How to Lead a Profitability Turnaround

Virtually every company is 30-40% unprofitable by any measure, while 20-30% provides all the reported profits and subsidizes the losses.

My new book, Islands of Profit in a Sea of Red Ink, explains why this happens to so many companies at this point in history, and tells managers how to fix it.

Many managers make the big mistake of assuming that a profitability turnaround must be a disruptive, one-time event. In fact, the most effective turnarounds are more like deciding to get healthy by eating better and getting regular exercise. When managed well, results come surprisingly quickly and the management team forms a culture of profitability that gets stronger and stronger.

A few weeks ago, I gave a talk and presentation to a group of top executives in Milwaukee at an event arranged by a terrific organization, 800CEOread. In the talk I highlighted some of the key points in my new book. Here’s a link to the presentation:

How to Be Effective: Structuring Change, Managing Change, and Leading Change

When I talk to former students, clients, and executives, I’ve found that their biggest concern is being effective – going beyond conceiving great new things and actually driving them into practice.

I’ve also seen that most people make two big mistakes when they think about change:

  • They fail to realize that managing change requires a really different process from day-to-day management, not harder but very different.
  • They approach change in a one-size-fits-all way.

Successful change, being effective, involves three things: structuring change, managing change, and leading change. I call this The Golden Triangle of Change.

This is the beginning of my new article, “How to Be Effective,” which appears on the current edition of My new book, Islands of Profit in a Sea of Red Ink, which will be released this week, amplifies and details these themes in the section on Leading for Profit. Here’s a link to my new article:

Welcome to Our New Era of Management

A few days ago, I visited a friend who is pioneering a new course at the Berkeley’s Haas School of Business. The objective of the course is to train graduate students in critical thinking – framing difficult management problems in creative and innovative ways.

The course is designed to shift their thinking from “how to do it” to “why to do it.” It is only by thinking creatively about the “why to do it” that a manager can design powerful new solutions and approaches that transform management. She is focusing on the most important objective of business education – to move beyond teaching students how to do the things that others have already figured out, and instead to teach them how to create the next generation of innovations that others will study.

After our conversation, I reflected on a panel discussion in which I participated earlier in the week. The subject of the panel was managing supply chain transformations, and the panel also included top supply chain executives from P&G, Chiquita, and Pepsi.

These three leading companies shared the same strategic dynamic. They were creating important gains in market share and competitive positioning because they were capable of partnering with their best customers to jointly create more and more powerful supply chain efficiencies. These efficiencies increased the customers’ profitability, which in turn drove large revenue increases for the suppliers. At the same time, they dramatically improved their own supply chain productivity. They were rapidly increasing their market share and profitability, even in a stagnant economy.

The discussion quickly turned to the question of how they did it: How can a company’s supply chain managers shift their focus from inward-looking cost control to the critical task of creating a much broader host of financial benefits through supply chain integration with the best customers? I have been asked the same question in various forms in discussions with CFOs, CIOs, and top executives in every functional area, who wonder how to shift their managers’ attention from narrow technical issues to broader, high-payoff matters.

The underlying problem is that we are shifting from one era of business to another. A great guide to the management implications of this shift is the classic work on organizational design and management by Paul Lawrence and Jay Lorsh. They investigated the question of whether the best form of organization was for a company to be centralized, with separate functional “smokestacks” that only came together at the top of the company, or to be decentralized with a high degree of interdepartmental integration at the local level. To figure this out, they looked at high vs. low performing companies in a few different industries.

What did they find? They found that it depends – on whether the company was in a stable, homogeneous environment or a rapidly-changing heterogeneous environment.
I always picture two polar extremes: a brewery and a plastics company. A brewery (before the days of craft beers) is in a relatively stable environment. The objective is to carefully set the operating policies of each department – operations, advertising, distribution, etc. – and not let the departments interfere with each other. Hence, the wisdom of a centralized “smokestack” organization where important changes in operating policies are tightly controlled and coordinated at the top.

A plastics company is at the other extreme. Every customer is different, and every project is different. Here, the company needs to form relatively independent teams for each project or cluster of projects. Each team needs to have representation from sales, engineering, manufacturing, distribution, etc., and the locus of coordination must reside at the team level.

When I talk to the managers in a company about their organization, in the back of my mind is the question: Should it look more like a brewery or a plastics company?

Our whole economy has shifted from one era of business to another. In the prior era, the Age of Mass Markets, the fundamental objective of most companies was to drive down costs through economies of scale, and this involved distributing as broadly as possible through arm’s length relationships. The markets were relatively stable and homogeneous, and most companies correctly were organized like the brewery. In this context, most managers were focused on the rather technical tasks in their own department – the “how to do it” issues. Most of our management processes were formed in this earlier era.

Today, we have shifted to a new era, which I call the Age of Precision Markets. Leading companies form different relationships with different customers, each with very different operating characteristics and vastly different profitability. My new book, Islands of Profit in a Sea of Red Ink, describes this transition in detail. The most successful companies have learned to organize like a plastics company – account teams that are multi-functional and highly coordinated at the local level. This is exactly the solution that the leaders of P&G, Chiquita, and Pepsi described in detail, and credited with creating their stunning success. (Think about P&G’s account team at Wal-Mart: representation from sales, supply chain, IT, and finance.)

In today’s era, the essential management task has shifted from the narrow, inward-looking technical skills of a mass-market-era manager, to a new set of tasks. Today’s successful managers have to be broad-gauge creative thinkers that can work with colleagues across departmental boundaries in a rapidly-changing world.

Managing this transition is the most important management challenge today. More than anything, the key success factor is for managers to shift their focus from “how to do it” to “why to do it” – exactly the need that my colleague’s innovative new course is designed to address.

The managers who master this essential understanding will be the leaders who guide their companies to ever-greater success, while their competitors who remain mired in the past fall further and further behind.

Unlikely Sales Heroes – Supply Chain Managers

You finally landed your first orders from that really important high-potential account. When should you bring in your supply chain managers?

In most companies, the standard progression is for the sales rep to focus on ramping up the sales volume, with a courtesy call from the company’s local supply chain manager only when the account is “safe.” Wrong answer.

This “sales first, supply chain last” way of dealing with account development is an obsolete and counterproductive approach to customer management that stems from the past “Age of Mass Markets.”

For most of the past century, businesses operated in the Age of Mass Markets. In this era, companies sought economies of scale through mass production, and they distributed their products as widely as possible through arm’s-length relationships. Most of our current management processes were developed in this earlier era. During this period, managers correctly focused on aggregate revenues and aggregate costs, and the role of a logistics manager was to move and store products at the lowest possible cost.

Today, all that is changing. We are in a new era, which I call the “Age of Precision Markets.” In this new era, companies form very different relationships with different groups of customers, and these feature very different degrees of supply chain integration and coordination, with vastly different profitability. The big problem is that all too often supply chain managers are not systematically involved in creating and managing these relationships. Instead, many are still primarily focused on internal cost control – like the logistics managers of old.

The consequence of this deficiency is a pattern of profitability that I have seen in my research and consulting with leading companies in over a dozen industries over the past two decades. In virtually every company, 30-40% of the company is unprofitable by any measure, and 20-30% provides all the reported profits and subsidizes the losses.

How can a top manager change this? By making supply chain managers essential partners with sales and marketing at every stage of the account development cycle – and even before the sales cycle begins.

The key success factor is to get sales, marketing, and supply chain management on the same page in three key business processes:

Relationship structure. If your sales reps are free to agree to a wide variety of customer requests and demands, it places a huge cost burden on your supply chain. The answer is for sales, marketing, and supply chain management to agree on a set of perhaps 4-8 standard customer relationships – ranging from arm’s length to highly integrated. Each relationship should have measurable value for both parties, and a clear to-do list for each party. Then your supply chain managers can create a streamlined process to support each relationship.

Market mapping. This is the process of matching customers to relationships based on an assessment of where each customer should wind up. This assessment involves both sales and supply chain factors, like buyer behavior and capability to partner. This is very different from simply asking the customers what they want. Your sales process should be focused on moving customers to the right relationships.

Account management. In major account relationships, the account development process must involve both sales reps and supply chain manages from the start. In a well-integrated relationship, your supply chain managers can dramatically lower both your customer’s costs – and your own costs – by influencing your customers’ inventory levels, order patterns, and other key (mostly supply chain) factors. When you increase your customer’s profitability, it almost always drives sales increases of 35% or more, even in highly-penetrated accounts. As a top executive of P&G once noted at MIT, “Our customer is Wal-Mart’s CFO.”

The bottom line is that it is essential to bring your supply chain managers into your earliest sales efforts. They will naturally work with their customer counterparts to identify areas of cost reduction that will come from working together. In the process, your supply chain managers will identify and nurture allies within the customer, and together develop a strong business case for selecting you as the premier supplier-partner. Today, both supplier selection and revenue growth are rooted in the foundation of trust developed between your company’s supply chain managers and their customer counterparts.

In a few days, I’m giving a presentation on “The Coming Revolution in Supply Chain Finance” to a national conference of supply chain management professionals. Here’s my message:

In leading companies today, supply chain integration leads directly to sales increases of 35% or more, even in highly penetrated accounts. Supply chain management is the fastest and surest way to increase revenues.

At the same time, top companies that structure their sales processes to bring in revenues that fit their supply chain’s capabilities see cost reductions of 30-40% or more. All revenues are not equally profitable, and thoughtful sales discipline is the best way to create quantum increases in supply chain productivity and efficiency.

Welcome to the new world: supply chain management driving huge revenue gains; sales discipline creating massive new supply chain efficiencies. In the process, financial performance going through the roof.

The Power of Constant Strategic Innovation

Strategic innovation is the lifeblood of business growth and lasting profitability. It enables you to push the envelope of customer value creation, positioning your company as the strategic partner of choice. It also allows you to price higher, grow faster, and leave your competitors in the dust.

On the other hand, companies that fail to innovate get stale fast – and they get left in the dust. The action question is how to manage constant strategic innovation in an aggressive but careful way.

There are two basic approaches to strategic innovation – one more common but less effective, the other less common but very effective.

The first features big occasional projects. Everyone has seen these. The project starts with a big, formal study, often with extensive customer surveys and very high visibility. It moves through the usual stages of analysis, and approval. Once management decides to go forward, the company launches a pilot. The objective of the pilot is to work out the implementation details. The process is generally formal and time-consuming, so the company needs to catch its breath for some time, often years, before the process starts again.

The alternative is to approach strategic innovation as an ongoing process. At the center of this process is a constant stream of showcase projects. A showcase project is an opportunity to engage a customer or supplier in a very limited-scale “learn by doing” project. There may be some hypotheses about what will work, but the project should be undertaken in an extremely open-minded way. Showcase projects are very effective because there is virtually no downside risk, and they create a very valuable opportunity to discover new ways to do business. Because they don’t require extensive analysis and formal approval in advance, they let managers be very innovative and creative.

A number of innovations that are now central to the way we do business grew out of showcase projects. For example, about twenty years ago, Baxter, the hospital supply company, entered into a “learn by doing” showcase project to discover whether there were new ways to partner with customers. It selected as a showcase partner a very small community hospital about a mile from its main distribution center. The hospital had just opened, and the hospital CEO was very interested in finding new and better ways to do things. Out of this showcase arose one of the first, and very widely followed, vendor-managed inventory systems.

Ironically, the more innovative the initiative, the less likely it would grow out of a big, formal study. Because Baxter’s showcase project had very low risk, it was possible to conceive, develop, and pilot the new vendor-managed inventory process – all without the need for formal review and prior approval. By the time executive approval was needed, the new system was already up and running on a demonstration basis, and the whole management team could come over and “kick the tires.” (Conversely, if the showcase had not yielded results, it would have simply and quietly ended.) At the time, this hospital became the most visited hospital in North America, as major hospital CEOs came to see the operation and talk to the hospital’s management.

Over the years, I’ve seen showcase projects produce amazing results in leading companies. Here are the key success factors:

  • Developing showcase projects should be an ongoing process, not an occasional event. Every company should have at least one showcase project at all times, although it is much better to have several. Because showcases are very limited scale, they do not create significant risk or require significant resources.
  • The definition of failure is not trying a showcase. A showcase offers the opportunity to see what works, and more importantly, to find out what doesn’t work. In virtually all cases, the original hypothesis won’t be the right one – but the process of exploring the initial thoughts will lead to the really powerful innovations. And these would not have been discovered had a showcase project not taken place.
  • Resist the strong temptation to engage your most important customer or supplier. The best partner for a showcase is a relatively small, but highly innovative, customer or supplier – where the risk is very low, and the conditions for success are highest.
  • Create a deliberate process to scale up the innovations that really work. Without an effective scaling process, a company winds up with a series of interesting innovations that sound good in a management interview – but that do not have a major impact on the company.

A management team that is adept at constant strategic innovation attracts the best customers and suppliers. They sprint ahead of the competition, and keep widening the gap. Showcase projects provide the building blocks of success.