An economist would tell her that she should take actions that maximize profit, a technically correct but useless piece of advice. In the economics textbook it is simple: choose the rate of output Q that provides the biggest gap between revenue and cost. In the real world, however, âmaximize profitâ is not a helpful prescription, because the challenge of making, or maximizing, profit is an ill-structured problem.
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Most great companies are formed to meet the goals and express the values of their founders, which is not always the same as maximizing shareholder wealth. For them, profit is simply a strategic necessity rather than the supreme end point.
This may be a jolting concept, we realize. But weâre certainly not the only management writers who have come to the same conclusion. Peter F. Drucker, in his classic text, Management: Task, Responsibilities, Practices, reached the same conclusion years ago:
Business cannot be defined or explained in terms of profit... The concept of profit maximization is, in fact, meaningless... The first test of any business is not the maximization of profit, but the achievement of sufficient profit to cover the risks of economic activity.
Our pet peeve is when a companyâs leaders think it should grow regardless of profit. This is just reckless, unless youâre a venture-backed firm pioneering new territory. For everyone else, we recommend getting profitable with the work you have, proving you can get to 15% profitability (based on our adjusted Simple Numbers), adding labor to knock profit back
to 10%, and then growing to 15% again. Lather, rinse, and repeat.
A well-known joke tells of the economist in the wilderness who, when he sees a bear approaching, pulls out his computer and begins to calculate an optimal strategy. His colleague, appalled, says: âWe donât have time for that!â âDonât worry,â replies the economist smugly, âthe bear has to work out an optimal strategy too.â Behind the joke lies a deeply serious point. The bear gains a decisive advantage by not suffering the illusion that the approach based on calculation might work.
Executives who complain about âexecutionâ problems have usually confused strategy with goal setting. When the âstrategyâ process is basically a game of setting performance goalsâso much market share and so much profit, so many students graduating high school, so many visitors to the museumâthen there remains a yawning gap between these ambitions and action. Strategy is about how an organization will move forward. Doing strategy is figuring out how to advance the organizationâs interests.
I call this a hump chart. Whenever you can assign profit or gain to individual products, outlets, areas, segments, or any other portion of the total, you can build a hump chart.