Increasing Profits, Sans Pain

Jonathan Byrnes, Senior Lecturer at the MIT Center for Transportation & Logistics.

Imagine if you could make your organization more profitable — without the substantial pain that often accompanies significant cost-cutting. Odds are good that you can achieve that goal, according to Jonathan Byrnes, a senior lecturer at the MIT Center for Transportation & Logistics. In his recent book, Islands of Profit in a Sea of Red Ink: Why 40% of Your Business Is Unprofitable and How to Fix It (New York: Portfolio/Penguin Group, 2010), Byrnes argues that in a typical company, 30 to 40% of revenues are actually unprofitable, while another fraction of revenues — often more like 20 to 30% — accounts for most of the organization’s profitability. MIT Sloan Management Review senior editor Martha E. Mangelsdorf asked Byrnes to share some insights about how managers can pinpoint — and increase — their companies’ sources of profitability. Here are some of his tips:

First, create a profit map to identify how profitable — or unprofitable — specific product sales to specific customers are. “Traditional accounting categories are too broad to see which accounts and products are profitable, and which aren’t,” Byrnes explains. His recommended solution? Develop a “profit map” that estimates the profitability of every order line for each customer — using transactions over a representative period, such as three to four months. The key? Don’t get bogged down in trying to create something precisely accurate. Instead, Byrnes recommends striving for “70% accuracy” — a level good enough to discern trends accurately without requiring inordinate investments of time and money. Working at 70% accuracy, “two managers can build a profit map in a month or two using standard desktop tools,” he notes.

Next, identify, protect and grow the “islands of profitability” within your company. Armed with your profit map, you may be tempted to start by addressing the problem of unprofitable customers. But Byrnes maintains that your first priority should instead be to “secure and grow your sweet spot” — those highly profitable customers that are critical to your organization’s financial success. “Typically, the best customers are being overpriced and underserved,” he observes. “The key is to focus your resources on your islands of profitability and find ways to make these customers more profitable.�