In all my experience, the most consistently tracked item is sales. Most organizations look at it daily (not a bad thing), it’s generally the easiest metric to quantify, and the least subject to manipulation. Wall Street, however, is obsessed with EPS. They could care less if you hit your sales target. If you miss your EPS target by $0.01, you could be crucified.
Many owners (not all, though), have the desire to grow their business. The main two reasons are that that additional sales should lead to more income, as well as a company with better long-term stability, making it easier to sleep at night knowing you can keep providing paychecks to employees. However, not all sales are created equal, as evidenced by the following examples:
- Company A: A large multi-national (under new leadership) embarked on plan to nearly double sales over several years. Admittedly, this growth plan did overtly state that the profit margin was to remain constant with historical levels. A significant part of the sales strategy was based on new products (for existing markets) as well as new products to branch into new markets. This approach was in definite contrast to the prior leader, who only allowed a new SKU to be created if another one was removed.
Due to many global changes which had an effect on the company’s financial position, as well as some internal challenges, the company needed to go through a restructuring.
Ultimately, 49% of 2,600 SKUs were eliminated, which translated into a sales reduction of 10%. More importantly, this allowed the company to eliminate over $3.5 million of fixed costs, which more than offset the loss of variable contribution from these products. In addition, it allowed for a 25% reduction in inventory, generating much needed liquidity. The company further eliminated another 10% of SKUs (but a significant part of revenue) by shutting down one division that could not be turned around.
The company ended up with a revenue base equal to 30% of the starting point from which it was planning to nearly double. However, it returned to being solidly profitable with a higher profit margin, despite operating in a facility that was only 33% utilized.
- Company B: A small manufacturer was purchased by a member of the second generation. The product selection was broadened to attract new customers and open up new markets. The revenue line did go up by over 25%, but the complexity of the business increased exponentially.
The business had over 260 products, but the top 8 accounted for 50% of the company’s sales. Almost 200 products accounted for only 10% of sales. The customer mix was just as profound, the top 40 customers were responsible for 80% of revenues, another 500 customers were responsible for 20%.
The new products (which were all completely different from core products), caused operational headaches with manufacturing, as well as increasing the complexity of purchasing. These problems snowballed by causing production and delivery delays, which led to lost customers. This loss of profitable business translated into operating losses, which then restricted liquidity, causing the company to be unable to get raw materials to finish all the orders it had in hand.
To add insult to injury, one “major” new customer ended up stiffing the company, to the tune of 4% of annual sales, turning a very marginal new customer into a big loser.
- Company C: A manufacturer who services large OEMs landed a new customer by winning the bid for a component in one of their programs. This new customer would increase the company’s revenue by almost 10%. The product line was designed to be fully automated to run efficiently for this high-volume part. The customer, however, accelerated their timeline and needed products before the automation was to be completed. The company agreed to start supplying products by using temporary labor while still trying to finish the automation of the production. This was analogous to changing a car tire while driving down the highway, and yielded the same result.
The labor required to meet production levels was more than 5 times what had been quoted for the job. Completion of the automation took even longer because there was less available time to program the machines and robots since production was top priority. The losses incurred until the automation was fully completed were greater than what could be earned back over the life of the contract.
To avoid these types of situations, it first starts with acknowledging that not all sales are necessarily good. Managers need to ask questions and continue to dig deeper until the answers begin to make sense. Sometimes firing a customer will actually improve your bottom line. Ideally, a company should have good reporting on product and customer profitability (at a variable level), this helps identify the low performers. However, the fixed costs associated with various segments of an organization can be hard to allocate and fully understand. Conducting a zero-based budgeting exercise can be a very eye opening in how resources are used throughout a company.
**Disclaimer: Startups can be justified in incurring large losses while growing sales**