May 29, 2014

Commerce Nightmares: Sales vs. Profit

Imagine, for a minute, being Mr. Ramsey. You are brought in to fix a restaurant. This restaurant spends a ton of money on marketing, and in return, has a full restaurant every night.

However, the restaurant is not as profitable as it could be. So Mr. Ramsey recommends not advertising so heavily. Mr. Ramsey instead recommends having food that is worthy of word of mouth. The owner hates this idea ... "but our sales will drop".

The CEO I worked for at Eddie Bauer had a phrase "drive sales profitability". He also had a phrase ... "grow or die". Now, I adored this CEO - he was absolutely fantastic. But those two mantras put a business in a tough spot. "Grow or Die" requires staff to do whatever it takes to keep the business moving forward, but usually, those tactics are not profitable, thereby violating the "drive sales profitably" mantra.

Ultimately, you end up with a graph like the one at the top of this post. And eventually, you move so far down the marketing expense line that you are, in reality, much, much less profitable than you could be. So when it comes time to "fix the problem", the business has moved so far down the expense line that a correction brings along an unintended consequence - sales pain. In the example above, profit can be improved from $14 million a year to $24 million a year, but there would be a corresponding drop in (in this case) catalog marketing expense of more than 60%.

Sales and profit issues are cultural. Amazon, for instance, reinvests all profits back into the business, allowing the business to grow rapidly. A company like Nordstrom prints 10% to 15% pre-tax profit, each and every year, and pays shareholders via dividends and stock buybacks. And then, in-between, are 95% of companies, companies that struggle to generate profit, companies that over-invest in marketing to grow sales in an effort to take market share from other companies.

We get ourselves in trouble when we try to do things opposite of the company culture. When I tried to "optimize" the Direct channel at Eddie Bauer (for profit), the culture rebelled against the sales drop required to optimize the business. In fact, most businesses I work with rebel against any drop in sales.