CHAPTER 5

Experience Counts

(What You Do Not Know Is Important)

Vignette: The Gun

I was told that he carried a gun all the time. He was the father-in-law of the country’s dictator and did practically whatever he wanted. No one ever contradicted him: with good reason.

He wanted to create a new airline company and needed the assistance of a management consultant to develop a feasibility plan and estimate the capital investment required. Since my consulting firm was the official auditor of some of the country’s organizations receiving international financial aid, I was chosen to perform this study because I spoke fluently one of the country’s official languages.

It was a sunny day, as most are on this island. The airport was bare. Very little infrastructure was visible. I passed customs and immigration easily. A chauffeur was waiting at the exit. My local business partner was there, too. She was the one who briefed me about this “special” customer. “He is very powerful,” she told me. “Watch how you address him.”

I was invited to his house, a mansion.

There was a hole in the upper wall of the spacious entrance, just above the stairs. It was a bullet hole, I was told. One day, he was furious and shot at his daughter’s suitor. He missed. The hole was a reminder not to alienate him. He left it there for all to see.

Knowing the profile of this customer was very useful.

Although he was a jovial and talkative person, he kept his financial information close to his “chest,” literally. He would pull a small notebook out of his jacket pocket and refer to it each time we were reviewing financial figures affecting his potential business venture.

I learned early on that the required investment for this new venture of his, which included an airline route from the island to the mainland, was not a deterrent. The profit potential of his planned business was so high that it would quickly overshadow any upfront investment requirements.

I could only speculate as to what his hidden agenda was. I dared not think out loud. The numbers did not support the venture; therefore, something else had to be behind this project. What was it?

I finally chose not to pursue this project. I did not want to know too much. I left the accounting firm.

A few years later, my decision was justified. With the fall of the dictatorship, it was useful not to be involved in any of that government’s projects.

Watch what you look for; you might find it.

Lessons Learned: Know Thy Customer

Knowing your customer is of paramount importance not only because management gurus like Peter Drucker ⁱ are telling us this.

In my case, it was a matter of survival. My life depended on how I interacted with this type of “customer character.” First impressions can be misleading. This was one of these.

Some management consultants consider that if there were Ten Commandments for business, the number one would have been “Know Your Customer” (KYC).

KYC typically includes the following¹⁵:

The aforementioned might sound counterintuitive because, according to Peter Drucker, a business’s most important person is the customer.

He wrote: Who must be satisfied for the organization to achieve results? When you answer this question, you define your customers as those who value your service; who want what you offer; who feel it is important to them.¹⁶

What you do not know may hurt you.

Vignette: Volume Is a Double-Edged Sword

The price of the letter delivery was the lowest in the local marketplace. Mark was very proud of this achievement. In less than a year, his new business generated $2 million in yearly sales. George, his father and the company president, was pleased.

The company was a long-term accounting client. Financial audits were performed regularly, and the company showed stable growth. Until recently.

George did not understand the reason for this recent loss in profitability and asked for external advice.

When I reviewed the various sources of this company’s income, I noticed that the new mail delivery revenues were added to the bottom line. Any expenses directly associated with those revenues were “buried” in the company’s other operating expenses.

The result was a misrepresentation of the profitability of this new line of business.

Careful analysis of the direct expenses associated with the mail delivery side of the company’s activities uncovered an expected result: a direct correlation between mail delivery volumes and mail delivery costs.

Translating this information into unit costing and pricing (the average price of one mail delivery and the average cost of one mail delivered) showed that the cost of every delivery was about 20 percent higher than the price of that delivery.

This explained the growth and market success of the mail delivery business: The price was lower than that of any competitor in this marketplace. The mail delivery expenses were consolidated with other business activities expenses. Therefore, the higher the volume, the greater the loss for the company.

The company was offered two options: either to increase the price of each delivery, which would reduce the competitiveness of this service (because the price was its only advantage), or to close the mail delivery business unit.

The company chose to close the mail delivery business unit.

Bean counters can be useful.

Lessons Learned: More Can Hurt

Profit–volume–cost analysis is a powerful tool that estimates how a business’s profits change as the sales volumes grow. This tool also helps identify the breakeven point.ⁱⁱ

Profit–volume–cost analysis often produces surprising results. Typically, the analysis shows that small changes in a business’s sales volume could produce big changes in profits.

Cost–volume–profit (CVP) analysis uses three pieces of information to show how profits change as sales revenues change: sales revenue, gross margin percentage, and fixed costs.ⁱⁱⁱ

Sales growth is not always profitable.

ⁱPeter Ferdinand Drucker (1909–2005) was an Austrian-born American management consultant, educator, and author whose writings contributed to the philosophical and practical foundations of the modern business corporation. He was also a leader in the development of management education. He invented the concept known as “management by objectives,” and he has been described as “the founder of modern management.”

ⁱⁱA breakeven point is the sales revenue level that produces zero profits.

ⁱⁱⁱCVP analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point, a company will experience no income or loss. This breakeven point can be an initial examination that precedes more detailed CVP analysis. (Source: Wikipedia.)