I contend that knowledge of the industry, product or service while useful is not paramount or essential to assuring greater corporate profits and the maximization of enterprise value. The key reasons why the corporate profits grew substantially in all of my companies during my tenures are passion and the use of my unique four-pronged approach.
In this first installment, I will begin to explain in detail my four-pronged approach and cite specific examples of how it is a sure-fire way for a CFO to substantially increase his or her company’s profits. I will leave the passion part to you. Naturally, each prong works to different degrees in each company, but if you use all four of them, I can guarantee you will see amazing results.
PRONG #1 - Understand fully an entity’s operations and develop the key financial metric that truly makes it “tick”.
While some senior executives understand their businesses well, they sometimes do not understand the key metric that most affects their companies’ financial results. As the CFO, you must be an operational efficiency expert who quickly ascertains the keys to successfully managing the business and maximizing its operating results. Once you have realized the key metric (generally it is one metric but it could be two but not more), you must preach the importance of this metric to the senior management team. If the CFO is successful in motivating the team to make this metric a real focus, the improved results will be huge.
Here are a couple of my personal experiences where veteran senior managers understood their businesses but not their companies’ key metric. By pushing management to become almost single-minded on the key metric, the company’s results changed “almost on a dime”.
My first example took place as an engagement partner with Tatum CFO Partners, LLP. My primary assignment was as the CFO for a cable installation company. When I arrived, the “angel” fund investor declined to provide any additional funds, and the Company was near bankruptcy (losing $300,000+ per month). The Company had no more than two months of funds before it would have to close its doors.
In order to keep their costs as variable as possible, the large cable companies outsource much of the installations to other installation companies such as the one for which I worked. Even though a technician would arrive at a customer’s home in what appeared to be a cable company truck, the technician was not really a cable company employee. My employer operated in the New York Metropolitan Area and had over 300 technicians performing television and high speed Internet installations for both Cablevision and Time Warner.
Through first hand observation of a technician’s work (I actually rode with a technician for an entire day), I realized that the technician was clearly not motivated to perform his or her work efficiently. The technician was paid hourly and averaged approximately four jobs per day. I realized the key metric to this Company should be daily jobs completed per technician.
When I returned to the office, I highlighted this problem to the veteran management team on one sheet of paper by showing them that the average revenue per hour was $25.00 while the direct costs (the technician’s pay, FICA, health insurance, worker’s comp, the total cost to operate the truck, the cost of the required uniform, etc.) was approximately $25.25. Thus, there was a shortfall of $.25 and absolutely no contribution to cover the corporate expenses (rent, office and management salaries, other office costs, etc.). I told them, the only solution was to dramatically change the method of technicians’ compensation.
I introduced an incentive compensation plan that was based on daily jobs completed plus revenues generated (since the amount of revenue earned by job varied somewhat based on the complexity of the work needed). Almost overnight, the average number of daily jobs completed per technician grew from four jobs to over nine jobs per day. While the number of assigned jobs did not grow, we were able to reduce the number of technicians by more than half. The tricky parts of the solution were negotiating successfully with the truck leasing company to return the idle trucks and with the landlords where the trucks were parked when not in use.
I did not stop there. I analyzed every technician’s performance to make sure that all technicians employed “best practices”. I noticed a few technicians were performing several jobs more than the 9+ average. They quickly explained that the job assignments were available from the cable companies at 6 AM, but the first appointment timeframe began at 8 AM. Instead of having a long breakfast, etc., these creative technicians did the pole wiring for many of their jobs from 6 to 8 AM without bothering the customers. Then, at 8 AM, they only had to wire the insides of each home and move quickly to the next assignment. Immediately, this became the new standard operating procedure.
Within six weeks, the Company began reporting consistent monthly profits because of my implementation of this incentive-based technician compensation plan and other cost reduction initiatives. This became a winning proposition for the motivated technicians as well. Historically, they had been earning about $400 per week but after implementing the incentive based compensation plan, the better ones were earning about $2,000 per week.
My next example was as the CFO of a $220 million NASDAQ manufacturer and distributor of flooring tools and adhesives that had been losing money. The Company’s senior management had used gross profit percentages by product and by customer to manage the business. While the annual sales and gross profit dollars had been increasing year after year, the Company’s profitability was not increasing.
After spending a good deal of time studying the profitability by product and customer, I realized that there were major variable costs below the gross profit line on the income statement (e.g. sales commissions shipping, interest costs to carry the receivables and dedicated inventory). In order to more accurately look at product and customer profitability, I quickly introduced and educated the organization as to the concept of product and customer contribution margin (instead of their traditional gross profit analysis). I define contribution margin as gross profit less direct costs. By eliminating certain products and re-pricing others (due to poor but previously unknown contribution margins), the domestic contribution margin dollars increased by 64% within one year. Even though the sales volume did not grow (in fact, it decreased by a small amount), the Company’s results went from an annual loss per share to over $1.00 of EPS within eight calendar quarters.
As these examples demonstrate, determining the key metric is imperative to maximizing corporate profits and enterprise value.
Stay tuned for the next installment – the second prong to profitability – that will be published shortly.