compensation programs with true sales transaction profitability, motivating your sales force to focus on what’s best for the company. Selling more profitably to existing customers also keeps your marketing costs down, as it is less expensive to sell to an existing customer than it is to win a new one. With these steps in mind, you can redefine your customer base, increase profits and position your company for sustainable, profitable growth.
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