Are We Making Money Yet?
By learning the costs in each of her messenger service's transactions, Claudia Post transformed herself from sales addict to CEO -- and not a moment too soon
In December 1994 Claudia Post, the founder of Diamond Courier Service, did something that offended every cell in her salesperson's body: she began shedding business she had already sold. While her messengers delivered gift baskets of fruit and candy, Post was delivering sour news to some of Diamond's customers: "After some careful analysis, I'm forced to make a difficult decision -- I have to relinquish part of my business with you." The chief executive and her sales manager had drawn up a list of clients to visit. Arthur Andersen, the Big Six accounting firm and one of Diamond's earliest customers, was on it. So was Montgomery McCracken, a prominent Philadelphia law firm -- Post's own law firm, in fact. She relished making those calls about as much as she enjoyed selling her personal investments, which she also did in order to save her company.
"I can't tell you how painful it was," Post recalls. "I mean, these customers depended on me."
The timing of these unsales calls was particularly ironic in that just a few months earlier, the Philadelphia office of the Small Business Administration had handed Post her first business award -- for civic involvement, job generation, and fast growth. She deserved the award. She had started Diamond Courier in August 1990, determined to outperform the downtown courier company that had just fired her from a sales position. Post plotted Diamond's sales growth on a straight trajectory, and it took her only 17 months to achieve her first objective, $1 million in sales. She nearly doubled that volume during the next year. "What she did was incredible," says the admiring owner of a Florida-based courier company.
In 1993, its third full year, Post's company had $3.1 million in sales. By then Diamond employed some 40 bike messengers and 25 back-office staffers and provided steady work for 50 independent drivers. There was never any ambiguity about Post's own role in the business: master networker and fearless cold caller -- the sales whiz every struggling young company needs. Post put the "star" in start-up, and she was happy. "I was busy having a great time selling. Cash flow? Profit before taxes? I didn't know how to figure out any of that stuff," she says. She was a selling machine. And to be sure that she could keep on selling, Post recruited a former colleague, Tony Briscella, to step into the sales manager's role at Diamond.
It was early that year, however, that symptoms of underlying problems in the business first became apparent. The usual start-up cash crunches grew more serious and arrived more often until eventually they became chronic. By the latter part of the year, Post was helping her staff shuffle the accounts payable and decide whom to pay and when. Briscella, her new sales manager, who'd previously worked for Federal Express, had begun to complain that he couldn't get accurate operating results. "I'd hear things like 'We either broke even or made $6,000.' That," he says, "drove me crazy." Despite Diamond's continued growth, it wasn't much longer before Post had to resort to selling her jewelry and liquidating long-held stocks from her Merrill Lynch account to generate the cash she needed to pay her employees. Of course, the more her cash problems mounted, the more Post, the consummate salesperson, wanted to get out and sell. Yet she increasingly felt chained to her desk by the by-then nearly daily crises. One day an anxiety attack, which she mistook for a heart attack, sent her to the hospital. As she left, one of the office employees called after her, "Don't you die on us!"
Post didn't die, but Diamond Courier nearly did. By the spring of 1994 the company was undeniably sick, and Post remembers thinking, "Here I am with a company that's doing $3 million plus, and I have no money. I'm working a gazillion hours a week. There's something terribly wrong here."
But what? Desperate and scared, Post asked a friend in the industry to examine her books. "Claudia," he said after a cursory look, "you're headed for the rocks."
What had happened to this growth company and its founder?* * *
There was nothing wrong with the service that Diamond provided to its expanding client list -- at least nothing beyond the usual sorts of snafus experienced by fast-growing companies. Customers loved Post and her company. But in four years Diamond Courier had grown in so many directions that it was no longer the one business that Post had started; it was more like six. As she had pursued the simple idea of running a downtown bicycle-courier business Post had seen and gone after other opportunities. Now, besides bike-messenger services, the company was into driver deliveries, truck deliveries, airfreight services, a parts-distribution service -- and even a legal service that served subpoenas and prepared court filings. Although all the businesses shared some common resources, each had its own line workers, manager, and administrative-support person, as well as its own steady customers and unique pricing and billing practices. In that respect, Diamond wasn't so different from a manufacturer that jumps into a dozen different product lines or a retailer that branches into several market niches in quick succession. The question was never, What do we do best? but always, What else can we sell?
It wasn't that diversification per se that had brought Post's business to the brink of failure. Any of the businesses Diamond now found itself in could conceivably have been profitable. The problem was that Post simply didn't know which, if any, of them were. She didn't know because she was operating on a set of reasonable but unexamined assumptions. She assumed, for instance, that if she kept selling and priced her services at market rates, she would build a profitable business. She assumed that growing volume would generate economies of scale. She assumed that if she took good care of customers, the business would take care of itself. She relied upon those and other assumptions because, as she admits now, she never took the time to question or test them. But even if she had taken the time, she didn't have the means. Consequently, Post continued to believe that sales would be Diamond's salvation when, in fact, nearly every sale she made pushed the company a little further into the red and a little closer to failure.
"Most entrepreneurs have no idea what it really costs them to produce a product or service," asserts Al Sloman. He's the veteran industry consultant recommended to Post by the friend who had examined her books and sounded the alarm. When he was hired to help her, Sloman made it his mission to get Post to understand more than the operational side of the courier business. She knew all about that. His goal was to teach her the business side of the business -- to get her to understand and acknowledge that in addition to dollars in (sales), she also had to deal with dollars out (costs). If Post was going to be the chief executive of Diamond Courier, not just its chief salesperson, Sloman believed, she would need the management-accounting tools that would let her test her assumptions. Over several months in the fall of 1994, Sloman helped Post learn to use several of those tools. But just as important, he also gave her a clearer understanding of what her job as owner and manager of a fast-growing company had to be.
Chief among the tools that Sloman showed Post how to use was profit-center analysis, which amounted to showing her how to build an income statement for every business line Diamond was in. A profit-center analysis can reveal which activities -- or, for that matter, which sales territories or branch operations -- are making money and which are not. For Post the analysis proved to be eye-opening.
The key to building a profit-center statement is knowing how to identify all the costs associated with a particular business activity. Sloman helped Post extract sales and cost data for each of the businesses Diamond was in by poring over work records and computer files. Line by line, they compiled the labor costs, the operating costs, and the administrative costs directly linked to each of the six business lines. They could have stopped there, but the profit picture would have been incomplete. Because Post's back office had grown so rapidly and come to generate such a large portion of total costs (sales, general, and administrative costs made up about 30%), they also had to allocate those indirect costs among the various businesses. How the overhead costs were allocated was crucial, because the allocation rationale would, in part, determine which businesses showed a profit and which did not. Sloman urged Post to use an allocation system known as activity-based costing. (See "Resources," below.) Essentially, activity-based costing assigns overhead costs to the various businesses not in proportion to their revenue shares (which is the conventional technique) but in proportion to their respective use of the company's resources. "If employees and managers could say how they used their time, we used that," says Sloman. "If not, we looked at the level of activity, say, the number of jobs per profit center" as the basis for allocating overhead.
As they proceeded through that exercise over a period of weeks, the scales began to fall from Post's eyes, and the errors induced by her earlier assumptions became painfully apparent. Nowhere had they been more misleading than in Diamond's original business -- downtown bicycle-courier services.
For instance, Post had assumed that if competitors could make a living with prices lower than hers, then she had to be making money, too. She had assumed that the revenues generated by her bike-messenger business contributed handsomely to total company revenues and profit, since the bike customers were among her oldest and largest accounts. (Besides, to Post's thinking, Diamond's downtown image was the colorfully shirted Diamond Courier cyclist.) Because the back office was always busy, Post assumed that her bike messengers were busy, too, which meant that they were working on commission, not for the minimum hourly wage she guaranteed them. And since the commission was roughly a 50-50 split, Post assumed that 50% was her gross margin.
How wrong she found that she was. The bicycle division, which she thought of as Diamond's core business, generated just 10% of total revenues and barely covered its own direct-labor and insurance costs. (See "Bike Delivery: Profit and Loss," below.) Worse, the division created more logistical and customer-service nightmares than any other single business, thereby generating a disproportionate share of overhead costs. Diamond wasn't making money on bicycle deliveries. It was charging customers $4.69 per job, but with fully allocated costs of $9.24 per job, the company was losing $4.55 every time a cyclist picked up a package.
Post's assumptions about her bike couriers' productivity had been completely wrong. Instead of the three deliveries an hour she assumed they made, the real figure was less than half that. So, instead of the 50% gross margins she assumed she collected on each $4.69 bike job, the real margin worked out to only 10% -- not even enough to cover her overhead, never mind providing a profit.
Sloman showed Post how to perform the same kind of analysis on Diamond's other operations. She was shocked to see that four of the six -- all except driver and truck deliveries -- were generating losses.
One Monday morning two months after Sloman's arrival, Post made an announcement. "I've made up my mind," she said to Sloman and her managers. "I know what I have to do."* * *
On January 3, 1995, post shut down the bicycle-messenger business, which was killing the rest of the company. She saw plainly that it was pointless to compete with operators charging $3 per delivery when she had to charge $10 just to cover her costs. (After all, the $3 operators were smaller companies focused on bikes.) And it made no sense to try to run the bike work simultaneously with the suburban and regional vehicle work, which was profitable, each job generating an average of $27.60 in revenues to cover $21.23 in costs. "We didn't need the bike service to have the vehicle service," says Post. "I knew I couldn't delay the decision, because every second was costing us money."
Was there a way to jettison the bicycle-courier business gently without losing the profitable driver jobs that came from the same customers? Post and Briscella nervously rehearsed what they'd say in face-to-face visits. A few customers wouldn't stand for it, and Post wasn't surprised when 4 of her top 30 accounts took all their business elsewhere. But she took her lumps up front. "I wanted to be clear and direct with my client base, and I think I gained credibility that way," she says. In the end Post kept all the large accounts that used her drivers more than her bikers.
Hard as the decision to close the bicycle operation had been for Post to make, it liberated her. No part of the business was untouchable anymore, and no part of the business was unknowable.
Within a few months, Post closed two more of Diamond's unprofit centers -- airfreight and parts distribution. Using the profit-center analysis, Sloman had prepared a pro forma income statement that showed Post she could actually increase profits by reducing sales. He showed her that by cutting $521,000 in unprofitable sales, she could eliminate $640,000 in costs. Sloman wanted Diamond to eliminate all services and customers that didn't generate a profit, but Post couldn't do that and didn't think she should.
She decided, for instance, that some services she couldn't afford to operate herself, such as airfreight, were worth brokering on occasion in order to retain clients that generated profits for her elsewhere. And she replaced a few of the bikers with walkers, who now service select customers at a premium price. Still, in 1995 she forfeited sales of about $400,000 -- most of them willfully.
Post also raised prices for some of the work Diamond did. Now that she knew how to wield a calculator and could compute her average cost per job, she realized that she'd priced too many jobs at or below breakeven.
Perhaps the biggest change for Post herself was that for an entire year, she stopped selling. Instead, she threw herself into the task at hand -- visiting dozens of customers and writing to hundreds more affected by the changes she was making. And when that was done, she realized how much more work she still had to do -- work that continues. She hasn't stopped looking for ways to trim overhead. (Her operations manager doubles as a dispatcher, for example.) And now that she understands her cost of sales -- and her company's sales cycle -- she is prepared for cash crunches. In other words, Post no longer views her company through the narrow prism of sales; she now has the broader view of a CEO.* * *
Today Diamond Courier is not the greyhound start-up it once was. The office is a lot quieter now. The rock-and-roll environment is gone; Diamond's baby-boomer managers have grown up. The company is healthier. There's cash in the bank -- which called recently to congratulate Post on her progress.
Post is healthier, too. She works out every day, and she's laughing again. She hasn't had to hock any stocks or jewelry in a long while; she recently rented a nice house for herself and her two sons. "I still don't balance my own checkbook, but I know now if my company is making money," she says. "Boy, do I know."
Thanks to a strong fall -- a good chunk of the $400,000 in lost revenues was made up with more profitable business -- Diamond managed to finish 1995 in the black, and the profits continued to accrue through last winter's snowstorms. Overall, revenue per job has more than doubled, from an average of $13 in 1993 to about $28 in 1995. Post and her managers think about sales differently, too. They're as likely to argue about which customers to drop as which prospects to pursue.
Now Post counts her blessings, along with her cash, every night. "I mean, I could have just spun out," she says. She knows so much more now. "I know what I need to break even every day," she says. "I monitor my payables. I know what my cash flow is and what's going into the bank every day. We created a budget, and I understand what it means to live budget-to-actual." A software program provides her with a daily report of revenue per job. "Look, I'm never going to be a serious financial person," she concedes, "but you own a business, it's your responsibility. I can't slough it off on somebody else. I have to know."* * *
Articles editor Susan Greco can be reached at firstname.lastname@example.org
THE REAL COST OF A BIKE DELIVERY
Diamond Courier charged $4.69 to make a downtown Philadelphia bike delivery. CEO Claudia Post estimated she was paying her messengers half that, leaving the other half to cover overhead and yield a profit. Since competitors with less volume charged as little as $3, she figured she had to be making money. (The industry's average margin is 5%.) Rigorous cost accounting, however, painted a different picture . . .
Total assumed cost: $4.46
Assumed profit: $0.23
Dispatcher's pay: $0.54. Bike jobs, Post discovered, ate a disproportionate amount of each dispatcher's time.
Telephone charges: $0.14. Messengers were always calling in to the office.
Miscellaneous: $0.07. Small office expenses included the bikers' T-shirts.
Allocated overhead: $3.60. This covers Diamond's managerial and administrative salaries, rent, insurance, collection costs, and so on -- averaged for each delivery.
Customer service: $0.57. Service reps handled customer relations and kept records -- a lot of work for such low-ticket transactions.
Workers' comp: $0.09. Post's bikers were part of a national insurance pool.
Messenger's pay: $4.23. This includes wages and commissions ($3.87) and payroll taxes ($0.36). Messengers were averaging fewer than half the three deliveries per hour Post had assumed -- meaning many never qualified for the 50-50 commission split Post had based her mental profit model on; instead they collected a guaranteed hourly wage.
Total actual cost: $9.24
Actual profit:: ñ$4.55
BIKE DELIVERY: PROFIT AND LOSS
Post's imagined per-job P&L . . .
Messenger's pay* $2.35
Overhead and profit* $2.34
. . . and the actual P&L she uncovered
Messenger's pay $4.23
Overhead (direct and allocated) $5.01
Profit (loss) ($4.55)
One-year financial results for the bike-messenger profit center
Revenues (on 71,658 jobs at $4.69/job) $336,000
Direct labor (messengers)
Wages and commissions $277,000
Payroll taxes $26,000
Gross profit $33,000
Direct overhead 
Customer service $40,700
Workers' comp insurance $6,800
Miscellaneous office expenses $5,000
Allocated overhead  $257,655
Total overhead $359,155
Profit (loss) ($326,155)
Includes all costs directly attributable to bike deliveries. Costs not directly linked to bike deliveries but apportioned according to level of activity -- number of bike jobs, for example.
The information contained in the resources below can help entrepreneurs think smarter about costing, pricing, and business-unit profitability
A free three-page executive brief on activity-based costing, a useful tool for companies whose overhead is growing as fast as their direct costs, is available from ABC Technologies, in Beaverton, Oreg. (800-882-3141). A 16-page manufacturing case study, "Why You Should Consider Activity-Based Costing," can be obtained free from Small Business Forum (800-419-5018). To see how the practice works in service companies, order a reprint of "Tracking Costs in a Service Organization," published by Management Accounting (800-638-4427, extension 280) in February 1993, which explains how Fireman's Fund uses activity-based accounting.
Accounting and Financial Fundamentals for Nonfinancial Executives, by Valarie Neiman and Eileen J. Glick (AMACOM, 800-262-9699, 1996, $18.95), covers the basics of cost accounting, the contribution concept, and other management tools. Two recent works demystify pricing and are well suited to service companies: Priced to Sell, by Herman Holtz (Upstart Publishing, 800-829-7934, 1996, $27.95); and No Apologies Pricing (Home Based Business Association of Arizona, 602-464-0778, 1995, $9.95), a 52-page booklet worth its price because of its wonderful simplicity.
Tracking costs is made easier with the "job costing" modules available with major accounting-software packages. See "Ledger-demain" in the June issue of Inc. Technology ([Article link]).
In a course in strategic planning offered by the respected Council of Smaller Enterprises (COSE), 30 company owners convene on Saturday mornings to analyze how they're making money (or not). Students team up with past graduates of the course, who serve as their mentors. The price: $2,695. Courses, which are held in Cleveland, Dayton, and Louisville, start in September and October. Call COSE at 216-621-3300 for more information. The 1,400-page course book can be had for $250; send a request to email@example.com by E-mail.
A primer on how to do a business-unit "contribution-margin analysis" is available at Inc. Online in the Interactive Worksheet area. The worksheet is titled " Is A Product or Customer Costing More Than It's Worth?"