If you’re a business owner, you already know that profit is the fuel that keeps your business running and enables future growth. But have you ever stopped to consider your profit per X? This simple yet incredibly powerful concept can be a game-changer for your bottom line.
It’s not about complicated financial terms that make you feel like you’re back in a stuffy economics class. It’s about understanding the primary drivers of your bottom line.
Profit Per X – Definition
Profit Per X is the variable that drives your bottom line the most. It’s the one thing that, if you could systematically improve it, would make the biggest impact on your bottom line. Jim Collins, in Good to Great, put it like this:
‘The essential strategic difference between the good-to-great and comparison companies lay in two fundamental distinctions. First, the good-to-great companies founded their strategies on a deep understanding along three key dimensions; what we came to call the three circles. Second, the good-to-great companies translated that understanding into a simple, crystalline concept that guided all their efforts … one particularly provocative form of economic insight that every good-to-great company attained is the notion of a single ‘economic denominator.’
This “X” is the economic denominator. It is not just something measurable, but also something that brings focus, and fuels your financial engine. It could be anything that directly aligns with your long-term business goals. This denominator is fixed and represents your company’s unique approach to scaling the business.
Let me give you a few examples:
While most airlines were focused on maximizing profit per seat, Southwest Airlines identified their X is an airplane. Their focus on Profit per plane led them to make strategic decisions about their types of airplanes, pricing model, routes, brand promises, and anti-brand promises (that is, who they are not).
Walgreens uses Profit per Customer Visit. Costco uses profit per Square Foot. Other businesses might conclude that their primary driver is profit per employee, per route, per hour of effort, per location, or per unit.
These metrics are not chosen randomly. They align with the strategic decisions these companies make, whether it’s about their products, services, customer strategies, or employee development.
So, take a moment to think about it: what’s your X, and how is it driving your profits?
The Hedgehog Concept
The concept of Profit Per X is an element of strategy derived from Jim Collins’s ‘Good to Great’ book. It is one of the three circles of his Hedgehog Concept, a strategy model I repeatedly reference during my strategic planning sessions.
Collins firmly believes that a successful strategy emerges when three crucial elements overlap:
- What you are deeply passionate about (your Core Purpose, or ‘why’),
- What you can be the best at in the world (your Core Competencies), and
- What best drives your economic engine (your Profit per X).
Collins proposed an essential question:
‘If you could pick one and only one ratio – profit per X – to systematically increase over time, what x would have the greatest and most sustainable impact on your economic engine?’
This question, though seemingly simple, can uncover profound insights into the inner workings of your company’s economic framework, leading to clear strategies, optimized operations, and greater profitability.
What You are Deeply Passionate About (Your ‘Why’)
The remarkable companies that have endured the test of time didn’t stumble upon their success by chance. They had a clear focus and dedicated their energy and resources to pursuing their purpose. The idea is not to try to force passion or declare an esoteric reason for being that secretly makes employees roll their eyes, but rather to identify why your company actually exists, and why it would be missed if it no longer existed. It’s something that gets your team out of bed in the morning, and makes it worth devoting their best effort and energy – versus doing just enough to get a paycheck.
It’s important to keep in mind that passion cannot be fabricated out of thin air. It’s not something you can simply ‘motivate’ people to feel. Instead, it’s about connecting your work with what you and your team are already deeply passionate about.
I’m not saying that you must be passionate about every little detail of your business. Rather, it’s that even the challenging or unglamorous aspects of the business feel worthwhile because of why you’re doing it.
Perhaps you’ve heard the anecdote of the three bricklayers who were asked what they were doing: The first one replied, “I’m laying bricks.” The second said, “I’m building a wall.” But the third one said, “I’m building a cathedral.” Two of them understood the work, but one understood why he was doing it.
What You Can Be Best in the World At
Every organization presumably strives to be the best, but only a few truly grasp the inherent potential to be the best in one key area – often at the expense of not being the best in other areas. It’s not about setting arbitrary goals to be the best overall; it’s about choosing core competencies to focus on developing, where you can genuinely excel in a unique and meaningful way.
You can be competent in many areas without having the potential to be the world’s best, but the idea is to identify opportunities where your organization has a real chance to outperform everyone else. This distinction is not just important; it’s game-changing.
What Best Drives Your Economic Engine
This is where the Profit per X comes in. Understanding what truly drives your economic engine is a crucial aspect of maintaining long-term growth and profitability that exceeds your industry average. It goes beyond surface-level observation and requires a deep dive into the mechanics of your business model.
Ask yourself this:
‘If you could choose just one metric to consistently increase over time, which one would have the greatest and most sustainable impact on driving your bottom line?’
Here are some additional questions to consider to help you understand your economic engine:
- What is your industry’s standard benchmark?
- What products and services drive your top line?
- What cost drivers are critical to profit that you can control?
- What units (X’s) would you want more of versus less of?
- What can you optimize that competitors are not focused on?
Don’t take the first or seemingly obvious answers. If you take the time to do a deep dive and evaluate several variables, the answers may surprise you. It could be profit per customer, profit per employee, profit per retail location, profit per square foot, profit per geographic region, profit per machine, profit per hour, or profit per product… to name a few examples.
The objective here is not just to decide on an answer, but to have meaningful dialogue that provides a clearer understanding of your economic model, and what factors you can improve that will make a significant difference to the bottom line.
Many of my clients take months to analyze this concept and test their assumptions. Nonetheless, this introspection can provide huge insights, even if there isn’t a single metric that stands out initially. The true power of this question lies in its ability to stimulate deep thinking, leading to a profound understanding of what truly propels your engine.
How to Use Profit Per X
To tap into the power of Profit Per X, it’s crucial to grasp its role not merely as a financial metric, but in guiding your strategic decisions. It shapes the path of your business by informing key decisions such as product launches, market expansions, and workforce planning.
Now, here’s where it gets interesting. Your Profit Per X isn’t something you can simply extract from industry norms or a textbook. It’s not a one-size-fits-all. Instead, it’s a unique identifier, like a fingerprint, that provides exclusive insights into what truly drives your profits, and how your business might operate in a unique way that gives you a competitive advantage.
So, how do you unveil this unique identifier? It takes a clear understanding of your business model, accurate metrics, and a discovery process to reveal which variable most profoundly impacts your bottom line, setting your company apart from competitors. Because it provides a competitive edge, it needs to be safeguarded to avoid competitors attempting to mimic or exploit it, weakening your competitive advantage.
Here’s an example:
Imagine you own a furniture-making business. After some reflection, you realize that your X factor is the value your customers place on your unique custom designs. So, you focus on Profit per Custom Design. This becomes your guiding metric and aligns every step of the process to optimize profitability – from improving the efficiency of design protocols, to material selection, to the process for extracting customer preferences to ensure you nail the perfect design the first time.
This not only ensures that every custom furniture order is more profitable, but it also strengthens your brand reputation, resulting in more referrals, more repeat business, and a lower customer acquisition cost… continuing to propel the profitability flywheel.
Without this insight, you could’ve just as easily focused on revenue per type of furniture (i.e., a chair versus a desk), the dollar value of each transaction, or any other number of generic metrics. While all of those metrics are valuable and can provide useful insights, lacking clarity on your profit per x would’ve led you down a completely different path – potentially missing opportunities to optimize profit and differentiate your business.
This is just one example; your X could be anything that significantly impacts your business’s finances and aligns with your overall strategy.
Good to Great Profit Per X Examples
Now that we’ve laid the groundwork for understanding the concept of Profit Per X, let’s dive into some real-life examples. These case studies exemplify companies that have successfully identified and leveraged their unique X factor to skyrocket their profits. By studying these examples from Jim Collins’s book, Good to Great, you’ll gain practical insights into applying this principle to your own business.
For Walgreens, an American pharmaceutical chain, their X was uncovered as the Customer Visit, wheras teh industry standard was to focus on profit per store.
So, they focused on opening lots of smaller stores instead of a few big ones. This helped them align their strategic choices with their goal of increasing the likelihood of customer visits by increasing proximity and enhancing convenience. At the same time, this increased the likelihood that people coming to their stores would spend more money per visit, as it was quick and easy to wander the aisles.
If Walgreens had followed the conventional metric of profit per store, they might have struggled to justify their distinctive strategy of situating stores near one another, as the economic implications wouldn’t have added up.
Instead of the conventional Profit per Drug approach in the pharmaceutical industry, Abbott Laboratories chose a different path. They defined their X as Profit Per Therapeutic Category.
This smart strategy allowed them to focus on a narrower range of products, each with a distinct therapeutic purpose. Instead of spreading its resources thin across a wide variety of drugs, Abbott Laboratories strategically allocated its resources to develop, produce, and market drugs that catered to specific therapeutic needs. This focus not only enhanced their expertise in these areas but also built a stronger brand identity, resulting in a significant increase in revenue and profit.
Most airlines typically focus on profit per mile or profit per seat. However, Southwest Airlines worked out their core customer valued practicality over cushy conveniences. They aren’t addressing the needs of a Fortune 1000 executive requiring a flatbed seat for a flight from the US to Europe. So, they shifted their focus from the standard industry metrics towards one that gave them a tremendous competitive advantage – Profit Per Plane.
Their One Phrase Strategy can be summed up as, “Wheels Up!” That is, planes in the air make their money, but planes on the ground do not.
It’s this laser focus on maximizing Profit per Plane that informs and influences Southwest’s strategic and tactical decisions. Everything from their flight schedules, speeding up turn-around times, point-to-point flights, efficient passenger loading and baggage handling procedures, and no-frills services are designed to ensure that the planes are airborne as often as possible – thus maximizing profit. This shift in focus has allowed Southwest to operate with a unique efficiency, differentiating them in a highly competitive industry.
Why is Profit Per X Powerful?
Understanding the true power of Profit Per X is more than just calculating a metric; it’s about shifting your business approach to focus on what truly drives your bottom line. But why is it so powerful? What makes this concept a game-changer for businesses with ambitions of sustainable growth and profit?
Enables Making the Right Decisions
The power of Profit per X isn’t limited to understanding your bottom line. Imagine the clarity you gain when you can pinpoint exactly what drives your profit, and which levers make a bigger difference than others.
This understanding helps to guide your strategic decisions, giving you confidence in where to invest your resources. Equally important, of the million good ideas you likely have for improving your business, understanding your economic drivers can also help you decide where not to focus or invest. Leaving behind good ideas to double down on great ideas.
Brings a Shift in Focus
With Profit per X, we’re introducing a whole new way of looking at your business operations. It’s not just about glancing at your income statement for an overall sense of profitability. Instead, we’re diving deep into the numbers to truly understand where that cash is coming from.
Imagine playing a game of darts. Rather than randomly throwing darts at the board and hoping for a high score, we’re helping you focus on hitting the bullseye. By identifying your most lucrative products, services, customer segments, or resources – your X – we can strategically invest your resources in these areas. It’s like honing your aim to maximize your point returns. Not only will this drive top-line growth, but it will also make your business more efficient, lean, and strategic, increasing the net margin.
Differentiates You From Your Competition
In the world of business, standing out is critical to maintaining healthy margins. Profit per X doesn’t just increase your earning potential; it gives you a competitive advantage.
Let’s take the example of a local bakery and a nationwide franchise. The franchise may concentrate on Profit per Outlet, while the local bakery focuses on Profit per Custom Cake. The franchise aims to maximize sales across all its outlets, where consistency, uniformity, and accessible pricing are critical to the overall brand. On the other hand, the local bakery is fine-tuning its focus on a niche, high-profit product, for a small but dedicated core customer. This shift isn’t just about profitability; it’s about carving out your own space in the market, becoming an expert in your niche, and distinguishing yourself from competitors in a way that your best customers crave.
Creates Different Priorities
Profit per X has the potential to radically transform your business priorities. Take, for instance, Oracle’s acquisition of NetSuite. Consulting and software were separate profit centers, but post-acquisition, they prioritized consulting as a recurring revenue driver.
This transition is akin to shifting your focus from a short-term sprint to a long-term marathon. Without a well-defined Profit per X, you may veer off course, juggling multiple profit lines. I.T. support companies transitioning to the managed services approach also face this. While initial consulting projects yield higher revenue and immediate profits, the real Profit per X lies in post-project recurring revenue of ongoing service contracts, where the revenue per transaction is lower, but over time, the margins skyrocket.
Drives Business Growth
In my role as a business coach, many clients share a common goal: scaling their businesses. However, many motivated CEOs jump right into growth tactics, and our initial conversations are their first encounter with the concept of understanding their real profit drivers.
Most business owners, especially those who started from the ground up and remain hands-on, default to measuring gross profit per job. While this metric is important to measure and can show efficiency over time, it might not necessarily be the top metric to indicate potential for growth. In fact, it could direct all their energy to a job-by-job microscope, blinding them to opportunities or operational efficiencies that might be more effective at stimulating rapid growth.
I’m not saying to dismiss common metrics. Rather, don’t default to industry assumptions; prioritize the metrics most relevant to your current business phase.
There’s a saying that “clarity is power,” and it holds. Clarity is a key driver of success and growth in business. But what does clarity mean in a business context? Profit per X or P/X is a tool that provides a simple view of what makes the company money. No debating about where the marketing focus should be, or which innovations to invest in – all of which can lead to a “one department vs. another” way of thinking.
Instead, imagine if everyone in the company knows what’s most important, and all of their jobs are designed to contribute to directly or indirectly improving that critical metric. When you know your P/X, you can apply that focus to every aspect of your business, whether it’s sales, marketing, R&D, or production.
Changes Your Industry
Profit per X doesn’t just transform your business; it has the potential to disrupt your entire industry. For example, when Walmart identified its focus as Profit per Square Foot, look at the impact it made on pioneering the big box retailing space, and the ripple effect on how retailers work with suppliers, technology, customer experience, etc.
Profit per X also serves as a valuable tool for comparing your performance with competitors. It might reveal that your profit per X falls behind industry peers, indicating the need for strategic adjustments to boost margins.
Creates a Better Understanding of Customers
Imagine you’re the owner of a software company, and your Profit per X is per User License. By focusing on it, you might find that certain customers purchase fewer licenses but consistently use high-margin add-on services, making them highly profitable. If you had focused on revenue per account (arguably the most obvious metric to manage), you might have missed the huge margin gains that these smaller clients can contribute.
This insight can greatly influence your marketing and sales strategy. Instead of casting a wide net to attract droves of new customers, or exclusively targeting high-end accounts that are difficult to land, you can tailor your efforts to attract and grow the type of customer that you know to be uniquely high-value. You can also customize your services to better meet the needs of these profitable customers, enhancing their satisfaction and loyalty.
What is an example of the Hedgehog Concept?
The Hedgehog Concept is a principle formulated by Jim Collins in his business book, “Good to Great.” It’s based on an ancient Greek parable that contrasts the fox, which knows many things, with the hedgehog, which knows one big thing.
In the context of business strategy, the Hedgehog Concept is about finding and focusing on what your company can do best, rather than spreading efforts across multiple fronts. This simplicity comes at the center of three converging circles: what you are deeply passionate about, what you can be the best in the world at, and what drives your economic engine.
An example could be a company that is passionate about creating innovative cybersecurity solutions, recognizes its potential to be the best in specialized threat detection algorithms, and understands that its strongest profit driver comes from selling subscription services to enterprise-level corporations. This company’s Hedgehog would then be providing top-notch cybersecurity solutions to companies with a high threat risk that need a long-term, multi-license solution. This clear, simple concept guides all the company’s strategic decisions and helps it maintain focus on what it does best.
What is an Economic Engine?
An economic engine, in the context of business, refers to the primary financial mechanism that drives your company’s profit This could be a unique product, a high-demand service, or a strategic method of operation. It’s what drives and sustains your business growth.
The economic engine can be identified by asking the question: What is the key metric or activity that most effectively generates revenue and profit for our business? This could be different depending on the nature of the business and the industry in which it operates.
Consider Profit per X as a component of your engine. This metric measures the essential, profit-driving aspect of your business. By understanding your Profit per X, you can optimize your engine, steering your business towards success.
What is Jim Collins best known for?
Jim Collins is best known as a highly respected author, consultant, and lecturer on topics related to business management, company sustainability, and growth. He gained worldwide recognition through his best-selling book ‘Good to Great: Why Some Companies Make the Leap…And Others Don’t’.
In his work, Collins explores the factors that transform good companies into great ones, introducing concepts like the Hedgehog Concept and Level 5 Leadership. His ideas have been widely influential, proving instrumental for many organizations striving to achieve sustainable excellence.