Have you recently looked at how your profit and loss statement evolved over the past decade?
I look at a metric called "profit factor". It's the rate, excluding marketing expense, that demand (what a customer wants) flows-through to variable profit (before fixed costs).
Here's an example, comparing 2012 to 2002:
In 2002, we weren't as good at fulfilling merchandise. We're far better at doing that today.
In 2012, we've artificially inflated our gross margins, and we give the gross margin back via discounts and free shipping. In response to folks like Amazon or Zappos (now the same company), we either increased prices and gave discounts/free-ship, or we kept prices flat, cut expense out of the product, and then gave discounts/free-ship.
Finally, costs have come out of the distribution center. It costs less, today, to pick/pack/ship merchandise than it did ten years ago.
In 2002, 39.8% of demand flowed-through to variable profit.
In 2012, 43.0% of demand flows-through to profit.
Also look at that fixed costs line. I increasingly observe that the fixed costs to run a business have actually increased. I know, this sounds contrary to what you popularly hear, but that's what I am seeing. I don't have a handle on it. In some cases, increased technology costs seem to get passed into the fixed cost line.
But when it comes to the profit factor, there are significant ramifications to improved profit factors.
For instance, in 2002, a marginal customer generated $2.00 per catalog.
- Profit = $2.00 * 0.398 - $0.80 (book cost) = Break-Even.
Today, a drop in productivity can be easily offset by an improved profit factor.
- Profit = $1.84 * 0.43 - $0.80 = Break-Even.
I keep hearing a phrase ... "we have to find efficiencies, so that we can maintain the buyer file". Loosely interpreted, this might mean "we have to find efficiencies, so that we can keep marketing to customers".
The p&l can only take a limited amount of cutting. To improve profitability, either productivity has to increase, or marketing has to decrease. The catalog business model requires sales decreases if marketing decreases. So this doesn't sound like a way to growth.
And yet, the new business models we read about are fueled by, as our friend Glenn Glieber would say, "free marketing".
In other words, we're reaching a theoretical limit on the amount of improvement we can get out of the profit factor. Without productivity improvements, marketing is next up on the chopping block.