Business failures have been much in the news in the last few months. The Internet bubble may already have burst, but the last of the froth is still gradually disappearing. It’s easy to have 20/20 hindsight - and of course, what happened to Enron couldn’t ever happen to you, could it? Perhaps not. Whether it’s a serious risk depends on your answer to the question, “which products and customers/channels make you money?”

Over half of all senior business managers are confident that someone in the business knows the answer to this question, but fewer than 20% actually know. And in our experience, if senior management doesn’t know, then to all intents and purposes nobody does.

Here are some of the warning signs that hidden in your business might be either a cash sink - where your hard-earned profits are poured away - or a pinch point - where the opportunity to grow profit substantially isn’t recognised. Do you recognise any of these?

• People talk casually about “loss leaders”
• You see reports on gross margin, but not on gross or net profit
• 30% or more of sales are at special prices
• “We can only compete on price”
• The business never generates the cash you expect, but the forecast says it will in 3-6 months, just like it did 6 months ago
• Your last price change didn’t stick
• You do “cost plus” pricing - doesn’t everyone?

Pricing is a key management discipline, but almost every company delegates decision-making to the lowest level, guided perhaps by some well-established rules of thumb that seem to have worked well for you so far. There may be an approvals process for significant contracts, perhaps with a standard spreadsheet, but never, ever confuse this with being on top of the issue of pricing.

The first thing you have to come to terms with is that, just as water tends to flow downwards to reach the lowest level, so does price, and so do profits. The downward pressure actually comes from people doing their job well, and it’s rare to find anyone on the ground charged with creating a counterbalancing upward pressure.

Here are few of the ‘guilty’ parties - but remember, as far as they’re concerned they’re all just doing their job...Sales hate losing sales to the competition, and have their ears close to the ground for price cuts, discounts and promotions...

Marketing want to achieve strong market share across the board, and to have the budgets to achieve that goal...

Operations aim to be the best in the business on every benchmark

Finance want to standardise reporting and focus on identifying definite problems

Management strive to keep out of the detail and drive the business forward

The problem isn’t so much that anyone is letting the side down, but that there’s a lack of co-ordination, and very possibly of the specialist skills needed to manage pricing for results. And the bad news is that if this is happening in your business, you could be the next Enron. If you don’t know where the money comes from and where it goes to, the plain fact of the matter is that however level-headed you are, if a serious issue develops anywhere in the business you’re just as likely to make a decision that makes the problem worse as one that makes it better.

The good news is that with the right skills and experience, it's possible to identify probable issues - cash sinks and pinch points - very quickly indeed. For a typical business turning over £2-20M, 4-6 weeks is realistic, while even in much larger corporations a thorough analysis should be achievable within three months. The problem, if there is one, is frequently one of attitude. It seems complicated, so it isn’t attempted. It will all become clear after the next business initiative - a new accounting or ERP system, implementation of Activity Based Costing (ABC), re-alignment of P&L responsibility.

Here’s an interesting case study. A medium-sized professional service business provided a fairly commoditised line of products, and consulting services paid for at day rates. The rates looked profitable, but over time bad debts and non-billable activities had grown, so that overall contribution was very low. At the same time there was serious pressure to reduce the day rates, as there was increasing pressure from solo consultants, who were charging significantly lower prices. Having grown increasingly concerned, the management team reluctantly concluded that while a consultancy capability was considered strategically vital, radical cost reduction was necessary with a focus on serving existing clients. Before implementing their decision, they called for an independent review.

The first discovery was quite a shock. The way that overhead costs were allocated in the business was simple, but radically misleading. The effect was that consultancy was bearing a slug of cost that was driven by the product business. The most likely effect of the planned change would have been to catapult the business into a full-blown crisis. It was still true that the consulting arm had a challenge, but the most serious business issue was in fact the commodity business. Detailed analysis showed that as much as 30% of product sales generated unacceptable returns, with over 10% actually losing money - in spite of an apparently watertight gross margin monitoring process. As a result, one product was withdrawn, and a team was targeted with working through a group of overall loss-making customers to recover this position over time, accepting that some customers would be lost to competition.

The second major finding was not, in fact, a surprise to anyone, but nonetheless critical. While it was certainly true that the company's consulting rates were seen as high, its larger competitors were charging more than twice as much for very similar services. Everyone already knew this and had a stock answer - “we just aren’t in that market.” And this answer was true as far as it went. Talking to a sample of prospective clients who had gone to the big names, the recurring theme was one of credibility. But exploring this further, in most cases there was no substantive issue: proposals had been thorough and professional, the company had a track record of similar projects, and no more specific problems were being raised. This led to the recommendation that the company restructure its pricing, increasing standard rates by 40% and senior consultant rates by 90%, which was adopted initially as an experiment, and then fully implemented.

The end result was double digit growth in both revenue and profits. This included a small decline in product revenue, but as this was carefully targeted the actual profit generated by the product business overall increased significantly, enabling the investment in updating the product range that had, in fact, been the issue that prompted the review of the consulting business in the first place.

Crucially, the management team gained the information they needed to make decisions that needed to be made. It was their skill and experience that produced the results - although that same skill and experience, looking at misleading information, would have made a painful and quite possibly terminal mistake.

Pricing isn’t the only - or even the most important - commercial skill to have in a business. In fact, for most businesses the pragmatic approach is to have a major price and profitability review every two years or so, and to use that framework to facilitate minor and routine price changes in the meantime. But for some companies - particularly those dealing in volatile markets - the management team must have informed day-to-day involvement in price decisions or risk waking up to a firestorm.

So perhaps next Board or Management meeting you should ask, “which products and customers are making us money?”

And insist on seeing the proof.

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