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What’s Your Profit Strategy? November 27, 2009

Posted by David Dirks in business strategy, Management, Solving Business Problems.
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The headline from a recent article in the Wall Street Journal:  “PSA Chief Unviels Profit Strategy”.  It seems that PSA Peugeot (the car maker), reeling from the car industry woes, is about six percentage points below the average operating margins of five of its best competitors.  The new CEO has declared that 55% of his project increase in profits over his 3 year plan will come from general cost cutting.  The balance of his estimated increase in profits will be generated by increased sales in high growth markets and better sales performance in Europe.

I noted a couple of simple things.  When a business is in dire trouble from a profit point of view, the 911 is on creating a ‘profit strategy’ that is designed to get a business back on the right track.

How does that profit strategy take shape?  If you study profit strategies of companies seeking to climb out of losses and into the green of profitability, you begin to see a few basic ideas:

1.  Wringing excess out of the overall cost structure of a business wherever possible. This is typically where the bulk of profit improvement generally comes from.  The responses to this strategy run the gamut. Some businesses undertake a slash and burn process without much thought to the what, why, when, where, and how of cost cutting.  That results in sometimes creating more weakness in the business by cutting out things that are critical to operational effectiveness the real excess.

The other side of the equation are those businesses that are slow to make the needed cuts that gives them the ability to redirect resources to other key areas of their business.  That slow response to incrementally reducing costs over time can lead to a sudden rush to implement draconian cost-cutting measures of all shapes and sizes.

There is no easy answer to how to approach cost cutting as a strategy for managing a business.  If you think about it, shouldn’t we always be looking for opportunities to wring the waste from our businesses wherever possible?  Companies like Walmart have created a culture of making sure that expenses are always measured and alternatives can be generated to reduce them.

Unfortunately, that’s not how many businesses operate.  I was once told that profitability can cover a lot of mistakes.  True enough, when times are good and cash flow is everywhere (the good old days!), we can be much more liberal in our overall spend.  Sometimes, our businesses can suffer from ‘cost structure creep’.  One day you wake up and wonder how you ended up with such bloated pockets of expenses.

If there are any redeeming values for an economic downturn is that it creates an opportunity to manage expenses like we should have done anyway.

2.  Selling assets to pay down debt & refinancing short term debt. AB InBev, the firm that bought the mega American beer maker Anheuser-Busch did just that after the merger and the economy created a drag on profits.  That strategy lead to a healthy increase in overall profitability despite a decline in overall sales of about 10% worldwide.  Getting rid of assets that are not essential and/or central to the core business you are in is always a great way to reduce expenses and, most importantly, re-direct resources to those areas of the business that need it most.  In the case of AB InBev, the need to increase sales volume and protect its most valuable brands, like Becks, Bud, and Stella Artois is going to take some additional investment…investment that will come from the increase in profits that can be redeployed for those efforts.

3.  Cost cutting is never a substitute for investing in your core business. AB InBev has opportunities to sell more of its Budweiser branded beers in different markets where they have an already well-established marketing and distribution platform.  They are also introducing some new beer products like Bud Select 55 and Bud Light Golden Wheat.  Those are key strategies and initiatives that require investment in their core business and brands.

Another example would be Chrysler.  There is a company that could probably cut costs all day long and never approach profitability.  Aside from their auto industry and economy woes, Chrysler forgot (or perhaps it’s last owners, Mercerdes Benz, ‘forgot’) to invest in new products to help it stabilize and maintain market share.  Instead, Chrysler now has the least amount of product coming through its business compared to just about any other competitor.  Cutting investment in their core business and reducing the percentage of their car line that they replace over time with newer models was clearly not an effective cost cutting tool for them. The result is continual bleeding of profits and loss of market share in an already troubled industry.

4.  In times of peace, prepare for war.  In times of war, prepare for peace. I’m not sure who said this statement but I didn’t create it.  However, it does have immense implications for how we deal with economic upturns and downturns.  In times of robust economic growth, particular focus needs to be paid to how we manage our expense structure and how we allocate investments in our core business.  When the economy turns sour and if we have been diligent in managing our costs, we’ll have the ability to invest in our core business (creating new products, expanding into new or emerging markets, buying additional market share through acquisition, etc.) when everybody else is scurrying to cut out or drastically reduce costs and investments into the core business.

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We’re quick to focus a lot of our energies on the usual suspects of strategy:  product, competitive, marketing, sales, and operation.  I would also include making an investment in a ‘profit strategy’ as well as an overall guiding influence over all other strategies.  A profit strategy should answer to basic questions:

  • Where are we going to wring out excess in our business and why?
  • What areas of our business deserve additional investment to help us meet our profitability targets?

Both of these questions have implications for the short, intermediate, and long term health of our business.

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