Studies show that very few companies generate a sustainable and increasing profitability. Why is it so difficult for companies to consistently generate strong profits? This is one of the most serious, complex and challenging issues facing management today and an issue that many management teams are not trained to address. Management teams are trained in managing things, but not profits.
Call a meeting of your management team and ask one simple question – "What are the five key drivers of our profitability?" My guess is the answers will sound like sales, cost containment, lower material costs, productivity, and quality. The problem with those answers is they are "results" and not "drivers" of profitability. Cost containment is not a profit strategy unless you know what the key drivers of your company’s costs are. Most management teams think in terms of functions and might say that our direct labor costs are too high or our cost to process an order is too high. But unless you understand what is driving your direct labor costs, how can you lower it with any strategic understanding of its impact?
We recently completed a project for a manufacturing client and the CFO and CEO both knew they had to cut labor costs. Their assumption was that there was not enough work (although they were working 24/7) and therefore productivity was too low so scheduling had to be the problem. Their answer was "let’s just cut the supply (direct labor personnel) and it will force a schedule correction." What resulted was a significant increase in QC problems and customer rejections. When we focused everyone on drivers, it became apparent to all that the key driver of their labor costs was related to an old myth having to do with production lead times. When that issue was addressed, production went to a five day, 2 shift operation, on-time delivery rose to 98% and QC rejects were reduced significantly while achieving a further reduction in direct as well as indirect labor costs.
It became clear to the CEO and CFO that they needed to do four things to create a sustainable profit focus in the company:
1) Define and communicate to everyone what the key drivers of profit-ability were.
2) Create metrics for each driver providing timely and accurate "Intelligence” on each metric to management.
3) Train management on how to drive the company’s performance and profits based on those metrics.
4) Link strategies with accountability based on those drivers and metrics.
In most companies, there are less than 10 key drivers that provide the most significant impact on overall profitability. Yet our experience is that most management teams have little understanding of what those drivers are and their impact on performance. Management ends up focusing on pennies while dollars slip away. If you want to lead your management team and entire company to a keen understanding of what really drives performance and profits in your company, do the following:
- Create a "Profit Map" of your company that breaks the company down into major cost and revenue components using the flow of an order as a base.
- For each major block on the profit map, create a "Driver Map" that depicts what the major drivers of each cost or revenue component is.
- Create a "Strategy Map" for the next 12 months that shows the key strategic initiatives being undertaken to grow the business, their drivers and metrics.
- Create a "Performance Matrix" that reflects your team’s evaluation of the above three maps in terms of the key drivers to manage and what the metrics of success are for each driver.
- Communicate the above results to everyone, train your management team in "performance management" and institute a monthly (or more frequent) Performance Management Reporting System so that everyone can understand and is able to manage the key drivers. Adherence to this process will create a strong profit culture in your company and will result in everyone understanding their role in profit building.
About the author: Tony Zecca can be reached via emailor at http://www.jhcohn.com.