Many business leaders believe that they should just keep
doing what's always worked. In some areas of business,
such as providing good service, that can make sense. But
often too much consistency holds a business back from
earning its full potential. To capture more of that
potential, businesses should continually upgrade their
business models (who, what, when, why, where, how, and how
much of what they offer). Here are three examples of how
to think about this question in terms of the dimensions
who, where, and what.
Who Is Served and Where
Let's first look at "who" is served. The lesson is to keep
it simple. Change as little as possible while becoming more
efficient and effective as an organization for your
customers and beneficiaries. The simplest way to do this is
to put more volume through an existing organizational
structure without adding fixed costs or increasing the
ratio of variable costs to sales.
In a for-profit organization you will naturally first want
to attract the most profitable potential customers. If
current customers buy a very small percentage (say 1 to 2
percent) of their needs from you, such a profitable
expansion may simply be possible by selling 40 to 50 times
more to selected current customers. You are already
spending time and money to gather a small part of these
customers' total requirements. In many cases your overhead
costs to provide more products and services would not
increase.
Let's assume your current pretax profits are 10 percent of
sales and your contribution to profits before overhead
costs is 30 percent of sales. This circumstance means that
selling more of the same mix of offerings at the same price
to an existing customer would almost triple the profit
contribution margin on the increased sales. Were that to
occur, a 20 times increase in volume would lead to a 60
times increase in profits!
By contrast, if an organization picks people and
organizations to serve who are located far away and desire
less profitable offerings, this choice of who is served and
where to serve them can increase costs to serve each
customer and beneficiary versus doing more with the same
customers. For instance, if the for-profit company seeks to
serve new customers globally who require local support, the
company's overhead and the cost of offerings may grow
faster than revenues. In that case, absolute profits may
decline or even turn into a loss. See Exhibit 1 which
quantifies this circumstance.
Exhibit 1: Adding Less Profitable Revenues in Diverse
Locations Increases Offering and Overhead Costs
More volume doesn't automatically translate into more
profits. If you have to sell items with less profit
contribution as a percentage of sales due to new customer
preferences and your overhead costs grow, you'll more than
offset the profit gain you hoped to obtain. In this
example, the corporate overhead cost remains almost
constant as a percentage of sales through the need to
support more geographic areas with administration, while
the profit contribution percentage drops from 30 percent to
20 percent. However, if overhead costs go up enough as a
percentage of revenues, the effect can be to turn a profit
into a loss.
Annual Pro Forma Financials Before Volume Expands
Revenues $1,000,000
Cost of providing offerings $700,000
Profit contribution $300,000
Corporate overhead cost $200,000
Pretax profit $100,000
20 Times Volume Increase with Higher Offering Costs and
Overhead
Revenues $21,000,000
Cost of providing offerings $16,800,000
Profit contribution $4,200,000
Corporate overhead cost $4,150,000
Pretax profit $50,000
What Is Served
Selling or providing more of what you already offer can be
a big help in creating efficiencies. But sometimes you are
serving virtually all of someone's needs for those items.
When that happens, consider what else you can profitably
sell or provide at a fair price with desirable qualities
and service that the customers you already have want to
buy. The advent of the Internet makes this evaluation much
more potentially rewarding because postal, air freight, and
electronic delivery choices enable you to serve most of the
world.
As with the previous examples, this for-profit challenge
requires considering the potential volume and the effects
on overhead costs and profit contribution margins. Exhibit
2 shows the kind of effect that a positive change in volume
can make by adding volume through more profitable items
that do not increase overhead costs very much.
Exhibit 2: Adding More Profitable Items to Expand Revenues
Without Increasing Overhead Costs as Rapidly Further Speeds
Profit Growth
This example shows the profit multiplying potential of
increasing profit contribution margins from 30 percent to
40 percent while decreasing corporate overhead costs from
20 percent to 3 percent of revenues. The result is a 7,700
percent profit solution. If revenues could be grown even
more, a 40,000% solution (a 2,000 percent squared solution)
could result.
Annual Pro Forma Financials Before Volume Expands
Revenues $1,000,000
Cost of providing offerings $700,000
Profit contribution $300,000
Corporate overhead cost $200,000
Pretax profit $100,000
20 Times Volume Increase with Higher Profit Contribution
Products and Limited Additional Overhead Expenses
Revenues $21,000,000
Cost of providing offerings $12,600,000
Profit contribution $8,400,000
Corporate overhead cost $600,000
Pretax profit $7,800,000
Copyright 2007 Donald W. Mitchell, All Rights Reserved
----------------------------------------------------
Donald Mitchell is chairman of Mitchell and Company, a
strategy and financial consulting firm in Weston, MA. He is
coauthor of six books including The 2,000 Percent Squared
Solution, The 2,000 Percent Solution, and The 2,000 Percent
Solution Workbook. You can find free tips for accomplishing
20 times more by registering at:
====> http://www.2000percentsolution.com .
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