Growth Begins Through Your Core, And So Does Decline

I have a feeling the Yellow Cab company wishes they had thought of the Uber app. Lets face it, most of us didn’t wake one morning and wish we could jump in a car driven by someone that just pulled up in their personal car and relatively unchecked by local officials. I use Uber as a preference because of the usefulness of the app, not because I prefer the driver. I will admit the car is almost always cleaner and something about the Plexiglas barrier in a cab makes me feel I am being taken downtown for questioning. The main reason I use Uber is that I can find a ride while in the comfort of my home or hotel room and I am notified as they pull up. When we are done, I hop out and save time by direct billing to my credit card. It is easy and that earned my business. While Uber has yet to make a profit, they essentially setup a taxi company in every major city in the US and many overseas without capitalizing a single car into their fixed assets. There was a well established, generations old taxi industry stuck in its ways, not improving and innovating in their core.

This series, Double-Digit Growth in a Slow Economy, discusses the methods that have successfully been used to drive growth when you aren’t able to count on a growing economy. We reference actual cases and companies that were transformed into growth engines beyond the natural buoyancy of economic growth.

This installment discusses the need to begin your growth strategy with your core business. Strength in your core business creates most of the incremental growth opportunities. A strong and vibrant core business also keeps completion at bay. In addition, a well run core business is the funding source for growth investments.

Part 1 of 3 – Growth begins through your core

The strength of any growth plan when there is no “free growth” emanates from the strength of the core of your business. Shore up your core business first. It is an imperative foundation to fund your growth as well as granting you permission for growth. You need to be the category leader or at least on the Mt Rushmore of your category. The scope of “core” meaning core products as well as core channels. This is your strength to get to the growth table. Of course you need a compelling case for your customers to go through the burden of a change. While the actual growth may come from something outside the core, the core provides most of your credibility to do other things. If you can’t manage your core well, how can you do something new or incremental?

Credible and Competent

If there is little buoyancy in the economy, then your gains need to come from competitors. What we are talking about here is the need to gain market share, to beat a competitor at their own game. It may come in the form of new space on the shelves for your products, more points of distribution, or more range of price points that will lift your business. We have to be credible and compelling. Credible meaning I can see how that company could be a bigger supplier to my company. Compelling meaning there is actually a business benefit for the customer to consider. A gap in either one is a weakness in convincing the market to shift more your way.

Your core may be declining. I see this in more cases than you might imagine. Too often no one is able to see the signs until some damage has been done. If someone else is better positioned to provide your core goods in your core channel that needs to change and change quickly. I often hear excuses intended to rationalize why it is OK to be losing sales in your core. Unless you are planning an extreme makeover, your core is your fuel, your funding and the basis of your mojo.

“We can’t make any money in that area anymore.”

And someone else can? You need to unbundle the reasons why and ask how you can reach a cost that would allow you to continue to succeed. It is a pretty simple formula backing up from the retail or trade price of items. My approach takes a retail price offered by our customer for these competing items and subtracts their known margin rate to the best of our ability. We have some knowledge since we know their margin on our goods. We now have a frame of reference for their acquisition cost of the competing goods. Taking our margin out next leaves us with an acquisition cost target for our business. Can we build the goods for that cost? Can we acquire them at that cost? It may not all be in physical product costs. It is more likely a blend of product costs and overhead costs. The point is to equally evaluate product costs, program costs, and SG&A. Chances are you have imposed some limitations without explicitly doing so. Perhaps the limits are on how you will acquire goods, making versus buying for example. Most manufacturing companies will hardly consider sourcing some of their goods where lower costs may exist. It is very difficult for most companies to step aside from their current practices and challenge the way things have always been done.

I have been through this exercise many times and the first phase is usually focused on disbelief that anyone can sell at a price lower than our company and make money. Probably not true. While there are “loss-leader” items out there, it isn’t all that common. Let’s assume someone can produce the goods at the necessary acquisition cost. What would we have to do to get there? We often start with product redesign, value management, etc. Those are important things to do and help take out unnecessary product costs. Don’t forget the other costs. What are your programs, discounts, and policies? They may be excessive and while you have to fund those elements, your competitor may have taken a net price approach or taken some in price and some in smaller programs. Would you believe a company would fund programs that equaled 22% of sales? I inherited one. This is a difficult legacy to reverse as an incumbent supplier. Gross to net calculations are something the finance team can do to help identify these costs.

There are some other not-so-hidden costs within SG&A. If your SG&A is 22-25% in consumer durables, you are looking at a part of your challenge. Typically a new entrant that takes space from your core has at least one actual advantage, your existing business is their incremental business. It is always easier to justify investment when the business is incremental. This is likely the only true advantage they have aside from physical differences you can identify.

Customers as competitors

In each business I have led we faced a very familiar competitor. To varying degrees, our customers were also competitors as they developed mature direct sourcing operations. Initially this is highly concerning. After all, if they can find direct sources from low cost countries they are undoubtedly increasing margin rates and will seek to shift business. Fortunately for a good manufacturer or distributor this is not always a total loss or even long-term loss. It does require your organization to minimize your cost structure and that is healthy. There are advantages from using the traditional supply chain over a Low Cost Country (LCC) direct sourcing model. The customer has to take on responsibilities long held by the domestic supplier. Inventory ownership, inventory management, investment in new products, warranty costs, shipping and logistics, and transitional costs are often overlooked initially in direct sourcing models. To compete here we emphasize the need to strengthen your core and your service levels. I have found in a number of cases that business moved away in a direct sourcing effort often comes back in a reasonably short period of time. It may not come back in its previous form, so flexibility on your part is critical.

Taking on the role of your supply chain looks better through the lens of margin than it does through the lens of management. You have to acknowledge that there is only so much margin, or mark up, you can sustain before you start driving your customer to seek an alternative. What this motivated me to do was to drive as much waste from the business as possible. Because I had limited room for margin, I could not afford to have waste that I was covering in price that in turn may drive my customers to replace me. Companies with extremely good margin rates should always defend their position, but great margins invite competition in some form. The price / value relationship defines how sustainable a strong margin rate will be.

Once we minimized waste, we had to emphasize value. We invested in creating a more dynamic offering. Taking more to our customer in the form of new designs, features, programs, promotions, and analysis of how they could grow their sales added value that was that much harder to replace in a direct sourcing model. The final driver to seek other sources is when we won’t play ball. There are often hard lines drawn somewhere. Many companies I have led had stated objections to providing private label goods alongside their traditional brand of goods. I found this to be an important offensive move and an important defensive move. The customer is going to source private label goods. If they source elsewhere, what are the limits of the value proposition found in those goods? Will they have all of the features of your higher cost goods at a lower price? If you are the supplier, you can play an active role in the design and value creation of the offering. In addition, you avoid a new entrant that has an interest in increasing the span of private label goods at every opportunity. If it is you, you can play a role in balancing that range. Would you like to hold the lower 25% of your category of goods at a lower margin or invite someone else to hold that space?

Private label goods are a growth opportunity for most business, not a threat. They are going to exist. You have a choice to be in the mix or not. You do not need to provide the full suite of programs and support for the private label, so while at a lower price it need not be at a dramatically lower margin. If you have read my prior writings, you will also note it is about creating EBIT dollars, not holding a margin percentage. A strategic supplier should be able to provide and manage an entire category of goods for a channel partner. I recall the first time I told Home Depot our company would design and provide their private label goods. The room went silent. I was asked to restate my position. My predecessors had been so steadfast in their position that we were not even considered a source when the opportunity opened up. Explicitly proposing it showed we were a partner for the entire category, not just when it was in the interest of our brand name.

The peanut butter approach leads to poor business-nutrition

Companies and financial organizations often assume their overhead structure is uniform across various business types. It is unlikely to be the case. Customers have varying costs to serve. There are more risks in one business versus another. Dissecting this variance can be important when your business is under competitive threat. Lets use an example where a business has a general cost structure of 35% on top of cost of goods accounting for SG&A, distribution and logistics, loss, shrinkage, etc. Not all parts of the business generate or require an equal proportion of costs. No matter how hard you try to avoid it, cost-plus pricing is usually our starting point in establishing price.

Cost + margin requirement = price?

We all know it is not market based, but we all do it at one time or another. The more you do, the more you apply a general overhead structure across all of your categories of business and customers. Your competitor may not be doing this. They may allocate their overhead and direct costs correctly meaning that some of their business cases can be seen as profitable when others would see them as marginal. It also means that these allocations have to go somewhere and this part of the exercise leads you to a much better understanding of what part of the business is driving your cost structure. If one part of the business has lower direct costs than another then those wrongly applied costs will now be correctly applied to the part of the business where it belongs and that pressure will lead to asking the right questions. I call this process creating a segmented P&L model. We need to create detailed P&Ls for segments of your overall business and have accountable leadership responsible and reporting on each P&L. It is common to have 10 or more segmented P&Ls in a business. It is an excellent management tool and will be discussed in greater detail in this series. The take away for the topic of managing your core business is that not all business segments have the same overhead burden and direct costs to serve. Knowing this allows you to manage your business in a much more informed way. Mark ups or margin rates can vary. Force your overhead lower when margins are lower. The segment P&L will show you what costs are driven by various parts of your business. If you don’t like what it looks like, it is time to intervene and make a change in the cost structure.

A good exercise to test the vulnerability of your core business is to have a team perform an exercise acting as if they are a new challenger to your business. How would they enter the market? What advantages can they create? How would they overcome barriers to entry? Should we leapfrog the current channels of distribution? How can they take business from… us? The answers that come from this exercise may lead to initiatives you may take to strengthen your core business. If the thought of a competitor taking any of these actions concerns you, it is always good to act by implementing these things yourself.

Self-imposed barriers

It is likely you have placed barriers in the way of continuing to lead in your core without realizing it. Habitually doing things the way we have always done them is at the root. Not challenging our barriers is the problem. “How can I… ?” is not often asked before a crisis occurs. Trying to preserve a given supply chain that is too costly, perhaps a plant. Not driving costs out of the goods so you can be competitive. You may have too high of an overall cost structure, the combination of SG&A and product costs. You may be protecting an underperforming sales or marketing function by assuming they are better than they are. You may not be looking for ways to cut out burdensome steps your customer faces in doing business with your company. Whatever barriers are preventing you from gaining in your core are the ones that may allow someone else to take that business from you. Study what they do better or differently. Often times we don’t understand the complete benefit of what someone does differently than us.

On Southwest “Bags Fly Free”.

What is the benefit to the company? Greater ticket sales from passengers who do not like baggage fees? Perhaps. That is the benefit people often perceive, but the ones that are overlooked go deeper into Southwest cost structure and overall efficiency. Airlines that charge for bags provide an incentive for passengers to carry-on. This brings a large number of bags to the gate. That means more bags through security, longer lines, higher TSA costs, which airlines pay and recently even had to supplement with their own employees to help get passengers through Atlanta for example. Look at the boarding process. The process of boarding becomes a race to board first to have space for your bag. Then we have the bags that won’t fit. Often discovered onboard with a few passengers that cannot find space. We now redirect the flight attendant to look for space and then when we are completely out we have a few passengers that have to walk their bags back to the jet way where we have to redirect someone from the gate and ground crew to get those bags in the baggage compartment. We have to tag it to the destination and load it. We cause a much longer boarding time and redirected 3 employees from their primary tasks for the exception processing. Southwest has a competitive cost advantage by not charging for bags. While other carriers don’t charge high rollers, they drive a tremendous number of bags into a less efficient process. It is all a component of total price, but one method creates a great deal of overlooked costs. Southwest doesn’t have a gate agent begging for gate checking of bags. They board the flight and get their fixed asset back in the air.

Baggage fees are promoted in business articles as a large revenue stream that has become the key to airline profitability. The more airlines charge, the more bags that come to the gate. I pondered this recently while boarding a flight and thought, at $25 per bag many come to the gate. At $7 per bag would most be checked? If 3x more were checked at $7 per bag would the airlines have nearly the same revenue and yet more efficiency in processing the bags?

What is your core?

The core of your business is important to define and manage. It is the source of your scale and should be the financing mechanism for growth. A strong core gives you permission to grow and expand into additional categories and with additional customers. A weakened core stresses the business and leaves customers less convinced in your value proposition. Losing control of your core is not as uncommon as it would seem. Every business I have led had lost control of their core. Too often declines in the core business are explained away little by little. An unattended core tends to become static and often leaves room for competition to creep in. Private label can also become a larger competitor to your core if it is static. A dynamic core tends to keep competition at bay and as we will talk later, private label plays a role, but a competitor need not supply it. Supplying a private label line your customer is seeking is a good opportunity both offensively and defensively.

The core of your business is often the legacy business and represents not only a majority of sales, but also a majority of margin dollars and most of the resources of the organization are designed to support it. The core will have mature systems and supply chain. The core of the business is not only goods, but channels. It is very common for the core business to have branches that are non-core. A business I led in 2010 had 58% of all sales through one big box retailer. It would be easy to define the core as that customer. It is the majority of sales. We were highly tailored to serve that customer’s systems and it was a priority. Part of that 58% was two small programs that made up 6% and 1% respectively. These programs were only sold to this customer and had completely separate supply chains and were totally separate product categories. These smaller branches were non-core because of the differences in supporting those businesses.

The second largest customer represented 15% of sales. Non-core because it is much smaller, right? Well, the channel was another big box retailer in a similar space and the goods were the same type. Although not identical SKUs, the supply chain was the same and the same processes and resources managed the businesses. This business would also fit the definition of our core. The third largest customer represented 12% of sales. It was also a big box retailer, but had served a very different market and had much different product and service requirements. The type of goods was similar to our previously defined core. The supply chain challenges were different. While it was a good business, it would not fall into the definition we are seeking for the core business. This in no way means we deemphasize this business. On the contrary, it may mean it is one of our growth engines that is enabled from our strong core since it is adjacent.

Sometimes a company will define its core not in the form of a business, but of a process. Cabinet manufacturers may feel their core is woodworking. A faucet company may feel their fundamental competency is machining brass. These are perhaps core processes that are critical to cost control, but they are not core “businesses”. If you define by a core technology, you are almost certain to face a challenge at some point that threatens the defined core technology. By 2010, faucet manufacturers were required to remove lead from brass alloys used in faucet construction for products sold in the state of California. Rather than building two types of faucets, a standard design was highly preferred. New technology was available that used polymer parts in the place of much of the brass in the original designs. While that was a core processing technology, the core business was faucet manufacture for sale through retail home centers and large wholesalers in the US and Canada. The core business was unchanged by the regulations, but the core technology shifted from brass machining done in-house to high-tech polymers sourced outside. Most other competitors failed to question the material use based on large investment in brass machining centers and a lack of exploring opportunities.

Have you heard of FW Woolworth Company?

It was once the largest retailer in the US and was the builder of one of the first skyscrapers in New York, the Woolworth Building. Their core business was a self-service retail store called a five and dime store. By the late 1980’s their core was gone. Their core business was replaced by other retail formats. They didn’t retain their leadership advantage by reinventing their core business and having a dynamic core. Their core did provide great funding for their expansion. The Woolworth building in New York was paid for in cash and the company made efforts to expand the core, but they forgot to maintain the core. One of their investments funded by the core led to where the FW Woolworth Company is today. The FW Woolworth Company is now Foot Locker.

Your core includes space.

It may not be in your core yet, but your core goods are there and if it isn’t part of your core channels, you are missing out. Often by self-limitation with fears of channel conflict. At other times by lack of familiarity exactly how much of your category is being sold online. Chances are your core customers are selling online today. Are you integrated into that? Can you serve those sales on a direct ship basis? I advise companies to embrace the change and to design their systems to serve this channel in a broad way and, directly.

Why the focus on your core?

You will struggle to grow from a weakened core business. Risks to the core are often overlooked. Believe it or not, core is often neglected. In 25 years I have been involved in leadership of 4 companies. All of those companies lost focus on their core and had to retrench after losing significant share by not remaining focused on the core. Sometimes a company will lose its core entirely. In my case, one company had lost $140m and another nearly $1b in sales in its core. It wasn’t a market force that led to the loss. Recovery was a multi-year effort and the make up of the company was quite different. Worse yet, investors suffered through the decline and the recovery. The lost time having to rebuild should have been focused on growth extending from the core, not restoring the core.