Profit Model

The Profit Model is fundamental to the success of the Business Model and ensures continuity of business whilst providing a platform for Stability and Growth. The Resource Model and Business Process Models provide the means of ensuring consistent performance as defined by the Profit Model and underpins the Value Proposition. Therefore the Profit Model and the decomposition of Profit Levels establish the core metrics for measuring Business Performance and assigning ownership and responsibility within the organisation.  Profits are recorded in the Profit and Loss Account and measured over a period of time i.e. Yearly, Quarterly and Monthly. Profit is also defined at different levels:

1. Gross Profit (Sales Revenue – Cost of Sales)
2. Operating Profit also known as Net Profit (Gross Profit – Overheads or Expense)
3. Profit after Tax and Interest PATI (Operating Profit – Tax-Interest Payments), which is the money on which Dividends to shareholders is paid
4. Retained Profit or Retained Earnings (PATI – Dividends), the money left for the business to reinvest

The management of Revenue, Cost of Goods Sold and Expenses items and the time period over which they are measured can be assigned to resources and business processes within an organisation providing a decomposition of responsibility.  The diagram illustrates the main operating and non-operating cash in-flows and out-flows and highlights the importance of balancing them to sustain a successful business model. The cash flow cycle provides an understanding of a business’s financial position, proving a confidence in whether it has sufficient cash, over the immediate future, to meet its short-term liabilities as they fall due. Unless the answer here is positive the company is in a financial crisis irrespective of its profit performance. This can be translated into working capital days, which provides the metrics that can be monitored and is part of an end to end process that if managed ensures that the Profit objectives are continuously achieved.

 

The diagram to the right shows the relationship between the Supply Chain high-level processes and the cash-flow through the business. It illustrates the relationship between operational processes and the operating profit within company. The measure Working Capital Days is an important indicator of how well the business is performing and is able to meet its financial commitments.

Taking it a bit further the diagram below shows the impact that suppliers and customers can have on the business model. It also highlights that if anyone in the supply chain has cash-flow problems it affects all parties. It is import that there is Supply Chain transparency and communication with customers and suppliers essential to the success of the business model will not have a negative impact the Value Proposition.

Communication between customers, your company and suppliers binds the participants in the Supply Chain and provides an early warning to all participants of potential problems or changes in the market dynamics. Shared metrics will ensure that each participant is fully aware and prepared to meet the challenges of fulfilling their contractual arrangements.

·         Revenue model - How much money can be made: price x volume. Volume can be thought of in terms of market size, purchase frequency, ancillary sales, etc.

·         Cost structure - How costs are allocated: includes cost of key assets, direct costs, indirect costs, economies of scale.

·         Margin model - How much each transaction should net to achieve desired profit levels.

·         Resource velocity - How quickly resources need to be used to support target volume. Includes lead times, throughput, inventory turns, asset utilization, and so on.

Business Modelling - A Performance Framework

Before embarking on a Business Process Management project there needs to be a clear understanding of the business model. Also a desire for the acceptance of change within the organisation as things progress over time and market dynamics fluctuate due to competition, product evolution and economic factors. By establishing a Business Model Framework it positions and defines the contribution that the Business Model provides to the organisation and the required end-to-end process measures needed to monitor the business performance

A Business Model comprises of four main elements:

1. Value Proposition – Within the context of the Business Model it applies to all the resources:
   1. Customers
   2. Partners
   3. Shareholders
   4. Departments
   5. Employees
   6. Suppliers

The value proposition describes the experience that will be gained from each of the constituents, it also defines the products and services offered along with the benefits each constituent will achieve from the business relationship. By having a Value Proposition that covers all constituents is ensures the Business model levels as shown in the diagram are linked and the impact at each level on the total model can be monitored and measured.

1. Profit Model – The profit model underpins the Value Proposition ensuring financial targets are met and establishes a platform for defining the Resource Model required to ensure the Value Proposition is delivered. It also provides the hierarchical measurement model required to manage the utilisation of resources needed to meet the profitability goals required by the organisation and its investors.
2.  Resource Model – Resources can be broken down into four main areas:
   1. Men – Human Resources, Skills, Knowledge and Experience required supporting the Profit Model.
   2. Money – Financial Investment, Return on Investment and Growth Rate required to ensure the continuance of the business over time.
   3. Machines – The Technology, Machinery and Buildings required to support the profit and planned growth targets.
   4. Materials – The investment in materials and technology and continued commitment by the suppliers to meet the needs of the organisation and its customers.
3. Business Process Model – Develop a Business Architecture around a framework that ensures ownership and responsibility by all concerned within the organisation to meet the goals and aspirations of the business. The Business Process Model should be hierarchical providing a means for continuous measurement of performance of resource consumption and output, at all levels engaged, in the delivering the Value Proposition and Profit Model goals of the organisation.  The Business Process Model should be continuously improved to ensure the effective management of resources and the elimination of waste.

The next few Blogs will develop this approach further. I have been engaged in numerous Business Process Consulting projects that have been at departmental level, justifying the purchase of software or supporting the delivery of specific projects as part of the change management process. It was hard to see how many of these projects contributed to the continued success of the organisation and where they fit into their long-term goals.