This is a problem that most small company leaders have.  I fell prey to it once.  And, I’ll share my personal experience, as well as this recent experience with a firm where I served as financial manager.

I worked with these folks three days a week- Mondays, Tuesdays, and Thursdays.  And, this week in question, I had to deal with a licensing issue that was neglected by the entrepreneur. (Let’s call him Ernest.) One that would shut us down.  And, for most of Monday and Tuesday, I had to shuffle between various offices to insure that we could get a clean bill of health and get our license renewed.  Which meant that I wasn’t in the office at all for the first part of the week.

I walked in Thursday morning to see utter pandemonium.  It seems that one of the employees of the firm, one who earned an MBA (at least that was the scuttlebutt- but over the year I worked with him, there was ZERO evidence he had any business acumen whatsoever) had convinced Ernest that there was a significant opportunity to make money.  And, the two of them (the MBA and Ernest) set about “capitalizing” on this opportunity.

(As an aside.  As the financial manager of the firm, Ernest should have discussed this opportunity with me before he jumped in with both feet.  Ernest didn’t even discuss this opportunity with the firm’s investors.  Oh, sure, Ernest may be the largest stockholder- but he’s not the majority stockholder.   Not quite “best practices”.)

Which meant that during the busiest season of the year for our firm, we were scrambling to supply our normal products- and stuff we never supply at all- to two other vendors who were handling a major convention.  Which meant that we needed to purchase even more inventory- most of which would be COD (since we had no long term arrangements with these vendors) – for our cash poor firm, just when we were to make ¼-¹/₃ of our gross revenue for the year.  (That’s why we were cash poor- we loaded up on inventory to capitalize on our big season.)

Oh, and we don’t have that many employees.  And, no trucks- since we used services like FedEx and UPS to deliver to our customers.  And, this big “opportunity” needed us to deliver directly to these two firms.  Some 20,000 pounds of deliveries to two locations.

And, it gets better.   It seems that these two vendors demanded “special pricing” for their big orders.  A reduction of 10 to 20% off our normal markup.  (We really don’t markup- we divide our raw material cost by 40%- which means we multiply the price of raw materials by 2.5 to obtain the sales price.)

Now is a good time to explain what that really means.  There is a big difference between markup and margin.     If you have a 40% margin (hypothetically), it means that your direct costs- raw materials, labor, and delivery- equal 60% of your gross revenue.  And, let’s assume you are really well run and garner a 10% profit.     That means for $ 100 of sales, you clear $ 10 in profit, after spending $ 60 on raw materials.   So, providing a customer a 10% or 20% cut in price means that you are only getting $ 80 or $ 90 in revenue.  So, you can see- there is NO profit on this sale.   Maybe even a loss.

Now, let’s look at our markup.   If we spend $ 50 on raw materials and markup the price, after dividing by 40%, then we are selling that item for $ 125.  Yup- it’s the gross revenue is higher in this scenario.  But, even with that higher revenue, we were still only making about 10% profit- or $ 12.50.  So, if we cut our sales price by 10% or 20%, means we are cutting our revenue by $ 12.50 to $ 25.00- which means we are losing money for sure.

And, it gets better.  Because we had to rent a truck.   We had to work more hours.  And, we had to use our meager cash for these sales- leaving us less cash to buy inventory we needed for our busy season’s sales.  Oh- and no one at this meeting (which was why we were supplying these two firms) was really going to know who supplied them.  So, the potential new business prospects were close to nil!

And, the piece de resistance?   These vendors didn’t pay us on delivery, like all our other customers do.  Nope, we had to wait for their money.  Which meant less money for the inventory needs for our regular customers.

Now, for my personal tale.  One of our businesses was a very high margin one, operating in the vanguard of medical services.  It was our hope- and our corporate mission- to expand this market segment from (it’s then current portion of) 1% to 5%, to 10%, to 100%- at which point we would then have about 50% market share or more of this now dramatically larger market.  And, in the first three years of operation, we did grow our market segment to about 15%- with a 90% share for our firm.

My operational team (that includes me!) thought we could grow this segment even faster if we supplied the other (clearly inferior) product choice.  Then, we could work from within the hospitals and clinics to convince them to switch to the better therapeutic modality.  This meant we should have them using our therapeutic mode faster than without this avenue of approach.

Our board (who, by the way, were not investors in the firm) reminded us this was a bad business practice.  We were clearly the Rolls Royce of the marketplace- albeit at Thunderbird prices.  (In case I lost you with this analogy, our product offering was the very best therapy out there- and our pricing was just slightly higher than the much lower-benefit choice- more than what they were paying, but not by much.)

And, our board members reminded us that we were still a small company.  One that had a “large” reputation.  And, we would never be able to build that reputation back to its stellar regions, if we chased after every sale and not the right ones.  Yes, we relied on our board.  Thankfully.  Kudos to Arthur Lipper and the (both) departed Bob Boyle and Bill Weissert for keeping us aligned with our mission and vision.

I didn’t write this to show you that getting a sale that loses you money is bad.  Because, if we didn’t give these customers (in the first scenario) a discount, then you might still think that escapade was a good idea.  Because we could have made money on those sales.   Just like my firm (the second scenario) would have made some money by selling the conventional therapy.

But, by including both tales, you should clearly see that the entire concept is wrong.  These potential sales did not fit the mission statements.  They didn’t fit the operational plans.  They didn’t even rely upon normal product lines.  We had to extend everything to capitalize on these “opportunities”.  Including making it tougher for us to meet our objectives- supplying our core customers with the great products they want, when they want them, at prices- and service levels- that make them want to come back.

Those are the questions we all have to ask- and answer properly- every time an “opportunity” comes along that is not part of our normal business processes.  And, if it doesn’t meet those criteria, then we must let the “opportunity” pass us by.

Because we want to be the best we can be in the business we expect to be in.