Catch Phrases Every Small Company CFO Has Heard (and Uttered)
Catch Phrase #2: We will make it up in volume!
CFO’s Response: But the profit margin is too low (or dropping)!
While catch phrases always contain an element of truth; using them as a justification for a business decision can sink a company. Catch Phrases and the CFO’s Responses are usually based on the different motives and personalities of the players involved. Avoiding the “sound bites”, understanding the underlying motivations and fears of each member of the team always leads to better outcomes.
Raising prices, eliminating low margin products or divisions and addressing production costs that are too high will many times reflect badly on someone in the organization.
The reason each team player perceives the profit margin is too low (or satisfactory) greatly influences how they approach the issue.
- Raising prices is always a difficult conversation the salesperson has to have with their customers. They need a reason that will be understood and acceptable to their customers. They want to provide their customers with full solutions.
- Operating & production personnel are constantly being asked to drive down the cost “to be competitive” yet many times they perceive they are being asked to “jump through hoops” by the sales department which can create inefficiencies in their operations.
- The CFO perceives the margin is too low through the lens of the financial data coming in. Supplier costs are going up and the sales department is afraid to raise prices and the operation and production data shows cost increases as well. Typically, not involved in the day-to-day conversations with customers nor on the shop floor each day, their assessment on the acceptability of the margin depends on their judgement of the truth coming from the team members frequently without any supporting evidence. The why behind the financial data.
Ultimately in the long run the marketplace determines price. The company can only determine their costs and the volume of sales they are willing to accept and decide if it will make an acceptable profit at that volume.
At this point each team member must set aside their beliefs and antidotal stories with hard, honest data and be open to challenges from other team members as to their conclusions.
In most cases a declining margin is the result of not one but a number of factors, some of which are beyond the control of the company. The data required is typically not routinely collected in a smaller company and requires ad-hoc analysis by each team member. Some analysis to consider:
- What are competitors’ prices in the marketplace and product/service comparability?
- Have we revisited supplier pricing recently?
- Has our overall product mixed changed?
- Has our customer mix changed?
- Are our competitors automating their processes driving down their costs?
- Are we producing along industry standards/best practices?
- What is the financial breakdown of each component adding to product/service cost.
- What interruptions to production/product service delivery have occurred in the last 90 days and what was their addition to costs?
- Are we pricing based on cost to produce verses market?
- Can show that lower profit margins due to product mix/customer mix changes are acceptable as such changes allow even greater cost savings in operational and other organizational costs or complexity?
After the team has reviewed the various factors driving costs they then must decide whether the margin is acceptable and/or the changes needed to improve it.
This step will only be successful if the various analysis and honest discussions have pushed each team members’ original understanding of the reason for the existing profit margin (and the ability to change it) towards a more universally accepted understanding of its components. It should also serve to drive a collective agreement as to volume and profit expectations.
I’ll Leave You With This….
- In addressing profit-margin issues many times management is too focused on a strict definition of profit margin, ignoring other organizational costs certain products or services require such as additional accounting or support staff, equipment, etc.
- The most emotion-driven and hardest to admit and correct are profit-margin issues that involve non-competitive costs in the production or operational delivery of the product or service. This usually involves replacement of individuals involved or the outsourcing of the production or service now internally performed. Remember this division may have been somebody’s brainchild and “baby” at one point and now you may be calling it ugly and unwanted.
If your team is not satisfied or would like to some insights regarding its profit margin please feel free to contact us at IFI.