How to discover cost inefficiencies
No-one is managing profitability in the vast majority of companies, and most managers are not even aware that this is a problem, according to Jonathan Byrnes in his book Islands of Profit in a Sea of Red Ink: Why 40% of Your Business Is Unprofitable and How to Fix It. Large portions of the business of most companies are unprofitable, and just a few islands of high profitability are providing all of the reported profit and at the same time cross-subsidizing the unprofitable business.
The book is divided into four sections: thinking for profit, selling for profit, operating for profit and leading for profit. According to the author, we have moved out of the age of mass markets into the age of precision markets, with the locus of value creation becoming customer relationship innovation centred on account management and supply chain management. Profit management is all about matching the right type of customer relationship to the right type of customer.
To discover and fix the areas of unprofitability in a business, the author recommends creating a profit map by: creating a profitability database with a representative set of transactions and costs, modelling representative customers, and projecting the results to the whole business. The profit map should enable you to identify areas of the business suitable for remedial action, and you should then repeat the process every six months.
The profit map is a quick substitute for activity-based costing. According to the author, you only need to analyse profitability at 70% accuracy; many companies waste too much time and effort arguing over cost allocations in activity-based costing systems. While this may be true, it seems to me that the accuracy of any system for determining areas of profitability in a business is dependent on the accuracy of the cost allocations.
The book consists of 36 relatively short chapters, written in a way that a person who reads only selected chapters can still gain significant insights; this necessarily makes much of the content repetitive for a reader who reads from start to finish. At the end of each chapter, the author highlights a number of helpful issues for the reader to think about. Although the book is aimed at businesses which sell products, much of it is adaptable to businesses that sell services.