Third Dimension of Profit
Many people have experienced love at first sight but on occasion your first instinct may not lead to an informed decision. There are times, when business leaders are looking for ways to improve their profit margins, their default choice is to painfully cut expenses or pay dearly for new client sales revenue. However, there is another choice (and it is not quite The Twilight Zone of business): the third dimension of profit looks at existing revenue to see if it can assist in driving profitability.
It can become daunting to target 100% of clients when searching for ways to achieve new levels of profitability. Instead, consider focusing on the top and bottom 10 percent of your customer base. Companies often look at the whole picture and become overwhelmed when trying to maximize profitability. For example, it is a common practice to burden loyal long-term customers and those accounts that are in the middle revenue range of our business with price increases, while avoiding asking the largest and smallest customers to contribute. Starting with the extremes can get that elephant down to a more manageable size and drive the highest impact on profit.
The Pareto Principle
This theory stems from the familiar business rule, The Pareto Principle, also known as the 80/20 Rule. In business 80% of our time is often spent on 20% of our customers. This causes some people to spend 80% of their time trying to fix the 20% instead of reinforcing the 80% and 20% dealing with the exceptions.
Many successful companies, spend 80% of their time focused on the 80% of accounts that are already doing well and the remaining 20% of time focused on the 20% that may not be quite up to par. For the purpose of this article we will discuss the clients that fall into this 20% by addressing both the top 10% of volume and the bottom 10% of volume.
The bottom 10% of clients isn’t usually the first place companies would look to increase profitability. However, one way to improving financial success is by implementing a process called addition by subtraction. This process analyzes profit produced by the smallest clients in order to ascertain which accounts are bringing value and how to make these accounts profitable. Companies that are willing to subtract their smallest, low or unprofitable clients will be able to reallocate time and resources that were spent to service those accounts to the remaining profitable clients.
Reducing production and consumption costs for your company begins by targeting the bottom 10%.
Using this process companies can add profitability through a reduction of revenue. This can sound counterintuitive at first but revenue can be obtained from analyzing the smallest revenue accounts. The crucial step to improve weekly revenue is to set a minimum invoice rate for those accounts that your company deems are too small and be prepared to separate from those accounts that refuse to meet the minimum. The revenue created by those clients accepting the new minimum can often offset the revenue lost for those refusing it.
Additionally, production and merchandise cost will benefit from the reduction of accounts no longer requiring our products. Finally, the reduction of accounts unwilling to meet the new minimum guideline will allow our service teams to reallocate precious service time to our more profitable clients.
Strategic thinking and planning is required to embrace this unique way of approaching revenue generation and the third dimension of profit.
One way to create additional revenue in the top 10% of accounts is to revisit unit prices and find leaking revenue. It is important to remember that often due to competitive pressures the largest clients make the smallest percentage contributions to profit margins.
Generally speaking, our industry will stop at nothing to acquire a new account, including providing rock bottom pricing as an incentive. However, what do we do when a $300 week account is affected by the economy and drops to $75 a week and is no longer qualified for volume discounts? In this scenario, which may be occurring too often in our current economy, we recommend pricing be reviewed in order to see opportunities that are present within existing customers. Even those companies that believe that they have safety nets in place to prevent this from occurring should understand that it’s worth taking a second look to maximize profits.
Attaining profit from the top 10% and bottom 10% of your company’s accounts is a nontraditional idea because most would balk at the thought of receiving increased revenue from extremely small and larger accounts. This approach of targeting the top and bottom is often overlooked and represents the third dimension of profit.