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Beware of business leaders who believe that they should just keep doing what's always worked. To capture more of that potential, businesses should continually upgrade their business models (who, what, when, why, where, how, and how much of what they offer). Here are three examples of how to think about this question in terms of the dimensions who, where, and what.
Who Is Served and Where
Let's first look at "who" is served. The lesson is to keep it simple. Change as little as possible while becoming more efficient and effective as an organization for your customers and beneficiaries. The simplest way to do this is to put more volume through an existing organizational structure without adding fixed costs or increasing the ratio of variable costs to sales.
In a for-profit organization you will naturally start by attracting the most profitable potential customers. If current customers buy a very small percentage (say 1 to 2 percent) of their needs from you, such a profitable expansion may simply be possible by selling 40 to 50 times more to selected current customers. You are already spending time and money to gather a small part of these customers' total requirements. In many cases your overhead costs to provide more products and services would not increase.
Let's assume your current pretax profits are 10 percent of sales and your contribution to profits before overhead costs is 30 percent of sales. This circumstance means that selling more of the same mix of offerings at the same price to an existing customer would almost triple the profit contribution margin on the increased sales. Were that to occur, a 20 times increase in volume would lead to a 60 times increase in profits!
By contrast, if an organization picks people and organizations to serve who are located far away and desire less profitable offerings, this choice of who is served and where to serve them can increase costs to serve each customer and beneficiary versus doing more with the same customers. For instance, if the for-profit company seeks to serve new customers globally who require local support, the company's overhead and the cost of offerings are likely to grow faster than revenues. In that case, absolute profits may decline or even turn into a loss. See Exhibit 1 which quantifies this circumstance.
Exhibit 1: Adding Less Profitable Revenues in Diverse Locations Increases Offering and Overhead Costs
More volume doesn't automatically translate into more profits. If you have to sell items with less profit contribution as a percentage of sales due to new customer preferences and your overhead costs grow, you'll more than offset the profit gain you hoped to obtain. In this example, the corporate overhead cost remains almost constant as a percentage of sales through the need to support more geographic areas with administration, while the profit contribution percentage drops from 30 percent to 20 percent. However, if overhead costs go up enough as a percentage of revenues, the effect can be to turn a profit into a loss.
Annual Pro Forma Financials Before Volume Expands
Revenues $1,000,000
Cost of providing offerings $700,000
Profit contribution $300,000
Corporate overhead cost $200,000
Pretax profit $100,000
20 Times Volume Increase with Higher Offering Costs and Overhead
Revenues $21,000,000
Cost of providing offerings $16,800,000
Profit contribution $4,200,000
Corporate overhead cost $4,150,000
Pretax profit $50,000
What Is Served
Selling or providing more of what you already offer can be a big help in creating efficiencies. But sometimes you are gaining virtually all of someone's purchases for those items.
When that happens, consider what else you can profitably sell or provide at a fair price with desirable qualities and service that the customers you already have want to buy. The advent of the Internet makes this evaluation much more potentially rewarding because postal, air freight, and electronic delivery choices enable you to serve most of the world.
As with the previous examples, this for-profit challenge requires considering the potential volume and the effects on overhead costs and profit contribution margins. Exhibit 2 shows the kind of effect that a positive change in volume can make by adding volume through more profitable items that do not increase overhead costs very much.
Exhibit 2: Adding More Profitable Items to Expand Revenues Without Increasing Overhead Costs as Rapidly Further Speeds Profit Growth
This example shows the profit multiplying potential of increasing profit contribution margins from 30 percent to 40 percent while decreasing corporate overhead costs from 20 percent to 3 percent of revenues. The result is a 7,700 percent profit solution. If revenues could be expanded even more, a 40,000% solution (a 2,000 percent squared solution) for profits could result.
Annual Pro Forma Financials Before Volume Expands
Revenues $1,000,000
Cost of providing offerings $700,000
Profit contribution $300,000
Corporate overhead cost $200,000
Pretax profit $100,000
20 Times Volume Increase with Higher Profit Contribution Products and Limited Additional Overhead Expenses
Revenues $21,000,000
Cost of providing offerings $12,600,000
Profit contribution $8,400,000
Corporate overhead cost $600,000
Pretax profit $7,800,000
Copyright 2007 Donald W. Mitchell, All Rights Reserved
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