One of the most enduring misconceptions people have about business is always the word ‘profit.’
And even among those with a relatively fresh understanding of supply chain basics, it is known that such misconceptions have created problems. These include lack of sustainability, loss of money and the eventual failure of the business.
These misconceptions confuse profit with other figures used when crunching the numbers of your supply chain. For instance, our last blog tackled the confusion between supply chain cash flow and profitability. Cash flow is the flow of money that needs to be maintained in order for the supply chain to keep producing.
But then, how do we really go about defining profit?
At its most basic, profit is defined as the revenue gained minus the costs of goods sold, meaning less costs of doing business.
Unlike cash flow, you can say that it is a sort of end result and not something that has to keep flowing in order for the business to run. Compare it to the remaining cash you have from your daily earnings after you have paid for expenses and dues (meanwhile, cashflow is closer to the electricity you need to keep the factory running).
This is just the beginning though.
The data being used to determine profitability is constantly being misinterpreted as well. This adds to even more misconceptions about what it is. These misconceptions often lead to very unpopular, reactive and self-destructive decision making that leads to even weaker profitability in the long run.
That is why here is a list that explains what profitability is not.
#1. It is not a reason to instantly drop products.
One way that profitability is often measured is in terms of how much a product is selling compared to how much it costs to make. This would be called the gross margin, which is then adjusted for costs of doing business. It’s something even a restaurant owner would be able to determine in order to afford the additional costs of doing business and then end up with a profitable business.
In a supply chain though, we might see individual products behaving quite differently from a product profitability perspective, and it might not be totally sensible to simply drop the products that are unprofitable. It might make sense to simply ask first why product A, B, or C is unprofitable.
This would lead to an investigation and deeper analysis of:
- Market – Is the product being targeted at the right market?
- Product life cycle – Is the product new or dying?
- Pricing – Is the product priced appropriately?
- Delivered cost – What is the delivered cost for this product? Is it the same or different to that for the other products?
- Transport and logistics – Is the product being transported, stored and delivered as efficiently as possible?
- Costing – Is the costing of doing business correct in the case of this product?
And even in the event that these questions do lead to the dropping of a product, we have at least learned some major lessons about our designs, our markets and our supply chains. You must always ask more questions before you decide to drop a product out of your portfolio.
#2. It is not a reason to instantly drop customers.
Profit is also measured in terms of cost-to-serve. Strictly speaking, this can mean a lot of things in a supply chain but where most people are preoccupied with the costs to serve is via a specific segment of customers.
For example, this could be driven by delivering to a certain geography, where the price of transport, and storage and delivery are not cost-effective.
In this instance, you might look at ways to do this more efficiently, like changing your suppliers or even your business model. You could find someone at the local level to do the deliveries for instance, or even appointing an agent or subcontractor. Despite that, it is not the fault of customers who still generate demand for your products.
There is always room to improve (or disrupt) the logistics that can reduce cost-to-serve, before losing customers.
#3. It is not a reason to instantly drop employees.
Lastly, we can’t of course forget the all-too-common scenario where employees are immediately set aside because the reports identified them as loss makers. It sounds like something from a Dilbert comic strip but it does happen in real life. (Just recall the controversial “barnacle” statement by Elon Musk regarding Tesla’s subcontractors.)
When you use profitability to reduce employees down to a mere statistic that needs to be adjusted, that is both irrational and abusive. If the complexity of supply chains should teach us anything, it is that reports don’t always paint a real picture of what is happening on the floor.
For all you know, the workers are struggling with poor equipment training. The equipment itself could be faulty. The location of the workplace may not produce ideal working conditions. As with the previous two misconceptions, profitability (or lack thereof) should only prompt you towards further investigation.
In a way, supply chain profitability is a term misunderstood because it has become emotionally loaded over the past several decades. When executives see a product is making them a loss, they panic and seek out short-term solutions. When employees or customers know of this, they too start experiencing that same anxiety.
Ultimately, however, profitability is just supposed to tell you that something in your enterprise is not operating in a healthy, optimal way and it is dragging down the whole business, and indeed affecting the entire supply chain. It is not an excuse to demand unreasonable, instant solutions. It can be a process of elimination but it shouldn’t lead to literal elimination as a solution all the time!
(Image from Pixabay.)