Hidden Profit Part 2: Bureaucratic Profit

One form of hidden profit is bureaucratic profit, which is what keeps bureaucracies going.

The familiar example is a government bureaucracy that survives on taxes. But, bureaucracies can crop up wherever there is a flow of cash to sustain it like businesses, charities, churches, trade organizations, governing bodies and so on.

A bureaucracy is group of folks that don’t necessarily add value to the organization, even though they are expert at making it look like they do.

When you scratch past the surface, what they contribute to the success of the business is elusive. But, they are masters are filling their calendars to look important and busy, being engaged in meetings and claiming credit for successes that couldn’t have happened without their input.

I can’t tell you how many times I’ve seen such folks leave organizations over the years and the organization didn’t miss a beat without them.

It kind of reminds me of that moment in a musical, just after a big song and dance, where the characters go on to the next scene and act as if the big song and dance never really happened, like it took place in someone’s head.

The organization keeps chugging. Sometimes, the remaining bureaucrats reminisce about a departed bureaucrat’s big song and dance, and that’s the main mark they left — stories of their song and dance.

When I’m feeling a mischievous, I like to interrupt these remembrances with something like, “Yes, he was a character, but do you have any examples of what he did to move the business forward? The revenue trajectory seemed to remain on course during his career here and has remained so since he left.”

Bureaucrat jobs exists more for the bureaucrat than for the organization. They might be interested in the steady income the job brings, the title it gives or the way the job can help them build their resume so they can get to the next rung on their career ladder.

Over years and decades, these bureaucracies become entrenched and tough to spot because the value they bring is assumed and there’s nothing to disrupt or put into question that assumption. It’s just assumed the company needs a VP of such-and-such, because it has had one for the last twenty years. Nobody has had to do a true cost-benefit analysis on the position, so it keeps going.

Bureaucracies are only threatened when there’s a massive disruption to the flow of cash that sustains. I can’t say for sure, but I assume Eastman Kodak had a massive bureaucracy before smartphones made the film and photo paper industry nearly go poof and the cash flow that sustained it also went poof. I would also venture a guess that many of the folks that were part of that bureaucracy, found other bureaucratic profits elsewhere to survive on.

The key point of this post is to introduce the concept of bureaucratic profit so you can recognize it.

There is a big spotlight on bottom line profits in our society while hidden profit, like bureaucratic profit, avoids detection.

Put another way, we often hear how bad it is for investors and founders to earn profits, but don’t hear much about all the folks that skim the bureaucratic profit before what’s left makes it to the owners with the notable exception of CEOs.

CEOs aren’t the only bureaucrats that deserve attention. SVPs, VPs, and Directors in company management are common positions for bureaucrats, as well as boards of directors.

If innovation isn’t easy, you’re doing it wrong

After some time working in mature companies it occurred to me how difficult companies make their innovation.

There is more action in just getting ideas through the political and operational hurdles. Ideas compete for executive approval and company resources. Ideas that win executive buy-in are then treated as if success is a fore drawn conclusion.

That’s how it worked at one of my former employers. My group went to the executives each year during planning with a list of 10 ideas to have them pick the 2-3 they wanted to try.

One year, we had a new CEO from a company with a healthier innovation culture (though he didn’t know it and neither did I, at the time).

We presented our 10 ideas and sat there with an awkward silence. He broke the silence after a bit, “So, what do you want from me?”

“Which 2 or 3 should we try?”

He responded, “Is there a reason you can’t try them all? I don’t know which one is going to work. Figure out ways to try them, even if on small scales, to find out.”

That completely changed how we approached our work. While he was there over the next three years we tried lots of stuff and found a lot of success. We spent zero time on the politics of trying to get buy in and almost all of time trying to figure out how to market research, proof of concepts, pilots and tests to figure out what would work for customers.

I now call this the ‘discovery innovation culture.’ It has some basic underlying principles, like the chances of success of any one thing is low, so try lots. Also, an ounce of customer reaction is worth 5 pounds of executive politics.

Sadly, I don’t think he knew the impact his innovation culture had on the business. He also did the typical CEO, top down ‘5 point plan’ like his predecessors and when that failed to make an impact, as most of such plans do, the board soured on him.

Ironically, the month after he left, the board approved rolling out one of the projects we discovered under his discovery innovation culture. It had a major impact on the business. He didn’t get a lick of credit for it.

It wasn’t his idea. It was a crazy idea that wouldn’t have seen the light of day in the political innovation culture. But, he didn’t stand in its way when one of the field leaders wanted to test it, like his predecessors would have.

Thinking back, I think he could have bought himself more time as CEO if he recognized what was happening and told the Board, Look, when I got here the innovation pipeline was bureaucratic and anemic. Innovation is the way to grow, but you have to be extremely lucky to grow if your pipeline only has 1 or 2 projects in it at a time. No wonder you have been struggling. I’m going to change that, but it’s going to take 3-5 years to see scalable projects coming out the other end of the pipelin. This is how we did it at the company I’m from and it works. Be patient.

After he left, his replacements brought back the political innovation culture.

In the 3 years under him my group alone rolled out about a half a dozen things that has stuck with the business.

Since he left about 10 years ago, the business has been going sideways and they’ve just been tweaking the stuff we rolled out. The energy has gone back to the politics of getting executive buy-in rather than just trying stuff and nothing new has come of it.

When I see organizations that are struggling to stay relevant, I tend to see the political innovation cultures that result in anemic innovation pipelines that usually do not produce enough successes to keep the business ahead of its evolving competition, which is innovating at faster rates in more discovery innovation cultures.

Hidden Profit: Expenses are profits for someone

We usually bucket profit as what’s left over after paying all expenses. We neglect that those expenses are also profits for somebody.

Huh?

Consider an organization that doesn’t operate for profit, like REI Outdoor. It’s organized as a co-op, which is owned by customers who have signed up to be members (which is a lot like a rewards program at other businesses).

Since REI doesn’t earn a profit, you’d think it’d charge less.

It doesn’t.

Why? Because it has the same costs as any sporting goods retailer like costs of goods sold, real estate, labor, marketing, shipping, distribution, executive compensation and utilities.

Not being for-profit doesn’t change any of that.

While we don’t usually think of salary as a profit for the employee, it is. It may not be exorbitant profit, but it’s enough to keep them showing up.

What about the CEO? Google says he make $3 million a year. Pretty good for a guy who runs a co-op. Would you consider that he profits from REI?

In my view, profit is something that you would be reluctant to give up. Most of us would be reluctant to give up our pay, even if we don’t make $3 million, so we are profiting from what ever pays us.

The point of the post isn’t that REI may not be all it’s cracked up to be.

The point is to consider that more than just owners of for-profit companies earn profit. We all do.

With that lens, the world looks different as you will see profits in more places than you did before and places that we don’t typically associate with profit-seeking. For example, you will see it in charities, government, churches, schools, trade organizations, sports leagues, awards shows and all sorts of governing organizations like US Soccer or USA Gymnastics and even in mountain bike trail building.

Certainly, there could be more than monetary reasons for being involved such things. You might be an outdoor enthusiast and you really dig working at REI because of that. That’s cool. But, my guess is a lot fewer folks would show up to work for REI if they paid half or a third of competing retailers.

How to lose a loyal customer: Exhibit AT&T

AT&T recently installed fiber optic in my neighborhood and surrounding neighborhoods and offered most of my neighbors gigabit internet service for $45 per month.

They sent two sales reps to my door to sell me the new service, only to discover that it wasn’t available at my address.

So, AT&T lost a 13 year customer. The cancellation conversation went something like this:

AT&T Rep: “We can upgrade you from 75 Mps to 100 Mps for $50 per month, which will save you about $20.”

Me: “So, you are offering me 1/10th what you offer my neighbors for $5/month more when you competitor is offering 5x that? Does that sound like a good deal to you?”

AT&T Rep: “No sir. I see what you’re saying.”

I’ve been pleased with my AT&T service for 13 years. I never complained or threatened to cancel to try to get a better deal as lots of folks do. It was doing the job. I never noticed issues with buffering or speeds, even as the number of devices connected to the net in my household has grown.

But, they shifted the goalposts by offering a product that appears to be 10x better than what they give me at a lower price to my neighbors, which suddenly shifted the paradigm on the service they give me to look like mush.

It added fuel to fire when the sales reps assured me that it was ‘very rare’ for them to skip houses and that it was usually just a matter of ‘getting their computers updated’ or ‘having someone come out and run the lines’. They made it sound easy. They gave me some hope that it was still coming.

Then, when I followed up with customer service, as one of the sales folks suggested I do, I was told that there were no plans to make it available. That seemed strange to me since the AT&T boxes sit one lot away from our block in the middle of a neighborhood that now has fiber.

One benefit that I got out of the experience is to be less hesitant to evaluate my options and switch. I discovered that switching was much easier than staying and trying to convince them to give me the service that they had two people try to sell me.

That’s the beauty of the power of exit versus the power of voice and a good example of why competition is a good thing. I wish their were even more competitors for internet service. I’m looking forward to more wireless competitors popping up with 5G and satellites.

Here’s how I ended my cancellation conversation: “If you ever want to win my business back, it’s pretty simple. Give me what you can give my neighbors.”

And that resulted in what?

One problem in the business world is that business folks approach business problems as if they are school assignments to be graded rather than trying to make something customers want.

Another problem in the business world is that their bosses often do grade their work as a school assignment, on the inputs rather than the outputs.

One of my old bosses taught me a trick to snap people out of this. Ask “and that resulted in what?”

Shark Tank Season Premiere Business Lessons

I’m a big fan of the show Shark Tank. I think it can provide valuable lessons to us mere mortals.

I was LOL’ing during a segment of last night’s Shark Tank season premiere as the Sharks taught a valuable lesson to a self-described “husband and wife dynamic duo” who were pitching their $12 direct-to-consumer healthy bread cube for a $16.7 million valuation.

What I found funny is that these folks would be rising stars in the corporate world with their energy, salesmanship and command of jargon (ahem, BS).

What I like about Shark Tank is that what is celebrated in the corporate world, is often ridiculed in startup land.

The company’s sales sound impressive, rising in three years to $2.1 million year to date.

The dynamic duo are also self-described “digital marketing experts” but the Sharks busted them on their acquisition cost of $50 for a loaf of bread, which is probably about 5-10x what it needs to be.

O’Leary asked how they get to the $16 million valuation?

Here’s the paraphrased exchanged:

We’re on track to do $5 million this year, you heard we’ve done $2.1 million year to date. We believe other companies like us can get a 6-10x multiplier on revenue in market.

O’Leary: But, you don’t make money yet. Are you saying you’re going to make money if you hit $5 million?

No, absolutely not.

O’Leary: So, when you become profitable? Ever?

We will become profitable when we reach a certain level of scale.

O’Leary: What is that?

Cuban: No kidding? [In a sarcastic tone] You will become profitable when you reach a certain level of scale?

[In a smarmy, we’re like Jeff Bezos tone] Our goal is drive top line revenue.

Cuban: No [bleep]?

[Looks on the dynamic duo’s faces show they realize that this isn’t about to go so well. What make them stars in the corporate world is making them look like snake oil vendors in the startup world]

Corcoran: I don’t think I’ve ever spent this time in my seat and heard more fancy words in my entire life. I think if I were to put any money into your business, I would not sleep a wink tonight.

The guest Shark: You guys did not come in and demonstrate what your path to profitability is. You missed it. You spoke about all your economics, which aren’t that great by the way, because you are paying too much to acquire the customer, as everybody said, you are not profitable on your first customers. So, I think for me, I’m out.

Cuban: Why don’t you run the company to be profitable now?

That’s actually exactly what we did, Mark.

Cuban: But you lost a million dollars!

To get here we drove CAC [customer acquistion cost] to the floor. We’ve the the #1 lowest CAC in the…

Cuban: [Throwing arms up] That’s such a nonsense grammar. You start small. You got a nice little product. Whatever you do, you go door-to-door and you make money and use that to grow…but now, your back is really against the wall because you’re losing money on every product you sell. So the more customers you acquire, the more money you lose, unless you can make sure that you’re selling them a whole lot more products. Then you get the loaf of bread unsliced, what do I do now? You gonna take a bite out of it?

That crust is very important to preserving the product. People buy that product for the trifecta of three reasons. You can’t find something this healthy, that tastes this good that’s this fresh.

Cuban: Then why don’t you say that?

Corcoran: That’s the best thing you’ve said all day.

Cuban: That was the best sales pitch you’ve made.

That packaging you’re looking at there is our Gen 2 packaging before we really dialed in that positioning statement…

Cuban: [waving hands in frustration] The jargon! You’re driving me nuts.Shh..You’re overselling with all the jargon when you have an authentically good product.

End exchange. They didn’t get the deal.

Here are some business lessons that I take from this.

Customer Acquisition Cost is an important predictor of success. Large companies with deep pockets have the luxury of being able to buy sales and make new product launches appear to be successful. But, if, like Cuban says, you lose money on every product that you sell because you have to spend so much to convince people to buy it, then it isn’t worth anything.

Another lesson is to cut the BS. So many large companies are jobs programs for corporate bureaucrats that embrace a BS culture to spin their lackluster contributions to the company’s performance into resume builders for them. The companies survive on the spoils of previous successes, many happened upon long ago, which is also what helps those companies weather the damage caused by these BS artists.

Premature solicitation and onerous survey gripes

When I visit your website that I never heard of before for the first time because I followed a link and you foist a ‘sign up’ pop-up on me before I read a single word, I leave. Maybe data shows that’s a good thing to do to increase your subscriptions, but an even better thing is to create good content to keep me coming back.

Also, companies, I don’t want to take a 5 minute survey after every single interaction I have with your company. Here’s a tip: If I return, I was happy. If I don’t, I wasn’t. You should have a good idea of what constitutes good service without me having to take my time to tell you. If not, maybe you shouldn’t be running things.

Breakeven Frontier

Many mature businesses are stuck on what I call the Breakeven Frontier and their managers don’t know it.

What is the Breakeven Frontier?

It’s also called saturation. Their products are available to nearly all the folks who naturally value them and the cost to increase sales is roughly equal to (or more) than the value of those extra sales.

So, the company might spend $10 million on advertising and see sales rise, but only enough to add $10 million or less to the bottom line.

Marketing isn’t the only breakeven investment for a mature business. Most investments they make to increase sales or reduce costs are also breakeven, at best, which is why I call it a frontier.

They might try to cut costs by putting fewer chips in the bag. Their supply chain will brag about the cost savings. But, customers notice and end up buying fewer bags of chips. A move that might save $10 million a year on potatoes can easily cost that much in sales.

What can businesses do when they’re stuck on the breakeven frontier?

A couple of simple things. They should be investing some of the earnings from their mature product in innovation to create new products that can find their own growth curves.

On the cost side, they should be looking at making cost reductions that do not actually lower the quality of the product. Taking chips out of the bag is not a good idea. Getting a better deal on the oil you use to make the chips, might work better.

I once had a nice chair: be cautious of statistical studies

I once worked for a company that had nice office chairs.

It wasn’t a huge perk. They didn’t make a big deal of it. They didn’t even mention it.

But I liked it. There were days without much else to look forward to at work than that chair. So it helped.

When I was procrastinating on starting a project, the nice chair was there to sit in and get me started.

When a meeting didn’t quite go my way, I turned the corner and saw the chair and it brightened things a bit.

I worked for other companies, where chairs were good enough. Nothing wrong with them. They were comfortable. They did the job.

But, not once did I look forward to my chairs there. Just like the folks that bought them, I never gave them a second thought.

Does this mean managers should approve nice chairs for their staff to improve motivation and productivity? I doubt it. I’m sure that benefit would be hard to detect in a way managers desire: “Workers with the nice chair are 10% more productive!”

Part of it was the nice chair. Part of it was a little reminder that the owners thought enough about employees to even think about providing nice chairs without expecting anything in return. That last part doesn’t replicate in a ‘data-driven decision to drive results.’

After all, when employees catch wind that the managers made the decision to drive results, they realize there was no soul in the decision, the employee was an afterthought and, oh yeah, there’s the expectation of more productivity.

In that way, the chair might become more of a sore spot than a bright spot in a person’s day, because it becomes a reminder that there is an expectation to do more because of it, even though it’s not exactly clear what doing more is.

Maybe it does mean that managers who genuinely care about their workers in ways that show up like buying them nice chairs without any expectation on results might be more satisfying to work with than managers who ‘do what the data tell them.’

Are you a gatekeeper or competition enabler?

If I were hiring a business manager, I would ask candidates to explain whether they view their role more as a gatekeeper for the organization or an enabler of competition?

Gatekeepers decide what the organization does and doesn’t do. They view themselves as the judge of the competition and their ideas usually win, at least in terms of what the organization does, not necessarily in the marketplace.

Competition enablers are open to let good ideas come from anywhere. They create systems that try more ideas and let the best ideas earn their way in our out.

They understand that customers are the best judge of this competition.

Leaders of highly innovative companies like Google, Amazon and even McDonald’s have tended to be competition enablers.

Mature businesses that struggle to stay relevant, tend to have gatekeepers in charge.

Think of Blockbuster as Netflix offered to partner with them. Blockbuster leaders could have easily said, you know this doesn’t seem like something customers would want, but let’s try it and see, because we could be wrong.

Instead, they acted as gatekeeper and said no, customers don’t want to wait for their movie to arrive in the mail. They want to be able to come in on Friday night and pick one out.

By the time they realized they were wrong enough, it was too late.

A common comeback to that is, but that Netflix deal was probably one of dozens of decisions Blockbuster faced and the rest didn’t work out. How would they be able to predict that this one would?

That’s the beauty of being a competition enabler. You don’t have to say no and worry about picking right or wrong.

You just have to ask, how can we try this so we can find out? Can we do it in a small test?

It’s a lot like picking stocks. You can do a lot of analysis and invest all your money in 2-3 stocks and hope for the best. But most folks learn that strategy banks more on luck than skill, because no amount of analysis can turn up information that simply isn’t known, yet.

A better strategy is to spread the bets out more, knowing you can always be wrong.

And, for every example that you can give of someone who did well picking 2-3 stocks, I can give you 10 more who did not.

I’ve worked for several mature businesses that struggle to stay relevant. The Board never realizes the root cause is that they keep hiring gatekeepers instead of competition enablers.