Is your company trapped by its history? Surprisingly, most companies are shaped by their history much more than they are structured to respond to today or tomorrow's opportunities and challenges. This problem is powerful, and so pervasive that no one even notices it. Yet it shapes virtually every aspect of a company's structure and its managers' behavior.
This article sheds light on this enormously important management problem and explains how profit-mapping enables real zero-based budgeting that can allow managers to turn their companies' history from a sea anchor into a powerful driver of competitive advantage.
Editor's Note: This is the third in an occasional series of articles based on transcripts of podcasts by MIT instructor Jonathan Byrnes. His Profit Levers podcast covers topics related to managing profitable growth, occasionally discussing issues of interest to marketers. Those episodes are the ones MarketingProfs will be publishing. The first article/transcript published by MarketingProfs was Big Data: Big Opportunity or Big Headache?; the second was How to Win a Price War (And Prevent Future Ones). This, the third article, is based on episode 4.
Have you ever wondered why we hiccup?
I recently reread a fascinating book, Your Inner Fish, written by Neil Shubin, a professor of anatomy at the University of Chicago. In this very readable book, he describes how we humans carry the very real vestiges of our evolutionary past—hidden right in front of our eyes—in the way our bodies work every day.
For example, hiccups. Shubin writes, "If the odd course of our nerves is a product of our fishy past, the hiccup itself is likely the product of our history as amphibians.... It turns out that the pattern generator [the nerve controller] responsible for hiccups is virtually identical to one in amphibians. And not in just any amphibians—in tadpoles, which use both lungs and gills to breathe."
Shubin continues, "Tadpoles use this pattern generator when they breathe with gills. In this circumstance, they want to pump water into their mouth and throat and across the gills, but they do not want it to enter their lungs. To prevent it from doing so, they close the glottis, the flap that closes off the breathing tube.... They can breathe with their gills thanks to an extended form of hiccup."
In short, our hiccups are a vestige of our evolutionary past—when we shared an ancestor with tadpoles.
In another terrific book, The Accidental Mind, David Linden describes the evolution of the human brain, and shows how "the brain is not an optimized, general purpose problem-solving machine, but rather a weird agglomeration of ad-hoc solutions that have been piled on through millions of years of evolutionary history."
What does this have to do with business?
It has everything to do with business.
Your Company's Evolutionary Past
If you really want to understand why a company does what it does, just look at its business challenges and situation 5-10, or more, years ago. Chances are that most of what the company does simply grew out of the way it met past needs, and that these business practices were passed along as part of the company's culture—"the way we do business"—over the years, without being reviewed and reconstructed.
I teach a very powerful case about this in my graduate course at MIT. This case presents a very complex optimization problem. Typically, the students work hard on the optimization and come to class prepared to discuss their quantitative approaches. I surprise them by starting the class discussion by asking "What is the problem we need to solve?"
After a lengthy discussion, it turns out that in fact the company no longer needed the process that was being optimized. Not only that, but the process actually was harming the company much more than it was helping it.
And, the more complex the optimization, the less likely the students would be to think about whether the underlying process was actually needed.
The prime lesson of the class is that the most important things a company does are determined tacitly, and are never seen, never questioned, and never examined. Within this tacit, historically determined framework, a lot of tuning up takes place, but the framework itself—"the way we do business"—is almost never examined.
What's most important is that the really big money lies in changing the tacit framework, not in tuning it up. But almost no one operates at this more fundamental level.
In fact, a prime objective of my MIT course is to sensitize students to this enormous opportunity in every company, and to teach them to identify the really big benefits that come from operating at a deep level of understanding. My companion objective is to teach them how to manage the paradigmatic change that is needed to transform a company's fundamental way of doing business.
What Margaret Mead Said
To emphasize the point about the pervasive unseen influence of the past, I tell the class a Margaret Mead story. When I was a student at Columbia, I took an anthropology course offered by the famous anthropologist, Margaret Mead, in the last year she taught. The course was about how culture was transmitted through the generations. We studied a variety of interesting situations, from Pacific Islanders to Morris Dancers.
Toward the end of the course, a student raised his hand and asked whether Americans had any traditions that were passed unseen through the generations. When Professor Mead asked what we thought, she heard responses like "hot dogs" and "baseball."
She then gazed out at the lecture hall with about 500 students in attendance. She asked everyone who was born and brought up in New England to raise his or her hand. I was brought up in Western Massachusetts and Connecticut, and my parents and grandparents were from Providence and Hartford, so I raised my hand. I looked around and we New Englanders were ringed around the sides and back of the room like a horseshoe.
Why did this happen? She explained that in the early days of town meeting government in small New England towns, the selectmen asked for volunteers to do the town's work. If there weren't enough volunteers, the people who sat in the front and middle were called upon to help.
So, over the years, New Englanders started to sit on the sides and back of the room—and this tacit behavior was passed down through the generations without anyone's realizing why, even long after people stopped going to town meetings. My wife, who is from New York City and likes to sit in the front of the room, finds this both frustrating and amusing.
The Problem With Zero-Based Budgeting
Several years ago, zero-based budgeting was very popular with managers. Its logic, on its face, is very sensible: All expenditures should be evaluated as if there were no pre-existing practices. I think of this as the "if I could only wave a magic wand" approach to business.
The problem with this seemingly obvious approach is that it is almost impossible for managers to penetrate below the surface business procedures to examine and question the more fundamental "way we do business." Managers almost always get so stuck in their traditional way of doing things that they become unable to carry out the objectives of zero-based budgeting. Hence, they fall back on tuning up existing practices for small incremental gains.
Breaking the Mold
How then can a manager see more clearly his or her company's tacit set of business practices, in order to take a real zero-based look at the company?
The answer is a technique that I call profit-mapping, which gives a crystal-clear picture of the company at a very granular level. A profit map shows the all-in profitability of every product in every customer every time a product or service is bought, and identifies where rethinking and resetting a company's "way of doing business" is most needed.
I explain profit-mapping in both my prior book, Islands of Profit in a Sea of Red Ink, and in my upcoming new book, The Digital Giants are Coming! Managing to Win in Today's Age of Revolutionary Change.
The essence of profit-mapping is to construct a full profit and loss statement for every transaction (that is, every invoice line)—every time a product is bought by a customer. (Our SaaS profit acceleration-solution company, Profit Isle, has the capability to produce this, even for very complex multibillion-dollar companies. By linking this information to a very powerful relational data structure, we can isolate and analyze exactly where a company is making money, where it is experiencing profit drains, why this is happening, and what to do to accelerate the profit peaks and reduce or reverse the profit drains.)
Every company is an "accidental company" in the sense that it is built to a surprising extent from old business practices. In my research and my work with clients, I've found, in industry after industry, that even in leading companies 30-40% of the business is unprofitable by any measure, while 20-30% provides all the reported profits and subsidizes the losses.
Why Does This Occur in So Many Companies?
This occurs in company after company because in our prior Age of Mass Markets, profitability was a function primarily of sales volume, which created economies of scale in everything from production to distribution to advertising. Prices were set by manufacturers, and distribution costs were very homogeneous because products were simply delivered to the customers' receiving docks.
In the past 30 years, we have moved into what I call the Age of Revolutionary Change, in which everything changed. Prices are negotiated, and often vary by account and product. Costs also vary widely, as suppliers form very different relationships—ranging from arm's length to highly integrated—with their customers. Industry boundaries are blurring, and capable new competitors are seizing market share.
In this new environment, markets are segmenting rapidly, and success or failure rides on a manager's ability to deeply understand where his or her company is making all its profits, to assess whether this segment is adequately differentiated and protected, and to channel the company's resources into the market segments with high sustainable profits. In short, the company must cut loose from the sea anchor of its history, and build its future with a real zero-based process. Profit-mapping is the only way to accomplish this life-or-death objective.
Today, the traditional broad accounting categories of revenues and costs, which worked so well in the prior era and which work well for financial reporting, are completely inadequate for understanding granular profitability. Yet we continue to manage as if we still live in the prior era.
What you get is the familiar pattern of "islands of profit in a sea of red ink," that is the vestige of doing business in a way that worked years ago, but no longer fits. Just like hiccups and sitting on the sides of an auditorium.
The Power of Profit-Mapping
The power of profit-mapping is that it yields an extremely powerful view of the company as it really is today—where it is working, where it is not, and why.
When you see this very granular picture of your company's profit landscape, you will immediately realize where your company's activities—its "way of doing business"—fit today's business needs, and where they are deficient because they are essentially continuing to apply old ways of doing business that are vestiges of the past and no longer appropriate.
With this detailed profit picture, you almost can't help but take a real zero-based look at your company. Of course, you can't just flash-cut to a new way of doing business. But you will be able to develop a sound step-by-step plan to bring your "way of doing business" into alignment with today's business needs.
And this is where the really big money is. How big? The upside is nearly always a profit improvement of 10-30% or more, year after year. All self-funded by the cash flow you will generate. The best of all worlds.
And without a hiccup.
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