The differences between high- and low-margin companies are as much social as they are financial. That makes them hard to reconcile, writes Phil Young
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Back in the late 1980s, big tobacco companies realized that the prospects for growth – at least in the US – were relatively limited. People were smoking less, and, for that particular bad habit, the only way seemed to be down. One way of making sure the decline in cigarette sales would not cause the companies’ engines to choke was to diversify into big processed-food makers. Tobacco and food are fast-moving consumer goods (FMCG) businesses, and the thinking ran that tobacco and food companies have similar business models, so the cost and revenue synergies would justify the acquisition prices. The reality was rather different.
In the mid 1990s, I recall a meeting with the HR director of training for one of the newly formed tobacco/food conglomerates. “One of our big challenges,” she told me, “is that we have two cultures – a high-margin culture and a low-margin culture.” I never received further explanation. But, nevertheless, her brief and somewhat cryptic remark was the first step on my exploration into the linkage between finance and corporate culture.
I was familiar with the concept of corporate culture, because it was a relatively new and fashionable concept at the time. But the use of a financial metric to describe a business organization’s culture was entirely new to me. I assumed tobacco was the ‘high margin’ and food was the ‘low margin’ business. I also assumed that the margin she was talking about was the gross profit margin. But what was the connection between margin and culture?
It is obvious that high gross-profit margins permit a business to spend relatively more money on expenses such as sales, marketing, administrative support and R&D than companies with low gross margins. But ‘high-margin’ businesses don’t spend more simply because they can afford to. They do so because that’s the nature of their business model: they make money by spending.
Why does a company like Coca-Cola spend so much on marketing? So it can continue to sell its premium-priced, high-gross-margin products. Companies like Pfizer and Microsoft spend a lot on R&D so they can come up with the next version of their respective high-gross-margin products – patent-protected drugs
Meanwhile, low-gross-margin companies like Walmart make money by selling as much as possible while maintaining very tight control over their operating and capital spending. In contrast to high-gross-margin companies, low-gross-margin companies make money by saving.
How all this plays out in the daily lives of those who work in the two types of business is interesting – and important. Which group gets to fly business class, have company-subsidized lunches or bigger expense accounts? Those who work in a business with a high-margin culture have very different expectations about salaries, benefits, bonuses, sales commissions, and general working conditions than employees in companies with a low-margin culture.
Unless these different expectations are managed and balanced properly, there could easily be discontent among the troops. High-margin-culture employees who are used to more resources may resent tighter budgets. Low-margin-culture employees who are used to fewer resources may resent cash being lavished on their counterparts in the high-margin side of the business.
How do leaders deal with this? A simple start would be to explain the differences in the way high- and low-margin businesses make money. This exercise paves the way for a better understanding of the corporate rationale for the allocation of resources across the entire company.
Once that has been explained, there is the troublesome question of what to do about it – a question big enough for a column of its own. I never discovered what the HR training director did to help integrate her company’s high- and low-margin cultures. But we all know that the tobacco-food conglomerates have long since demerged. In business, as in life, clashing cultures can be hard to reconcile.
Phil Young PhD is an MBA professor and corporate education consultant and instructor