Loss = Gain

November 11, 2003 - 11:34

Is it easier to lose money or use an intelligent loss of business to evaluate how our businesses are run?

Sol Price, who founded Price Club that has morphed into today's Costco, was fanatical on a business principle he called "the intelligent loss of business." The concept behind this principle was that by continuously analyzing and evaluating the sales and profitability of items and categories through quantitative measures, it became readily apparent that item and program deletions must be made to improve the whole of the company. Weaning out the weak sisters -- those items and categories that did not generate return on investment -- allowed the redeployment of assets and resources to those who generated the desired minimum results, while at the same time freeing up resources to invest in new strategies or categories.

Challenging Principle

Granted, this principle can be challenged in our industry for a number of valid reasons. First, for the sake of offering a viable assortment to the retailer and/or consumer, some items that don't perform well, even some that lose money, must be kept to maintain the completeness of a program. For example, an analysis may show that nails don't make money, but hammers do. Yet if you stopped stocking nails, it could do irreparable damage to the ability to sell hammers.

And some poorly performing categories should be maintained because they have the potential to grow and mature into good business segments, given enough attention and fine-tuning or re-positioning.

And, we all recognize that we don't make money on every crop produced, just so long as, at the end of the year, the bottom line meets our expectations; some loss leaders are a necessary and acceptable evil.

But the mindset behind this principle is applicable to the way we evaluate our businesses -- something that many of us are reluctant to do. Too often, we get emotionally attached to strategies that have no hope of ever producing the desired results, especially as the economic climate and business strategies of our customers change. To survive in tough economic times, whether you are a grower, manufacturer or retailer, we need to be willing to accept the obvious and make the necessary changes, to analytically and unemotionally make the decision to intelligently cut the losses and re-invest the available resources.

Intelligent Loss of Business

This intelligent loss of business evaluation process shouldn't stop at just the product level. Rather, extend the thought process to include a strategic review of who your customers really are. Should you make the conscious decision on which you should continue to sell, who has the potential to become your MVCs (most valued customers) and whom you should think about abandoning, even sending them to your competition! It's proven that the bottom 10 percent of your customers, in terms of sales and profit, require up to 50 percent of your resources to maintain, whether this is money (i.e., slow/late payments, highest credits), time (they are the ones who complain the most and generate the highest cost of sales efforts) or operations (order the least quantities that are the most expensive to deliver or service).

Conversely, your largest accounts, the ones who contribute 70 percent of your financial success, probably only receive 10-20 percent of your resources. Think what the positive impact on your business would be if you cut loose the lowest 10 percent of your resource hogs and re-invested those time, people, attention and money resources back into your top performing accounts or those that have the potential to grow! Yet this is one of the hardest decisions we never make…to stop selling to a current customer. But, if taken in context of the intelligent loss of business principle, it's a decision that makes rational sense.

I talked recently to a large wholesale grower/retailer who has applied this intelligent loss of business precept to making some very significant changes to his business model. In the past, he grew large quantities of poinsettias for wholesale customers and for his own retail operation. But with the market retail pricing strategy insanity on this crop, the large quantities other growers have planted on speculation and the prediction of higher fuel/heating prices, he recognized that growing his own crop would most likely create substantial profit losses. By closing down some of his growing ranges in the fall and not growing poinsettias, he would actually contribute more profit to his bottom line! He's growing what he thinks he needs to support his retail operation; if his sales exceed his production, he can always go into the spot market and purchase more from his former competitors.

But he's not abdicating the total production sales volume during poinsettia season; rather, he's getting into other specialty crops that don't cost as much to heat or have the same competitive pressures on wholesale pricing. But they do fill a niche need for his retail customers who are looking for post-Christmas product that isn't available from huge space commitment poinsettias growers.

At the same time, he's evaluating the addition of other specialty crops that can supplement his current and continuing distribution model of his other core products, looking for opportunities to provide incremental value to his retailer customers.

Will Changes Occur?

Will all of these intelligent loss-of-business changes work out as planned? Maybe, maybe not. Will the loss of sales volume on the poinsettia crop be offset by the added sales of new specialty crops? Probably not. Will the bottom line profit be higher as a result of these production changes? Hopefully. But the important point is that his evaluation approach is based on a rational and unemotional review of the status quo. And the decisions made will allow the redeployment of resource assets that will most likely produce higher bottom line returns.

Most mass market/big box retailers go through an extensive annual assortment review process called "space wars," an analysis of sales, gross margin and inventory utilization (return on invested capital) by linear display footage and by comparing items, items within categories and categories against one another. This logical and unemotional review tool allows buyers to develop their assortments for the following season that make financial sense and meet their corporate goals.

For instance, in order to free up space and inventory investment dollars for expanded or new categories, some current items or categories must be discontinued; as a rule of thumb, the bottom 10 percent of the items or categories are challenged to free up the resources needed to support the new items or categories. This analysis helps identify the bottom performers and, if the numerical ranking passes the common sense test (i.e., if you're carrying an assortment of 6-, 8- and 10-inch plastic pots in three colors, and the 8-inch of one color is a poor performer, it wouldn't make sense from an assortment standpoint to drop that size and color, rather, it might make sense to reduce the shelf space on that one poorer performing size and color).

It's human nature to try to make every item, category, strategy or customer a profitable success; yet deep down, we all know this is a physical and practical impossibility. By applying and embracing the intelligent loss of business principle, you can make your business stronger and more profitable, freeing up the resources to keep your strategies and programs fresh and exciting. A classic example where Loss = Gain.

About The Author

Stan Pohmer is president of Pohmer Consulting Group, Minnetonka, Minn. He can be reached by phone at (952) 545-7943 or E-mail at spohmer@pohmer-consulting.com.

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