Defining “exceptional” was a project in and of itself, but it began with one question: “How much of a difference is enough to make a difference?” What Raynor’s team ended up doing was generating something of an actuarial table for business success.
“If somebody says I am 82 years old. Is that person old or not? Well, if they live in the Northern Islands of Japan, that is early middle age because those people live forever. If they are from Tanzania, they are probably the oldest person in the country. What counts as old is a consequence of your context.”
What makes a company great?
Raynor and his team also developed a mathematical algorithm that corrected for age of business, date, amount of debt, size and industry, among other variables.
The goal of the analysis was to strip out the effects of luck and variation to come to an answer to the question: “What do managers do to make companies great?” says Raynor, who is based in Mississauga in Ontario, Canada.
After identifying 344 top performers, Raynor and his team, who officially started working on the project in 2007, looked for common traits to define how those exceptional businesses acted.
The team largely came up empty.
However, when Raynor and his team started to look at how those exceptional companies think, the principles started to become clear.
The principles of greatness
They are as follows:
1. Better before cheaper. Differentiate yourself from your competition based on quality, not price. While you may achieve some level of success undercutting your competition with cheaper prices, you will almost never become exceptional on a price-based model.
2. Revenue before cost. It will be more valuable to your company to drive your revenues higher than it will be to drive your costs lower. Cutting costs may result in some degree of success, but, most likely, your company won’t sustain an exceptional level of greatness.
3. There are no other rules. Technology, talent, markets, people – it can all change. But don’t mess with Rule 1 or Rule 2.
Exceptional companies include long-haul trucking company Heartland Express and teen clothing retailer Abercrombie & Fitch. The companies are all publicly traded companies, larger than the sorts of companies that many young entrepreneurs may have on their hands. But Raynor says the three rules still apply to younger, smaller companies, if with a modicum of compassion in the application.
Choose a direction, not a route
Consider the rules “a compass, rather than a map,” says Raynor. “You are lost in the forest and somebody says civilisation is North. If I hand you a compass, I have done you a favour. You still have to be creative. You can’t just walk straight north, you will bump into a tree, walk off a cliff, do whatever it is you do. And so sometimes you have got to go East, West, double back South even and really pay attention to cost for a while, but you want to make sure that over time, you are pushing your company in one direction versus another.”
Very often, new start-ups are especially cash strapped. And Raynor recognises that. But the rules of putting quality and revenue first still apply on a comparative level.
“If you want to have higher profits than your competitors, the way to do that systematically is not to have lower costs than your competitors,” he says.
Raynor cautions that this doesn’t mean businesses should put “gold-plated Aeron chairs and Godiva chocolates in all the conference rooms,” but that businesses should figure out where they are better than their competition and exploit that gap with higher prices or higher volume, not lower costs.
“It is all about your relative position. If you want to be relatively more profitable, you want to have relatively higher volume and/or relatively higher price” than your “relevant” competition, he says.
Q: How can I identify the customers I should shed- the ones who suck up my time and energy in exchange for meagre returns?
A: Most business owners know in their guts that a good chunk of customers are not profitable. But in a universe in which it’s drummed into us that the customer is always right, it amounts to heresy to admit that a customer may, in fact, be wrong and should go.
It’s difficult to send any potential revenue packing, but culling the client list is worth it – it frees up resources to take better care of your best customers.
The Pareto principle, more commonly known as “the 80-20 rule,” can be applied to customer profitability. In short, it means that 20 percent of your customers likely provide 80 percent of your profits. Inversely, it says that 20 percent of your customers may be sucking up an astounding 80 percent of your direct customer costs.
The problem is that many small-business owners don’t have the tools they need to determine if one unprofitable client is worth nurturing for a big payday down the road, or if they should say, “Sorry, I can no longer work with you,” and move on. That’s why I’m here to help.
Analyse Profit By Customer
Profit equals revenue minus costs. Simple, right? To analyse customer profitability, we must assign revenue and costs to each customer. For those of you with thousands of customers, you’ll want to put them into groups.
For example, a restaurant could divvy up its patrons among the breakfast, lunch and dinner crowds; a building-supply house could group retail and wholesale customers separately.
Revenue is usually pretty easy to pull, since accounting systems can match each sale or invoice to a specific customer. Costs, however, are trickier to determine. Without burying you in the arcane world of cost accounting, I’ll lay out a simple yet effective approach.
Assign the costs of goods sold plus the direct costs of acquiring (marketing), serving (your staff’s time) and retaining (follow-up) customers to an individual or customer group.
Keep in mind that for this exercise, overhead costs are not assigned to customers. But even without including overhead, you’ll have enough information to make good decisions.
The actual number-crunching is, unfortunately, not trivial. You may need the help of an experienced analyst, controller or CFO to do the work or to set up and train your staff to periodically run the numbers themselves.
I often find that a company’s chart of accounts needs to be tweaked to get costs into the right “buckets” to make the profit analysis correct and straightforward.
The Numbers Game
With a revenue-cost number attached to each customer, you can easily identify those who are ruinously unprofitable. And now you have a choice: You can work to make them profitable- i.e., raise their prices or cut the costs associated with serving them – or get rid of them.
On the flip side, you’ve also identified customers that make up the majority of your profits. Don’t just use that information to send them a nice thank-you note; consider exactly what it is that makes them profitable.
Can you turn other customers into better ones? How can you find new customers like the most profitable ones you already have? And what do you need to do to keep them?
After running through this exercise the first time, make it a regular task (quarterly is a good frequency to shoot for). This way you can catch problems before they seriously affect your business; for example, a longtime great customer who suddenly turns into an unprofitable one. That’s one client you want to nurture, not cut.