We have spent the past two weeks discussing portfolio analysis in great depth here on Profit. Value. Life. Now we will take a look at some portfolio analysis case studies.
First, I introduced the benefits of portfolio analysis: greater margin—in both profit and life. Next, I described the process for performing a portfolio analysis: use accrual accounting, categorize all costs, and classify the numbers by customer, division, and by product or service. I also discussed ways to apply the insights and optimize the business.
However, it can sometimes be difficult to picture how to apply a theory without seeing case studies. I have had the privilege of working with several great business owners in this area, so let’s review a few real-life examples where performing a portfolio analysis led to fantastic results.
Knowing When to Outsource in Landscape Construction
One commercial landscape construction customer came to us with a huge red flag: the net profit margin was much lower than what the owner believed was acceptable.
It is vital to be as neutral as possible when examining issues such as this one. Look for the extremes and do not allow anything to cloud your judgment. Trust the data, trust the patterns. As I discussed in my last post, it helps to review the portfolio analysis as a team. Different perspectives (and outside perspectives) can help.
We performed the portfolio analysis on each job. We found some jobs were significantly below average profitability and reviewed those jobs in great detail. After closer examination, we found that many of those jobs involved performing a service in-house that had been subcontracted previously. The company began to perform the service in-house to increase the gross profit margin.
To be blunt, the analysis showed that the company was not good at performing that service. They had to perform rework routinely, and the rework was quite expensive.
On paper, their gross profit margin should have increased. In reality, it decreased. Performing that service was more difficult than it appeared. The company returned to subcontracting that service and the gross and net profit margins increased.
Incidentally, in the 2018 Benchmark Report for the Landscape Industry, the most profitable landscape construction companies had a modest, yet significant, amount of work performed by subcontractors. I suspect these companies have found a “sweet spot” in the use of subcontractors. Subcontracting enables these companies to fix the costs, reduce risk, and focus on other aspects of the construction project.
Client & Pricing Optimization in Landscape Services
With one commercial landscape maintenance company, we performed the portfolio analysis by computing the net profit margin by division. We determined that one division was not as profitable as we wanted. That division had provided significant revenue growth for the company, but the increase in revenue had not created growth in net income.
Based on the portfolio analysis, the company changed its pricing for services in this division, knowing that revenue would likely decline, but profit would increase.
With another commercial landscape maintenance company, we performed a similarly structured portfolio analysis and came to a similar “not profitable enough” conclusion about one division. However, in this case, we determined that we could not raise pricing in that division due to constraints in the market. That conclusion meant that the company would no longer serve clients who only wanted services from that division.
The owner changed the sales focus accordingly and did not renew contracts with clients who were likely never to use services from other divisions.
In both cases, implementing changes allowed each business owner to increase profit in terms of margin and dollars without taking on extra work.
Remember, the goal is not to have the most contracts—it’s to have the most profitable contracts.
Product & Division Optimization With E-commerce
One excellent way to create greater profit margin is to optimize offerings of products and services. In one case, I worked with a client that sold small consumer appliances over the internet. This client was an early player in e-commerce and sold products in eight categories or divisions.
Based on experience and the company’s low net profit margin, I suspected that some of these divisions were losing money.
Working with the owner, I developed a spreadsheet that allocated (by division) the revenue, cost of goods sold, incremental costs such as advertising and shipping expense, and overhead.
The insights were amazing.
Five product categories had a negative contribution to overhead – meaning if the company just stopped selling those products, the company would make more profit. These categories were an obvious cut.
Clearly, there are times when a company makes a strategic decision to continue funding a money-losing division. For example, as discussed here, sometimes a very profitable customer base will be “married” to the totality of the offer, and cutting money-losing divisions would risk “scaring off” this highly profitable customer base. In this case, there were no strategic reasons to continue selling these five product categories.
The sixth product category was break-even in terms of incremental profit. It covered its COGS and incremental costs but no overhead costs. The owner elected to terminate this product category because of other difficulties.
The seventh product category was highly seasonal. Revenue was highly correlated to specific weather patterns. If the weather did not cooperate, the division would have negative incremental profit. If the weather cooperated, the division would have significant net profit. If there were unfavorable weather, the company had to store considerable inventory until the next season.
In this situation, we can see the importance of evaluating data for multiple years in the portfolio analysis. If we had not allowed enough time to elapse and had completed the analysis only looking at a season with favorable weather, we would have come to a less-informed, incorrect conclusion on this division.
The owner terminated this product category because the weather is not predictable.
The final product category was a big winner in terms of revenue growth and net profit margin. It was an easy decision to focus on this division. And focus we did. For the next two years, the company’s revenue stayed flat as we discontinued product categories, but net profit dollars and margin soared.
It was tough for the business owner to make the decision to discontinue those product categories. Most people measure companies based on revenue. Growing revenue requires diligent, creative work. Even though the process and analysis were solid, it was uncomfortable to eliminate that hard-won revenue.
Still, with those product categories cut, the owner was free to focus on more favorable revenue streams. The long-term advantages far outweighed the short-term discomfort.
Creating Healthy Margins in Business and Life
The ultimate goal of portfolio analysis is to gain valuable insight to inform strategic decisions. Once performed, this vital part of the pre-planning process will make the planning and budgeting process as easy and efficient as possible. A thorough and thoughtful analysis will put business owners in a much better position to make strategic decisions about the direction of their companies, and it will allow them to maximize growth while optimizing the net profit margin.
Growth for growth’s sake is not the goal.
The goal is building a business that sustains itself, that provides value, and that gives the business owner the best possible life margin – which means freedom and discretionary mental energy to focus on the goals for the business as well as the important things in life.
Portfolio analysis is a vital step on the path toward that reality.
Read the Whole Series
Part 3 (this post)– Portfolio Analysis in Action — Select Case Studies