This is a problem that most small company leaders have. I fell prey to it once. And, I'll share my personal experience, as well as this recent experience with a firm where I served as financial manager (temporary CFO).
I worked with these folks three days a week- Mondays, Tuesdays, and Thursdays. And, this week in question, I had to deal with a licensing issue that was neglected by the entrepreneur. (Let's call him Ernest.) One that would shut us down. And, for most of Monday and Tuesday, I had to shuffle between various offices to insure that we could get a clean bill of health and get our license renewed. Which meant that I was not in the office at all for the first part of the week.
I walked in Thursday morning to see utter pandemonium prevailing. It seems that one of the employees of the firm, one who earned an MBA (at least that was the scuttlebutt- but over the year I worked with him, there was ZERO evidence he had any business acumen whatever) had convinced Ernest that there was a significant opportunity to make money. And, the two of them (the MBA and Ernest) set about “capitalizing” on this opportunity.
( As an as As the financial manager of the firm, Ernest should have discussed this opportunity with me before he jumped in with both feet. largest stockholder- but he's not the majority stockholder. Not quite “best practices”. )
Which means that during the busiest season of the year for our firm, we were scrambling to supply our normal products- and stuff we never supply at all to two customers who were handling a major convention. Which means that we needed to purchase even more inventory- most of which would be COD, since we had no long term arrangements with these vendors) – for our cash poor firm, just when we were to garner – – 1/3 of our gross revenue for the year. (That's why we were cash poor- we loaded up on inventory to capitalize on our big season.)
Oh, and we do not have that many employees. And, no trucks- since we use services like FedEx and UPS to deliver to our customers. And, this big “opportunity” needed us to deliver directly to them. Some 20,000 pounds of deliveries to two locations.
And, it gets better. It seems that these two vendors demanded “special pricing” for their big orders. A reduction of 10 to 20% off our normal markup. (We really do not markup- we divide our raw material cost by 40% – which means we multiply the price of raw materials by 2.5 to obtain the sales price.)
Now is a good time to explain what that really means. There is a big difference between markup and margin. If you have a 40% margin (hypothetically), it means that your direct costs- raw materials, labor, and delivery – equal 60% of your gross revenue. And, let's assume you are really well run and garner a 10% profit. That means for $ 100 of sales, you clear $ 10 in profit, after spending $ 60 on raw materials. So, providing a customer a 10% or 20% cut in price means that you are only getting $ 80 or $ 90 in revenue. So, you can see- there is NO profit on this sale. Maybe even a loss.
Now, let's look at the concept of markup. If we spend $ 50 on raw materials and markup the price, after dividing by 40%, then we are selling that item for $ 125. Yup- the gross revenue is higher in this scenario. But, even with that higher revenue, we were still only making about 10% profit- or $ 12.50. So, if we cut our sales price by 10% or 20%, means we are cutting our revenue by $ 12.50 to $ 25.00- which means we are losing money for sure.
And, it gets better. Because we had to rent a truck. We had to work more hours. And, we had to use our meager cash for these sales- leaving us less cash for our normal sales. Oh- and no one at this big meeting we were desperate to supply was really going to know who supplied them. So, any new business prospects were close to nil!
And, the piece de resistance? These vendors didnt pay us on delivery, like all our other customers do. Nope, we had to wait for their money. Which means less less money for the inventory needs for our regular customers.
Now, for my personal tale. One of our businesses was a very high margin one, operating in the vanguard of medical services. It was our hope- and our corporate mission- to expand this market segment from 1% to 5%, to 10%, to 100% – and where we would have about 50% market share or more. And, in the first three years of operation, we did grow our market segment to about 15% – with a 90% share of that segment coming to us.
My operational team (that includes me!) Thought we could grow this segment even faster if we supplied the other (clearly inferior) product choice. Then, we could work from within the hospitals and clinics to convince them to switch to the better therapeutic mode. This meant we could have them using our therapeutic mode faster than without this avenue of approach.
Our board (who, by the way, were not investors in the firm) reminded us this was a bad business practice. We were clearly the Rolls Royce of the marketplace- albeit at Thunderbird prices. (In case I lost you with this analogy, our product offering was the very best therapy out there- and our pricing was just slightly higher than the much lower-benefit choice- more than what they were paying, but not by much.)
And, our board members reminded us that we were still a small company. One that had a “large” reputation. And, we would never be able to build that reputation back to its stellar regions, if we chased after every sale and not the right ones.
Yes, we relied on our board. Thankfully. Kudos to Arthur Lipper and the departed Bob Boyle and Bill Weissert for keeping us aligned with our mission and vision.
I did not write this to show you that getting a sale that loses you money is bad. Because, if we did not give these customers a discount, then you'd think it was a good idea. Because we could have made money on this sale. Just like our firm would have made some money by selling the conventional therapy.
But, by including both tales, you should see that entire concept is wrong. These potential sales did not fit our mission statements. They did not fit our operational plans. They did not even exceed our normal product lines. We had to extend everything to capitalize on these “opportunities”. Including making it tougher for us to meet our objectives- supplying our core customers with great products that want, when they want them, at prices- and service levels- that make them want to come back.
Those are the questions we all have to ask- and answer properly – every time an “opportunity” comes along that is not part of our normal business processes. And, if it does not meet our criteria, then we let it pass us by.
Because we want to be the best we can be in the business we expect to be in.