The 11 Rules of Highly Profitable Companies

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How do you generate the most profit with the least effort? How do you maximize margins without sacrificing quality? 

 

I'm not talking more customers, nor more revenue, nor more offices and employees. Profit.

 

Based on my interviews with high-performing CEOs ("high-performing" determined using annual-profit-per-employee measurements) in more than a dozen countries, I've listed 11 common "rules" below. This is a return-to-basics call.

Here's your cheat sheet for consistent profitability -- or doubling of it -- in 3 months or less. 

1. Repetition is Usually Redundant — Good Advertising Works the First Time

Use direct response advertising (call-to-action to a phone number or website) that is uniquely trackable – fully accountable advertising — instead of "image" or "brand" advertising (e.g. billboards with no URL/phone/messaging), unless others are pre-purchasing product to offset the cost (e.g. “If you prepurchase 288 units, we’ll feature your store/URL/phone exclusively in a full-page ad in….”).

Don’t listen to advertising salespeople who tell you that 3, 7, or 27 exposures are needed before someone will act. Well-designed and well-targeted advertising works the first time. If something works partially well (e.g., high click-through with low percentage conversion to sales (CVR), or low click-through with high conversion, etc.), indicating that a strong ROI might be possible with small changes, tweak one variable and micro-test once more.

Cancel anything that cannot be justified with a trackable ROI. 

2. Pricing before Product – Plan Distribution First 

Is your pricing scalable?

Many companies will sell direct-to-consumer by necessity in early stages, often through a simple website. Only later do they realize that their margins can’t accommodate resellers and distributors when they come knocking. This is true whether your "distributor" is iTunes, a worldwide widget distributor, or Orbitz.

If you have a 40% profit margin and a national distributor needs a 70% discount off of retail (or "cut") to sell into wholesale accounts, you’re forever limited to direct-to-consumer… unless you increase your pricing and margins after-the-fact, or launch new "premium" products to fix the problem. For a bootlegged start-up, this distraction can equal sky-high customer churn or death altogether.

Plan out your first two years of distribution plan before setting pricing.

Think digital is different? Think again.

Test assumptions and find hidden costs by interviewing those who have done it: will you need to pay for co-op advertising, offer rebates for bulk purchases, or pay for shelfspace or featured placement? I know one former CEO of a national brand who had to sell his company to one of the world’s largest soft drink manufacturers before he could access front-of-store shelving in top retailers. 

3. Less is More – Limiting Distribution to Increase Profit

Is more distribution automatically better? Not necessarily.

Uncontrolled distribution leads to all manner of head-ache and profit-bleeding, most often related to rogue discounters. Reseller A lowers pricing to compete with online discounter B, and the price cutting continues until neither is making sufficient profit on the product and both stop reordering from you (or selling/referring your product). This race to the bottom requires you to launch new products, as price erosion is almost always irreversible.

Avoid this scenario and consider partnering with one or two key distributors instead, using that exclusivity to negotiate better terms: less discounting, prepayment instead of net payment terms, preferred placement and marketing support, etc.

Whether Apple or Estee Lauder, sustainable high-profit brands usually begin with controlled distribution. Remember that more customers isn’t the goal; more sustained profit is. 

4. Net-0 — Create Demand vs. Offering Terms:

This is related to Rule #3.

Focus on creating end-user demand so you can dictate terms. Often one large advertisement, bought at discount remnant rates, will be enough to provide this leverage.
Just because everyone in your industry offers payment terms doesn’t mean you have to, and offering terms is one of the most consistent ingredients in start-up failure.

To avoid getting strung out and cash-flow poor: Cite start-up economics and the ever-so-useful “company policy” as reasons for needing prepayment and apologize, but don’t make exceptions.

If you agree to receive payment on net-30 terms (they pay 30 days from invoice, or receipt of product), it will become net-60, which becomes net-120. Time is the most expensive asset a start-up has, and chasing delinquent accounts will prevent you from generating more sales.

On the hand, if tons of customers are asking for your product, resellers and distributors will need to buy. It’s that simple. Think a big order from Wal-Mart is a godsend? Be careful.

Since they're almost always net-180+, and they can return unsold product, it could actually be the death of your company. How are you going to pay for the needed inventory?

Typically, debt. What will you do if they return half of it because they didn't give it proper placement, so it didn't have sufficient sell-through? Be careful, lads and lasses.

Put funds and time into strategic marketing and PR to tip the scales in your favor. Consumer demand = your ability to negotiate better terms. 

5. Limit Downside to Ensure Upside — Sacrifice Margin for Safety

Don’t manufacture products in large quantities to increase your margin, unless your product and marketing are tested and ready for roll-out. In other words, only when you already have a proven demand and can forecast sell-through rate.

If a limited number of prototypes cost $10 per piece to manufacture and sell for $11 each, that’s fine for the initial testing period, and essential for limiting downside. Sacrifice margin temporarily for the testing phase, if need be, and avoid potentially fatal upfront overcommitments. 

6. Niche is the New Big — The Lavish Dwarf Entertainment Rule

Several years ago, an investment banker was jailed for SEC violations.

He was caught partly due to his lavish parties on yachts, often featuring hired dwarves. No joke. The owner of the dwarf rental company, Danny Black, was quoted in the Wall Street Journal as saying: “Some people are just into lavish dwarf entertainment.”

Niche in the new big, I tell you. And here’s the secret: it’s possible to niche market and mass sell.

iPhone commercials don’t feature dancing 50-year olds, they feature hip and fit 20-30-somethings, but everyone and his grandmother wants to feel youthful and hip, so they strap on Apple gear and call themselves converts. Who you portray in your marketing isn’t necessarily the only demographic who buys your product — it’s often the demographic that most people aspire to. The target isn’t the market.

No one aspires to be the bland average, so don’t water down messaging to appeal to everyone–it will end up appealing to no one. 

7. Revisit Drucker — What Gets Measured Gets Managed:

Measure compulsively, for as Peter Drucker stated: what gets measured gets managed.

Useful metrics to track, besides the usual operational stats, include CPO (“Cost-Per-Order,” which includes advertising, fulfillment and expected returns, chargebacks, and bad debt), ad allowable (the maximum you can spend on an advertisement and expect breakeven), MER (media efficiency ratio), and projected lifetime value (LV) given return rates and reorder %. Consider applying direct response advertising metrics to your business.

Look at "lean start-up" metrics for more methods of measuring during the start-up phase. The work of Eric Ries is a good starting place. 

8. Hyperactivity vs. Productivity — 80/20 and Pareto’s Law

Being busy is not the same as being productive. In fact, being busy is a form of laziness -- lazy thinking and indiscriminate action.

Forget about the start-up overwork ethic that people wear as a badge of honor–get analytical. I'm not going to say "work smarter; don't work harder," as I'm fine with hard work...but only as long as it's applied to the right things.

The 80/20 principle, also known as Pareto’s Law, dictates that 80% of your desired outcomes are the result of 20% of your activities or inputs. Once per week, stop putting out fires for an afternoon and run the numbers to ensure you’re placing effort in high-yield areas:

What 20% of customers/products/regions are producing 80% or more of the profit? What are the factors that could account for this?

Invest in duplicating your few strong areas instead of fixing all of your weaknesses. 

9. The Customer is Not Always Right — “Fire” High-Maintenance Customers

Not all customers are created equal.

Apply the 80/20 principle to time consumption: What 20% of people are consuming 80% of your time? Put high-maintenance, low-profit customers on auto-pilot. Sure, process their orders, but don’t pursue them or check up on them. And “fire” high-maintenance, high-profit customers by sending a memo detailing how a change in business model requires new policies at your company: how often and how to communicate, standardized pricing and order process, etc.

Indicate that, for those clients whose needs are incompatible with these new policies, you are happy to introduce other providers.

“But what if my largest customer consumes all of my time?” you ask? Recognize that 1) without time, you cannot scale your company (and, oftentimes, life) beyond that customer, and 2) people, even good people, will unknowingly abuse your time to the extent that you let them.

Set good rules for all involved. Minimize back-and-forth and meaningless communication. 

10. Deadlines over Details – Test Reliability Before Capability

Skill is overrated.

Perfect products delivered past deadline kill companies. Better to have a good-enough product delivered on-time. Google "minimal viable product" for more on this philosophy. Even the great Reid Hoffman, co-founder of LinkedIn, has wisely said that, "If you are not embarrassed by the first version of your product, you've launched too late."

Test someone’s ability to deliver on a specific and tight deadline before hiring them based on a dazzling portfolio.

Products can be fixed as long as you have cash-flow, and bugs are forgiven, but missing deadlines is often fatal. Calvin Coolidge once said that nothing is more common than unsuccessful men with talent; I would add that the second most common is smart people who think their IQ or resume justifies delivering late. Don't tolerate it. 

11. Keep it simple. Complicated answers are rarely the right answers.
'Nuff said.

Tim Ferriss