Excessive focus on margins can cost you. The best example is the purchasing manager who was about to place an order for four years' worth of stock of a certain item.
Why commit scarce cash to stock that would not turn into cash again for four years? Yet she was behaving quite correctly, as she had been tasked with achieving the lowest possible unit cost in order to maximise the gross margin.
There are many other hidden trade-offs, such as that between margin and risk. This is the reason behind the recent horseburger scandal. The supermarkets pushed the price of value burgers lower and lower to improve gross margin until someone felt compelled to take a chance on some dodgy 'beef' which turned out to be horse.
The same mechanism operated in the Texas City refinery, where managers reduced costs very effectively by cutting back on maintenance and repairs. Everything was fine until an explosion in 2005 killed 15.
And there is a hidden trade-off between margin and growth. Google famously allows its engineers to spend 20% of their time doing work that isn't in their job description. Google could boost margins by abolishing this, but since the 20% time has produced many valuable new products and features, how long would the company still be Google?
If you ever hear a company praised for its 'single-minded focus on improving margins', sell the shares (and avoid eating the burgers). You can't be single-minded about margins - they are just part of a spider web of interrelated variables: growth, risk, quality, cash flow, the future ...
Alastair Dryburgh is the contrarian consultant, specialising in solving problems that can't be solved by normal means. He is also the author of Everything You Know About Business is Wrong (Headline, £13.99). More at www.alastairdryburgh.com
