A cautionary tale of costcutting
Not all Profits are ‘Good’!
The US Second Quarter earnings season is nearly over and, for those of you who missed it, most companies reported increased profits.
Yet the market, as a whole, has been nonplussed. And a recent research report published by Goldman Sachs has shown that the stock market rewarded companies that reported higher sales more than those that reported higher profits. Why?
Things are not (always) as they seem
There’s a well-known saying in financial accounting that ‘turnover is vanity, profits are sanity, cash is reality’.
And reading it, this adage makes sense.
Until every company starts applying it. That’s when profits can be a form of insanity – and the markets – it seems, are beginning to agree.
The reason for this is that many of these companies have been able, for the last few quarters, to boost profits on the back of costcutting measures – like laying off staff, screwing down suppliers, and running down inventories.
But there is only so much costcutting that can be done before a company cuts into its own bone – and causes fatal damage.
The Curious Case of Connaught PLC
But there is only so much costcutting that a company can do before it starts to destroy the ‘deep value’ it has accrued over the company’s lifetime.
Last month, shares in UK quoted Connaught PLC slid by 80% as exactly this seemed to happen.
Over the years, management had been able to juice profits by, among other things, delaying payments to suppliers, taking over other businesses and squeezing them to the bone, and cutting costs right left and centre. Profits rose and shareholders were delighted.
Nothing wrong with that, you might say. Profits, after all, are sanity.
But not when the customers don’t go along with it. If you increase your profits to the detriment of your customer value proposition, often your sales fall (as they defect) and profits quickly become a form of delusion. That’s when a company often has to start from scratch all over again – think restructuring, boardroom dismissals, and change management programmes.
But it doesn’t have to be this way.
The Change that needs to happen
We’re not saying that Connaught’s fate is going to befall all the companies in the market.
What we are saying, is that costcutting can only take you so far. Go beyond that point, and it can be harmful – it can lead to ‘bad profits’.
We’re certain that Connaught is not the only company that will see their long term business models suffer because of this approach. And, as per the Goldman Sach report, it seems the market is beginning to get wise to what’s going on. Now, ‘beating last month’s numbers’ is no longer good enough. The market seems to want to see both top-line and bottom-line growth.
This will require a change in mentality among entire boardrooms. One that goes from scarcity mentality and incrementalism, to abundance mentality and quantum change.
It’s about human capital
‘Too much intelligence and energy’ Warren Buffett wrote, ‘is being devoted to scraping the crumbs off the table of capitalism instead of preparing the meal.’
By rationalising supply chains, implementing technology, offshoring and outsourcing, companies have experiences a golden decade of ever-increasing profitability.
Unfortunately, this has not been matched by top-line growth. Yes, many multinationals have been able to expand in Asia, but many are also struggling to achieve the market share they think they should be getting.
Applying a hard-driving Western-style ‘scarcity mentality’ isn’t helping. And the dangerously-skewed obsession with ‘making numbers’ as opposed to ‘making and keeping customers’ (Drucker) is probably resulting in huge opportunity costs.
Many companies seem to be trying to produce more golden eggs by strangling the goose. It may work in the short term, but over the long term this can be catastrophic, with rocketing staff turnover and employee disengagement, customer disengagement and – lo and behold – declining sales.
Instead, companies need to look at building their capability, through their human capital, in order to boost long-term growth.
Take this approach
The change required is a simple one. Instead of focusing on tangible factors ‘inside-out’, companies need to focus more on the intangible factors outside-in.
Specifically, this means defining and enhancing a customer experience for long-term value creation. This means working on employee and customer engagement. And it means – vitally – focussing on metrics other than profits alone. Apple, for example, hasn’t simply focussed on profits. In fact, for years it has tried to deliver a decisive customer value proposition and customer experience and foregone some quarterly profits in the company’s efforts to do so.
It is now the world’s biggest IT company.
‘Business leaders have become master mechanics in siphoning out current earnings, but they fumble for the right wrench when it comes to gearing up for growth’
Frederick Reichheld, The Ultimate Question
Companies can enhance their growth easily by focussing on just three factors (in equal measure). They are:
Customer Say – Advocacy and Word of Mouth. Do you give your customers something to rave about?
Customer Stay – Loyalty. Do you deliberately evoke the researched emotions that will make the loyal?
Customer Spend – Do you know (and know how to create) the researched emotions that lead to higher customer spend?
Time to engage customers and employees alike!
If you would like to find out more about how Talent Technologies helps you achieve customer and employee engagement through boosting your human capital, simply complete this form here and we will send you an information pack.
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