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Home > Performance Management Best Practice > Increasing the Profitability of Small and Medium Enterprises—A Practical Guide

Performance Management Best Practice

Increasing the Profitability of Small and Medium Enterprises—A Practical Guide

by Tom Brown

Table of contents

Executive Summary

  • A company’s survival depends on more than just revenue generation. Revenues must always exceed costs.

  • Managers must know in detail exactly how revenues were generated for the past three years; this analysis should classify revenue by product line, customer, geography, and in any other way that helps to paint a well-defined picture of the true sources of business income.

  • There are important distinctions between probable and possible future revenues. Probable revenues hinge on maintaining the business already in place; possible revenues come from managing your business with greater expectations.

  • Managing costs are often the starting point for increasing profits. Before cutting costs, it’s important to exercise the same level of analysis as was used to pinpoint revenues for the past three years.

  • The three most likely places to start with cost cutting are worker or manager costs, inventory costs, and overhead or processing costs.

  • Increasing revenue without increasing costs disproportionately is the best way to grow a stellar business.

 

Introduction

Many managers too often forget that business income should always exceed the cost of doing business. Deni Tato is a good example. She started her Cincinnati-based business, Contract Interiors, in 1986; by 1992, the business needed a large warehouse for the hundreds of chairs and desks in inventory. Contract Interiors employed some 50 employees. Yet in 2000 the company’s $15 million in revenue was generated against the backdrop of an economic downturn; all that inventory, payroll, and operational cost amounted to a level of overhead that strangled profits. In short order, Deni formed alliances with other local companies and transferred some of her employees to their payrolls, while also offloading her warehouse and delivery trucks. Contract Interiors became a sales and marketing company with a smaller, tightly focused staff of 18 while sustaining revenue levels and boosting profitability.

The Bottom Line

When people talk about the top line and bottom line, they are talking about the difference between revenues at the top of the income statement and what remains at the bottom of the spreadsheet after all costs have been subtracted. The bottom line is the number that represents a company’s profitability.

No matter where a company’s bottom line is today, its managers should—and most probably can—boost its profitability. How? They must ask, first, whether the business can generate higher revenues reasonably, and then whether it can cut costs efficiently.

Generating Higher Revenues

A manager who is unwilling to settle for the same results year after year should ask how the company can increase revenue without disproportionately increasing costs. This business hurdle, of course, can’t be fully addressed until the manager has a detailed list of company sales for (at least) the last three years, projected revenue for the current year, and an estimate of sales for the next three years. Past tax statements can be examined to determine the reported income. But profitability thinking requires that a manager categorize past revenues in as many ways as he can: by year, individual product, product line, customer, geography, sales channel—even by selling technique (for example sales representative, direct mail, online). Pinning down a crisp outline of how the company generated every sales dollar for the last three years is important because it helps to delineate current and future revenues.

Starting with the detailed revenue analysis for the past three years, the manager can then look at current-year performance to see if last year’s numbers will hold or slide. The current year’s analysis should then be tested using the same, or very similar, reference categories. In looking back over three years, it’s easy to allow wishful thinking to permeate projections. For example, it’s easy to project that a company’s largest customer in the past will double in size and, happily, will double orders with all vendors. But that thinking doesn’t take into account the possibility of competitors taking away contracts now in place. It also doesn’t take account of a large customer moving in an entirely new direction, removing the need for goods and services it may have been buying for years. In short, a manager must list past, present, and future revenue numbers, and then consider projections for present sales—and especially future sales—with intense scrutiny. Every projection should be challenged. When a manager has settled on a set of numbers that is (a) conservative, (b) justified, (c) rational, and (d) supportable, the probable near-term revenues for his business have been plotted. Only now is he ready to ask how his business can increase those revenues.

This increase can be called possible revenues. Probable revenues come from managing the status quo responsibly so a business doesn’t go backward. Possible revenues come from managing your business with greater expectations. A manager would be wise to ask:

Can this company profitably expand what it makes? Large corporations such as Apple Computer were not always billion-dollar enterprises. Yet Apple is a good example of how, time after time, this question drove its business to new heights. First Apple focused on providing a desktop computer with a small footprint, then on computers that could be carried in a briefcase, then on computers that could be handheld while playing music (the iPod line), then on computers that could make phone calls (the iPhone) while doing thousands of other assorted personal chores, such as managing calendars, finding restaurants, even reading books. Apple learned that each product could be the springboard for another product. It didn’t invent the wheel, but the company surely reinvented it over and over, much to the benefit of Apple’s bottom line.

Can this company profitably expand how it sells? Brian Scudamore simply wanted a summer job. In 1989, he was a university student in Vancouver looking for seasonal work. Not finding any, Scudamore started “The Rubbish Boys” by buying a truck for $700 and offering to haul away anything that the trash services would not. His business grew. Then Scudamore asked himself if there were a way to do this online, in essence to become the “Fedex” of junk. Today, that expansion from a look-us-up-in-the-phone-book company to an internet business has made 1-800-GOT-JUNK a huge success story, now operating in 300 locations in three different countries.

Can this company profitably expand its customer base? Joe Steffick started tying fishing flies back in 1954. He became very good at it—so much so that he began selling them as a sideline to his job at a plate glass factory. Then he started selling his flies through a sporting goods store, then a hardware store, then a department store chain. In time, his nascent company grew to the point that Joe’s Flies are now sold in small and large stores as well as online. There are many keys to this success story; but, at the heart, there is one key driver: Steffick and his associates kept asking who else might want to use their products. The answers—from local sportsmen to department store shoppers to fly-fishing enthusiasts buying equipment online—have helped the business to serve an ever widening array of customers.

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Further reading

Book:

  • Kubinski, Ron. Building a Breakthrough Business Through Significant New Business Growth and Profitability. Houston, TX: American Productivity & Quality Center, 2004.

Articles:

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