When I was a financial advisor with Merrill Lynch, I was working with a couple who worked for Nextel. It was following the tech bubble burst of 2000/2001 and we were discussing diversifying their holdings to provide for their future. Their net worth at the time was roughly $2 million, down from a peak of about $3.7 million as a result of the depressed stock. They agreed with every recommendation, but added, “We want to wait for the stock to recover before we do this. I just can’t bring myself to sell a stock for $30 that was worth $60 just a year ago (emphasis added by me).” I responded by saying that you could look at it as being worth ½ of what it was worth a year ago, or 30 times what it was worth two years ago. They didn’t listen, the rest was history, and last I heard their net worth was less than $100,000, and they planned to work for some time.
I was reminded of this story recently as I presented our program on Creating Demand to a group of CEO’s. The topic we were discussing focused on understanding your clients better than they understand themselves. One of the attendees said, “the only thing my customers think about right now is cutting costs – there is nothing else.”
I shared with them my thinking about the psychology of cost cutting and emphasized the need to recontextualize the conversation. Another attendee responded, “when your industry is down 25% and a competitor is willing to provide it at half the price you are, marketing can’t get you out of that mess.”
While I agree that marketing (at least how its’ defined by most executives) is not the answer to every question, I’ve now had time to think about the situation. My response today would be, “Maybe your company was never as big as you thought it was.”
Let me explain.
For at least the past 50 years, margins and financial performance, as measured by percentages, have been on the decline for businesses. When margins compress, the only way you can increase profits is to increase your volume at a greater rate that your margins are compressing.
So, for the last 50 years, businesses (as a whole) have been focused on increasing volume over margins – the center of what most people call commoditization. This resulted in businesses leveraging themselves to greater degrees to: a) increase the resources they had to chase volume, and b) increase perceived rates of return. The problem with this approach is that when relative demand decreases, profits are drained (what many analysts call a “profits recession” which the US has been in since about 1998); and when absolute demand decreases (as it has over the last 24 months), businesses are destroyed.
Fred Reichald talks about good profits and bad profits in the bestselling book The Ultimate Question. While I like Reichald’s definition, we have a slightly different definition:
- Good profits – those revenues and profits that earned because of the unique problems you solve for your target customers. I refer to this as your core business
- Bad profits – any revenue or profit earned from anything other than your core value proposition. I refer to this as your non-core business.
Bad profits are okay so long as you use them to reinforce your good profits and core business. Great companies to this religiously, average companies rationalize that they are being opportunistic.
As the economy appears to be reemerging from its doldrums, it is now more important than ever to remember what great companies do to make recoveries last. They refocus on their core and grow from there, even if that means they must be smaller than they were.