Jonathan, you are the author of “Islands of Profit in a Sea of Red,” a book that can help companies build profit in a very short time; I’m a big fan. Could you please describe your professional journey?
I say in jest that I have tried very hard not to grow up. A lot of people who are academics around Boston feel like grown up graduate students. I have basically valued the freedom to go where my interests have taken me. I built two careers in parallel with one another. I’ve been teaching at MIT for over 20 years, and I have a doctorate from Harvard in the field of business, in strategy, marketing, and operations. At the same time I’ve built a very successful consulting and software business. I really work in two areas which are directly linked to each other. A lot of the work that I do with clients becomes core to my course, and every year I have three to five professors from abroad sit in on my course at MIT learning how to teach it. At the same time the things that I figure out in my research and teaching I bring to my clients. What I do is work with people to understand their problems and how to change things so that they can take advantage of new opportunities. I have had a dual career for virtually my entire adult life and it’s just been a wonderfully delightful thing to wake up in the morning and say, “which should I do today?” and yet be disciplined by the need to create real value all the time because as we both know, Margaret, the customers say whether it has value or not.
What piqued the interest to ask the specific question that you address in your book about managing profitability and especially customer profitability?
A number of years ago, back in the mid 1980’s, I was doing a lot of work for Baxter, the big hospital and laboratory supply company. We were working on a vendor-managed inventory project, as well as what’s now called inventory echeloning and cross-docking that Wal-Mart and others do. We were looking at the profitability of the business trying to figure out how to improve it, and I discovered that even though they were doing quite well and they had highly audited financial statements, I couldn’t understand in detail where they were making money and where they were losing it. The categories that are used for financial reporting– for example, revenues, cost of goods sold, different sales costs, and other sorts of costs are aggregated categories. Years ago that was fully adequate to maximize profitability because you had economies of scale in virtually every element of business, so in order to win you just simply had to maximize revenues and get big. When you got big your cost per unit went down so you achieved high profits. What’s happened in the meantime is that pricing is all over the map with different products and different customers, and the cost to serve is all over the map with different degrees of integration with different customers– we don’t just drop the boxes off at the receiving docks. Consequently, you have a crazy quilt pattern of profitability in virtually every product in every account, and the aggregated categories of revenue, cost of goods sold, overhead cost, G&A, and the others simply average a lot of high profit and low profit situations. By developing a unique way of figuring out profitability – by essentially doing a full P&L statement including overheads on every single invoice line – I could get the costs right and get the revenues right and attribute them to each product in each account, and then I could put it in a database and really analyze it. We have software now that does that. In our Profit Isle business, we’re running databases for companies with 50 to 100 million records. It’s very industrial grade and highly optimized software. At the same time what’s really critical is working with these companies to help them understand how to create profit improvement processes that direct and align sales reps, supply chain managers, product managers and others on what to do to improve profit. I focused in on two areas. One is a micro-detailed understanding of profitability and the second is a very actionable pathway to success that has been proven over decades by companies working with this sort of information and these sorts of processes.
In the last three decades, how much progress have we made in terms of business leadership adapting the concept of managing for profitability?
It’s been adapted to various degrees, but it’s still a very open playing field. The companies that we have worked with have over a hundred billion dollars in client revenues running through our models. They range from an $8 billion international distributor based in Europe to a $100 million retailer in the USA. We work with big and small companies alike. It’s not unusual to double the profits of a company within a year or two. We had one company that tripled its stock price within two years and had 40 percent profit lifts in the places where it had initiatives. The results are really very fast and striking however they seem confined to a relatively small number of companies. The companies that we deal with have been extremely successful and they are almost always the leaders in their field. The people who come to us are typically the ones that are doing the best and they want to become 2 or 3 times as good. The companies that are lagging usually don’t come to us, and don’t want a lot of help. We have worked with the leaders in almost every field.
Why is it that companies are slow to choose to adopt something like this?
That’s a really, really insightful question Margaret. In my experience the biggest issue is that everybody agrees that there’s an opportunity there but nobody knows what to do about it. In our research, we discovered that in virtually every company that 30 to 40 percent of the company is unprofitable by any measure. We’re now working with companies that are market leaders in their industry where 7 to 10 percent of the customers are providing well over a hundred percent of the profits. About 10 years ago I spent time talking to 50 CEO’s and CFO’s primarily affiliated with Harvard and MIT where I have my contacts. We asked them, “Do you agree that there’s an enormous profit opportunity here?” The CEO’s and CFO’s said, “We agree; we do see that but we have no idea how to approach it. We do know that we don’t want to “fire” 70 percent of our customers.” The answer of course is that you would never fire a customer, you want to make the customer profitable – but the most important thing is to secure and grow the business that’s giving you all of your big profits. The way I would phrase it is, “if 10 percent of your customers are giving you 120 percent of your profitability, what percent of your “love” (resources) are they getting?” I would assure you it’s not 70 percent, but probably closer to 10 to 15 percent. There is misalignment between the resource and the payoff. Very early on in doing this work I shifted focus from figuring out where the profits are to the more important issue which is how do you create a highly manageable set of processes to convert this set of opportunities into results? What do the sales people do? What would be the right intervention with the sales rep, how many accounts to work on, what characteristics do they look for in the accounts, how can you judge whether they’re going fast or slow, how do you manage it, how do you compensate it, what about the product people, what is the right product portfolio for different segments? What should your supply chain managers do to align your operations with profit potential. It’s a very complex set of questions but if you have an eye for analysis you can figure out very precisely what the answers are, and then you can put that into a set of information and organizational processes where everybody in the company is doing the right thing on every detail rather than simply getting the averages right. It’s that chasm between knowing that you should do something and knowing that there’s a process that’s highly practical, that fits what we’ve always done that will give us results that are twice as good. That’s why so many companies are not doing what they could do.
You mentioned earlier that the ones that really get this and seem to jump on it are the industry leaders, the companies that already have strong leadership at the top which is akin for high performance.
Given leaders are pursuing this but it’s a small minority of the total market, do you feel like there’s going to be a greater polarization of those that have success and those that don’t within each industry?
The real question is who gets the best piece of the market, who gets the customers that are not price sensitive, who gets the customers that have high growth, who gets the customers that are relationship buyers, who gets the customers that have the right order pattern and the right operating fit so that you get extremely high profits even for the same revenues? The real scramble is for the best customers, and some companies are going after the best customers; others are just simply chasing revenues and losing the best customers and these companies are doomed. You have customers with revenue growth but profit declines, and you have other accounts where you can grow both revenues and profits.
In eagerness to move forward to pursue this type of work, what’s often most misunderstood or done incorrectly in the attempt to improve customer profitability?
I think that there are two things that are pretty fatal. The first one is “my goodness I have to work on everything.” That’s a recipe for a train wreck, it’s just a disaster. The best process is be very, very careful to focus the sales reps and the others on a relatively small number of high payoff situations and really load the sales managers with information on how to change things in the accounts, in the product mix, whatever it is. So the first caution is not to boil the ocean. The second thing is to be very focused on the right priorities. If you simply hand profit reports to a sales force, they will go out and find a couple of small accounts, they’ll have them order two times a week instead of four times a week, declare victory and go on with life. What you really want to do is focus first on the small number of accounts that are giving you all of your profits and secure them, figure out how to grow them, figure out whether you’ve got a compelling value proposition or whether you’re becoming commoditized. If you do have a compelling value proposition, understand how to accelerate and build on it. Then you want to go out and identify other accounts that can be your future islands of profit accounts – either where you’ve got a small share of wallet or even where you don’t have any, and bring them into the fold. Then, and only then, do you start to turn around the unprofitable ones. Your most precious time and attention is the sales rep’s time and attention that is devoted to changing an account. That’s a very scarce commodity and you have to be very, very careful that you apply it to the most realistic and highly productive situations. Then you want to track how well the different reps are doing so that you can teach them to be more effective. It’s not just recognizing opportunities but also increasing the company’s ability to capitalize on them.
Where is the tipping point? When will this become so necessary for the next level of business success that everyone will move in this direction?
By the time there is a tipping point, it’ll be pretty late for the people who are lagging. I think that there’s a land rush for the right customers and the right business right now. There will be fewer advantages later.
What are the pillars to great strategy?
The acid test of great strategy is what you say no to, and most companies are not willing to say no. The two great values of profit analytics are first, you can focus all of your human resources on being most productive because you’re doing the things that pay off the most. The second one is the macro strategy issue: you can figure out where you’re making money and where you’re not broadly speaking and say do we have the right value proposition? If all customers and all revenue dollars are equally desirable (and that’s what most sales compensations systems tell you) then you’re going to be all over the map in what you’re trying to do, trying to protect every dollar everywhere. The key to success is to be custom designed to get the most profitable dollars, by building your value footprint in the most profitable segment of the market, and align your operations with sales and marketing to get, keep, and grow that segment and to constantly pump value in. For other parts of the market that don’t fit you, you can serve them but it’s more of a menu approach. I was in a distribution center in Louisiana about a year or two ago and 40 percent of the cost structure of this major distribution center (800,000 square feet), were one off requests from little customers that were caused by what I call minnows – low volume, low profit – and they were just disrupting the whole thing. Company after company winds up in that situation because they don’t have the profit map and the profit analytics to understand where they’re making money, and how they’re making money. Therefore they can’t focus on one piece so they’re focused on not losing this and not losing that and it just pulls them apart. A highly focused competitor will come in and eat their lunch every single time. Name the companies that are the great companies of our age and they all are extremely focused. You can tell right away what they say no to and everybody in the company would agree.