By Jon Denney
Where is the first place business leaders tend to focus when they decide that profits need a boost?
It’s the sales team. Often, company leadership takes a critical eye toward the sales department and decides that the team needs to take it up a notch and make more sales happen. While that route certainly is one way to improve profits and increase profitability fairly immediately, it isn’t the only way.
This recent exercise from a company I dealt with in my consultancy points out that there are alternative avenues to creating additional profits. They include focusing on what I call “the three P’s of profitability” – pricing, purchasing expenses and production costs.
Let me explain how other operational aspects, above and beyond the amount of selling that’s being done, can lead to higher profits. I’ll use the example of “ABC Company” for two separate years.
In year one, ABC Company had annual sales of $2.2 million and total annual expenses equaling $2.068 million. That left a net profit of $132,000 — a 6 percent net profit margin. Since the company’s average sales transaction (average invoice) was $1,000, that meant the business incurred about 2,200 sales transactions in the year.
But the following year, the company changed things up:
They raised their pricing by 2.5 percent
That increased the average invoice from $1,000 to $1,025.
The company did not lose one piece of business from the price increase.
Annual profit increased by $55,000 ($2,200,000 x .025 = $55,000) from just that action.
Step 1 results: a 2.5 percent price increase earned a profit gain of $55,000.
Examining Labor Costs
Next, the company looked at its labor expenses more closely. It determined that:
Of $2,068,000 in total expenses, $1,116,720 was spent on production labor and production labor-related expenses (taxes, health insurance, workers’ compensation and unemployment insurance programs).
That data showed that the company’s production labor, as a percentage of sales, equaled 50.76 percent. (That meant for every dollar ABC Company invoiced customers in 2016, 51 cents of each dollar went directly to pay production labor costs.)
Looking at Work Efficiency
The company next focused on how its employees might help improve profitability. The leadership asked its production team to help boost profitability by changing employee work habits slightly, focusing on work efficiencies. The company:
Reasoned that an 8-hour shift = 480 minutes.
Determined that if every production team member could work a little faster, take a little less time on breaks, and work more efficiently, the company could probably pretty easily produce the same amount of work in 24 minutes less per shift.
Estimated that if employees were able to do smarter and more focused work, each person could produce the same amount of work in 456 minutes as they had been producing in 480 minutes per shift.
This may sound self-serving until it’s revealed how such changes impact productivity – thus profitability – by meaning not having to staff as heavily or doing the same work with fewer hours dedicated to labor.
24 minutes saved per person per shift, divided by 480 (total minutes per shift) results in a 5 percent time savings.
A production efficiency improvement of 5 percent — thus a 5 percent reduction in production labor — equals a profitability increase of $55,836 ($1,116,720 x .05 = $55,836.)
Step 2 results: a 5 percent reduction in production labor costs (24 minutes per person per 8-hour shift) earned a profit gain of $55,836 for the company.
Next, ABC Company reviewed all other expenses (as reflected on their annual income statement detail report). The company determined that about $500,000 in annual expenditures could either be reduced or eliminated. ABC then set a goal to reduce those costs by a total of $20,000 (4 percent) in the current year. It then reduced expenses by:
Renegotiating with longtime vendors
Competitively bidding supply purchases
Consolidating and refinancing loans
Eliminating unnecessary recurring charges
Eliminating marketing efforts that yielded no return
Negotiating fast-pay discounts for customers
Negotiating discounts for customers who paid by check instead of credit card
Cutting back on frivolous expenses.
Taking those steps, the company beat its goal of reducing expenses by 20 percent — reducing purchasing expenses by an additional 5 percent. That added a total monetary gain of $25,000 ($500,000 x .05 = $25,000) new profit.
Step 3 results: a 5 percent reduction in purchasing costs earned a profit gain of $25,000.
How It All Adds Up
Taking into account all the people, purchasing and production changes it implemented, the company realized it had generated significant funds:
$55,000 resulting from the 2.5 percent price increase
$55,836 saved in production labor
$25,000 saved in purchasing costs
All those actions resulted in an increase in the company’s total profits in the second year of $135,836.
Fully apart from sales efforts, those three operational steps boosted the company’s annual profits to a new level — from $132,000 in 2016 to $267,836 ($132,000 plus the newly-found $135,836) — more than doubling them in one year. That is a profit gain of about 103 percent without having to sell a single item more than they did the prior year!
While leadership typically focuses on the sales department as its first solution to increasing profits, this exercise shows that all departments and all functions are able to add profits to the bottom line through increased efficiency and decreased expenses.
It’s a new way of looking at the whole picture – and it’s something your sales team will be very grateful that its company leadership is taking into account.
Jon Denney heads the Professional Business Coaches Alliance, North America’s premier business-coaches organization. He also operates an executive coaching consultancy, offering individual coaching for business owners plus strategic planning, group coaching, and leadership development services. In the past 10 years, he started and grew four different, profitable, multi-million dollar ventures. He’s at: Jon Denney Executive Coaching, LLC, Syracuse, N.Y. and: [email protected]; 315-952-9704.