Photo by Charlotte Coneybeer on Unsplash
Profit is a seemingly simple concept to understand.
Profit = Sales - Expenses
I’ve seen many business people struggle with understanding why they are profitable or insufficiently profitable in many cases. Teams often get twisted up in knots, trying to explain their results.
“We’re charging too much!”
“We’re not charging enough!
“Our overhead is too high!”
“Our quality isn’t good enough!” or “We’re investing too much in quality!”
It can appear to be an overwhelming problem to solve. But it does not have to be if you think about profit in the right way.
Management theorist Peter Drucker refers to profit as “The result of the performance of the business in marketing, innovation, and productivity,” calling it the only effective test of performance.
In other words, profit is simply a feedback loop that tells you whether the market that has learned about your products sufficiently values what you are selling, given what it costs you to produce it.
It is that straightforward. If you are profitable, the feedback loop is saying you are performing well (enough) across the dimensions of marketing, innovation, and productivity. If you are insufficiently profitable or unprofitable, then the feedback loop says you are not performing well on at least one of these dimensions. To update our formula from above,
Profit = f(Marketing, Innovation, Productivity).
It’s an easy enough concept, but I’ve seen even seasoned leadership teams get hung-up on it when examining their firm’s financial results. Breaking it down as Drucker does is enlightening, perhaps more than it should be. But the most valuable insights are typically that way.