Book review: Islands of Profit in a Sea of Red Ink, by Jonathan L S Byrnes

Determining which parts of a business make money and which don't is all very well, but what do you do with the unprofitable bits?

by Andrew Wileman
Last Updated: 05 Nov 2010

'Islands in the stream, that is what we are.' The main propositions of this book go something like this: It's astonishing but true that nearly 40% of almost every business is unprofitable, while 20% to 30% is so profitable it provides all the earnings. It offers a systematic approach to determining which bits of the business are which. Key reasons for this split, says the author, are that most businesses have not adjusted from the Age of Mass Markets to the Age of Precision Markets and from product-driven competition to customer-driven competition. Islands gives a set of 'profit levers' to create and improve profitability.

And here's my freshly minted list of things to consider when deciding if a new business book merits more than an exasperated 60-second flick-through and a tossing in the bin: Is it true? Is it new? Is it actionably true and new? Is it a good read?

Let's take the message in the title first: 'it's astonishing but true' that nearly 40% of almost every business is unprofitable, while 20% to 30% is so profitable it provides all the earnings.

When I started in consulting in 1977, the first thing we'd ever do to impress clients with our brilliant insight was some kind of product, customer or channel profitability analysis (those were pre-PC days and clients weren't so used to MBA number-crunchers). We'd often find exactly that outcome.

As we became more sophisticated at it (and got faster PCs), we would factor in shelf space, asset turn and logistics cost to get at direct product profit for retailers (mid-1980s), or customer lifecycle cost and customer lifetime value in financial services (1990s). I know several turnaround CEOs and they always do it early in a new job, to try to find quick wins from repricing or abandoning unprofitable segments. My friend Richard Koch has written an excellent book on the 80/20 principle, which is sort of the same idea.

So, if it were true, it certainly wouldn't be astonishing - and it certainly would not be new.

But is it even generally true, these days? Thinking of the several businesses that I consult with and know well, it would be absolutely untrue in half the cases, and possibly true but rather 'so what, we know that' in the other half.

The absolutely-untrue businesses are either network businesses, where variable cost per customer or unit is very low, like a global technology transaction platform, or social networking (what matters is contribution to fixed costs, and very few activities have a negative contribution) or the opposite, where variable cost per customer or unit is very high, so the business is very aware of loss-making activities and eliminates them quickly (like Ryanair or online travel agencies). While it would of course be true that profitability could show great variability, our ability to change that variability is mainly constrained by competition, not by our own lack of understanding.

There are some of my businesses where the thesis could be true, which are businesses with a balance of fixed and variable cost - like building materials distribution or enterprise IT services. But even here, although profitability analysis could always be sharpened up, the main question is: I know which customers are less profitable, or even absolutely unprofitable. But so what? My key question is about how to improve profitability, not how to prune the customer base, or how to get 10% more accurate in allocating inventory cost - acquiring customers is really expensive. (To be fair to Byrnes, he does recommend improving before pruning.)

As for (briefly) the third core proposition: I thought the move from mass to precision markets was a 1980s theme, or 1990s at the latest. The 'Segment of One' was hot in the late 1980s; Amazon and Dell invented personalisation and made-to-order PCs in the 1990s. And the focus on 'customer-driven competition' can be quite dangerous: think of BA versus Ryanair, think of which has segmented and tried to nurture its customers most assiduously (clue: not Ryanair) and think which one is now the world's most profitable airline. Or ponder whether it was product-driven innovation or customer-driven innovation that enabled Apple to destroy Nokia's global mobile phone dominance in two years.

The last of Byrnes's propositions is about 'levers' to improve profitability. These are pretty reasonable and quite readable, if again a bit old hat if you are a regular reader of Harvard Business Review, McKinsey Quarterly and so on: get in bed with your customers' supply chains, differentiate customer service levels, focus your sales team on customer potential, not current sales.

There's a side-trip into change management that would reinforce any prejudices you might have against that snake oil. And there's an annoying element of FAWS throughout (False Accepted Wisdom Syndrome), management views said to be commonly held that are then debunked: 'revenues are good, costs are bad', 'all customers should get the same great service', 'don't change a good thing' - I can't remember the last time I heard any of those around an exec table.

So, scores out of 10 for Mr Byrnes. Is it true? That's a five. Is it new? That's a two. Is it actionably true? That's a four. Readable? That's a six. Overall? It's a four to five that needs to work on the tango and foxtrot.

Islands of Profit in a Sea of Red Ink: Why 40% of your business is
unprofitable and how to fix it
Jonathan L S Byrnes
Penguin Books/Portfolio £20.00

Andrew Wileman is an independent management consultant and business author.

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