August 08, 2012


In the banking world, when you borrow too much money and you fail, you go through a period of de-leveraging.  It is a painful process.

Our worldwide economy is about five years into a de-leveraging process.  Many of us lost jobs, or took a beating on home values, all part of a de-leveraging process.  It stinks.

This happens in our world, too.  You can tell by looking at a profit and loss statement.

Here's a summary of a reasonably healthy profit and loss statement.
  • Net Sales = $50,000,000.
  • Ad Cost = $5,000,000.
  • EBITDA = $6,000,000.
  • Ad to Sales Ratio = 10%.
Three years later, we see something like this:
  • Net Sales = $53,000,000.
  • Ad Cost = $8,000,000.
  • EBITDA = $5,000,000.
  • Ad to Sales Ratio = 15%.
Clearly, the business is struggling.  Sales have plateaued, so Management is spending a ton of money to keep sales growing.  This hurts profitability.

Three years later, the business is in trouble.
  • Net Sales = $55,000,000.
  • Ad Cost = $10,000,000.
  • EBITDA = $3,000,000.
  • Ad to Sales Ratio = 18%.
Here's the problem.  This business probably needs to de-leverage.  But when it de-leverages, it will be much, much smaller.
  • Net Sales = $35,000,000.
  • Ad Cost = $5,000,000.
  • EBITDA = $3,500,000.
  • Ad to Sales Ratio = 14%.
Can you see why Management would balk at de-leveraging?  The business shrinks by close to 40%, and profit barely changes!

There's two issues with this.
  1. Nearly $20,000,000 of sales is being generated for no benefit whatsoever.  Why generate sales that don't produce short-term or long-term profit? Be honest.
  2. What could you be doing with the $5,000,000 of ad cost that is not generating any profit whatsoever?
Answering the second question is critical.  What could you do with the $5,000,000 you are spending to generate no benefit whatsoever?

Most of us cannot answer that question, and for a good reason.  It's a hard question to answer!

As a result, we keep plugging along, hoping that something will mysteriously change.

It's pretty darn important to have an answer to the second question.

P.S.:  I cannot tell you how often I run into the "$20,000,000 demand and $0 profit" problem.  It's everywhere.  Your paid search people cause this problem, and your catalog circulation people cause this problem.  You mail so close to break-even or by paying for clicks right around break-even.  Now, I get it, you're theorizing that the long-term value of these decisions pay for themselves.  That may be true.  But what the heck else could you be doing with that money?  You could practically start a new business!  But nobody wants to lose $20,000,000 of demand that generates $0 profit.  And I know, you're going to start leaving comments with MBA theory about why this is a good decision.  We can agree to disagree.