Ideas

Thinking About Your Company

TSG management consultants are business problem-solvers. The majority of our work involves profitable companies and leaders wanting to optimize financial and organization performance.

Think-to-Solution…

How we think-to-solution, and help clients do the same, is consistent with Oxford Dictionary’s second definition of Problem: “An inquiry starting from given conditions to investigate or demonstrate a fact, result, or law.

Use the latest technology to get inside our heads and you’ll see something like this…many interconnected neuron networks working together in concert.

neuron

Brains function holistically across different regions to collect-analyze-synthesize information and make sense of our surroundings. Communication occurs through electrical and chemical discharges. The bright lights in the photo signify electrical activity and information transfer between neurons.

A similar information sequence plays out with our clients. The only difference is mode of communication. We use language and data to help make sense of their businesses.

Consider this familiar situation…

The Red Flag…

You’re leading a profitable mid-size company. Another year is in the books and results are in. The P&L shows profits are down somewhat. You do some quick math and note a 6% decline from the prior period.

The decline is troubling. The impulse is to take action but you’re not sure what’s behind the performance dip. At first blush, any number of different factors could be at play.

Your thinking is dead on. Without analysis, the number of possible causes is certainly more than one. In fact, possibilities could easily hit a dozen or so as you consider the range of inputs capable of impacting profitability. The devil may be in the details but, so is the solution.

Assume a trusted business advisor knows a crackerjack management consultant. She’s willing to make an introduction. Your call. You think about it and decide to accept her offer. You’re looking for a concise summary of why profits declined (problem definition) and what to do about it (recommended action).

Here’s what you can expect…

Broad then Deep…

All engagements begin by clarifying clients’ definition of the problem. Initial questions are specific to their concerns but can broaden to include other factors relevant to performance.

thinking-honeycomb

We want to know which and how these factors contribute to the problem and optimal solution. Are profits down because of company practices; perhaps weak branding, failure to respond to changing customer needs and demands, more competition, or new disruptive products that threaten to hollow out everyone’s profitability?

Or, maybe the problem is outside the company. Is the industry or larger economy a factor? Comparing company growth rate to the industry rate can help isolate the problem and determine solutions.

Responses quickly elicit hypotheses or hunches about what’s going on.

thinking-gears

Hunches trigger specific problem-solving frameworks…

Frameworks…

A framework is a jump off point for deeper analysis. Hunch #1: A 6% profit decline suggests a profitability problem. We use a Profitability Framework to explore the hunch:

thinking-profits

When profits are down either revenues, costs or both have changed. We break down and segment one component at a time to isolate the cause(s) driving the decline.

Revenues

Starting with Revenues we identify the financial performance trends: Revenue growth rate during the past 3 years, growth rate from prior year, growth rate in relation to industry rate; etc. Bottom line: Are Revenues declining, flat, or growing?

The Revenue formula allows us to drill down further. It isolates the two primary inputs to revenue generation: Volume and Pricing. Is the company selling as much as possible and being fairly compensated for what it provides customers?

thinking-revenue

To move things along, let’s assume revenues showed a slight uptick during the period: Modest volume increase but less than the industry growth rate while prices and gross margins remain unchanged. The revenue side appears okay, “Now what?”

Costs

We return to the Profitability equation and shift to Costs. As with Revenue, we break Cost into its components, this time: Fixed and Variable. Are costs higher? Which type? We run the same comparative performance analysis for each input.

thinking-cost

Turns out Fixed costs are stable compared with the prior performance but there’s a notable increase on the Variable side. Interesting, since variable costs usually track to sales volumes, which we know are marginally better but largely flat.

Pop quiz: Is an increase in variable cost the culprit?

Sure looks like it, mathematically. But we’re not there yet so we drill further down. Like most companies, our hypothetical one breaks variable costs into Cost of Goods Sold (COGS) and Selling General, and Administrative (SGA). SGA breaks down further into: Administrative, Marketing, and Development. COGS, administrative and, marketing are flat.

However, development spending is up quite a bit. We discover the company is developing a new product. The leader describes it as groundbreaking and essential to remaining competitive and sustaining performance. One more thing: It’s early in the development cycle, so spending will continue and likely increase moving forward.

New compelling information should never go unnoticed or unexplored. Instead, we summarize the analysis to this point and consider the problem from a different perspective.

We Interrupt this Process…

With the Profit Framework we note a modest Revenue increase and identify Variable Cost as the culprit. Ordinarily, the recommendation is reduce cost. Except increased variable spending is tied to a new product initiative and will continue. We therefore conclude that opportunity to improve Profitability through the cost side is limited.

So we rule out the obvious culprit. Again, “Now what?” The answer is dig deeper into potential weaknesses. Earlier we took note of the fact that sales growth lags the industry. Is just okay sales growth really okay and why the lag? So, we circle back to the Revenue side of the Framework.

Back at it…

Revenue growth results from consistently offering something the market wants that is better than the competition. Keeping momentum requires understanding the four inputs to Volume and Price, including the company’s Growth Engine or internal revenue generating activities.

revenue-growth-chart

The inputs enable us to understand why (Customer/Product/Competition) and how (Growth Engine) the company generates its Revenue. Do products provide unique value, are prices commensurate with value or compressed by the competition, and is there the organization wherewithal to further scale?

Data highlights include:

  • The company delivers five products: Two are profitable, two are breakeven, and one is unprofitable.
  • 13% of customers drive 87% of revenue
  • All customers are valued and treated equally
  • Sales activity is focused on serving existing customers
  • New competitors are leveraging technology to improve customer experience

Putting it all together…

Conclusion:

Costs are higher due to new strategic initiatives but lagging Revenues are problematic.

Recommendation:

Our fictitious Company should strengthen Revenue Generating activities: product and pricing, to improve Profitability, better absorb increased cost, and remain competitive.

Reasons:

  1. Products are under market and competitive pressures
  2. Customer concentration is high creating increased risk due to key account loss
  3. Customers are not segmented making it difficult to align value proposition and pricing
  4. Insufficient new business development activity

Going Forward…

Leaders interested in strategic impact benefit from the approach and mindset demonstrated here. Solving business problems well surely requires sound analysis and synthesis skills. But like any other process, a healthy dose of creativity comes in handy.

Witness our case example. Profitability is a mathematical outcome. It’s quite natural to quickly identify what’s numerically out-of-line and respond according to the quantitative solution. Except here, creating a tactical campaign to reduce costs misses the boat.

Maybe it would narrow the 6% gap in lost profitability? But tepid revenue performance clearly indicates the bigger problem. Spotting the core issue is precisely how consultants add value.For the executive team, identifying and deciding to take on the Revenue issues is what strategic impact and leadership is about.

Contact us for a chat on thinking about your company.