Pretty much every company wants to increase its profit, and most managers devote a large portion of their time to trying to increase revenues and margins, or reduce costs. As a financial manager and consultant, I have been involved in many profit improvement initiatives. Here are some examples – they are mostly from construction, retail and land development, but the concepts can be applied to any business.
Allocation of Resources
Where a company chooses to invest its resources has an important effect on its profitability and ROI. This can be managed at the time of the initial investment, but ongoing investment needs to be reviewed with a critical eye.
Profit maximization – A land developer and builder was very disciplined in its due diligence on land acquisitions. Land development is a surprisingly complex process involving massive investment, and is subject to a seemingly endless list of restrictions and costly requirements from all levels of government. So choosing between land investment opportunities is a painstaking process, but often subject to emotional responses. We built a linear programming model to maximize the profitability of our land use plans based on our budgets and timing, as well as the attendant marketing and government constraints. This removed much of the emotion from the land acquisition process.
Unprofitable operations – A homebuilder was focused on entry-level housing, and suffered from tight margins and the need for economies of scale and tight discipline in that sector of the business. At the same time, its land entitlement and development business was generating high margins and even higher returns on investment. With 80% of the company’s overhead, but only a small percentage of profits coming from homebuilding, we weighed the investment required to operate a full-scale builder in a higher price category against the potential return, and decided to walk away from the business entirely. Overhead was drastically reduced, and capital was redirected to the more profitable business of land development.
More profit with lower investment – A retailer was famous for the department stores it had operated for many years. Over time, though, these stores had lost ground to competitors, and capital investment had been cut back in proportion to declining profits. The company also operated a number of successful specialty store formats. A time of reckoning came, and the company realized it could make management changes and invest heavily in its department stores, possibly reaching the level of success, for example, of Target Stores. After an intense review, though, they recognized that specialty stores had a higher potential return, a relatively lower investment, lower risk and correspondingly low barriers to entry in niche specialty markets. Relying on its depth of experience, the company closed its famous department stores, and reallocated its funds and energies toward rapid growth in specialty retailing. It became one of the top-performing companies on the New York Stock Exchange.
Drawing on strengths – Another homebuilder operated in a single market, selling low margin homes during a downturn in the housing market. Recognizing its strength in efficient, low cost construction, it started looking for new opportunities. We focused on selling houses at full margin for rental by investment partnerships, expanding regionally into new markets through joint ventures, construction for hire of military housing and multifamily construction.
Does your CFO lead your management team in constant evaluation of your resource allocation process?