In Hidden Profit, you suggest that the key to greater profitability isn’t reducing expenses, but understanding the underlying economics well enough to make precise decisions. What inspired you to develop this framework?

For most of my career, I got called in after somebody had already decided the answer was to cut costs across the board.  Earnings were down, the board was unhappy, and the plan was to take ten percent out of costs. As they saw it, my job was to go find the ten percent.  So I’d find it. And about a year later the company would be in worse shape than when I got there. 

It took me a long time to understand why.

When you cut across the board, you’re cutting evenly into two things that are not even. You take the same ten percent out of the part of the business that’s making money as you take out of the part that’s losing money. And the losing part was always the part burning more of everything — that’s why it was losing money.

So you’ve made the company smaller, and you’ve made it weaker, and you did it with a perfectly accurate set of financial statements.

Here’s the thing that changed how I work.  A company will tell you it runs at a thirty percent margin. Everybody manages to thirty. The budget’s built on thirty. The bank’s model says thirty.  Then somebody finally looks — and half the business is at fifty, and half is at twelve.  There is no thirty percent business. There never was one. Thirty is just the place where two completely different parts of the company met in the middle and cancelled each other out.  And every decision anybody made — what to price, what to chase, what to cut — was made on a number that describes nothing that actually exists.

So, you look closer. Find out which customers and which products are actually making the money, and then you can make a real decision — reprice this, walk away from that, put the capacity somewhere better. That’s the book.  The profit isn’t hidden because somebody hid it. It’s hidden because it’s been averaged. 

Focus should be on those things that are draining the profits out of the company.  They are never everything across the board.  When you cut across the board, you are cutting symmetrically into two things that are not symmetric: the work that makes money and the work that destroys it. And because the work that destroys money almost always consumes more resource per dollar of revenue — that is precisely why it destroys money. 

An across-the-board cut takes proportionally more away from the profitable work than from the unprofitable work.  You have made the company smaller and you have made it worse. And you have done it with a completely accurate set of financial statements.

“Precision,” not “austerity.”  Once you see it that way, the framework writes itself.

Why do you think so many business leaders focus on growth while overlooking the profit opportunities already within their organizations?

Two reasons. One of them nobody ever says out loud.

The first is that growth is a story you can tell. The number goes up, everybody in the room gets to be part of it, and it’s fun.

Now picture the other thing. Picture standing up in a management meeting and saying, “Good news — I’ve found seven hundred thousand dollars. It’s been sitting in Product Line C, which has been losing money for six years, and every one of us has been in this room the entire time and didn’t look.”   That’s not good news. That’s an accusation. And everybody in the room knows it.

Nobody ever got promoted for discovering that the company has been wrong. So the discovery doesn’t get made. Not because people are dishonest — because the organization has no way to reward it and there are many ways to punish it.

The second reason is arithmetic, and this is the one that should worry a chief executive. Growth can be pursued in ignorance. Margin work cannot.

Growth is easier. It is not cheaper. It is easier.  You can chase revenue without understanding your own economics. People do it every day, successfully, for years.  You cannot improve margin without understanding your economics precisely — which means somebody has to do the unglamorous work of building a real cost model, and then somebody has to defend it against every function whose numbers it makes look bad.

When you grow, ask where the new business is actually coming from. It’s coming from the deals you won on price — because those are the deals that were available to win.   So the new revenue comes in at a worse margin than the business you already had. And you needed more capacity to serve it. And the new customers pay you slowly.  And it did not come free. You needed capacity, so fixed cost went up — call it a million. You needed working capital, and the new customers pay slowly, so a chunk of cash went out the door and is not coming back.

You can grow your top line twenty percent and barely move your profit at all. I’ve watched it happen more than once, and everybody in the building thought it was a great year.   

And here is the part that should worry a CEO: if your incremental business comes in below your average contribution margin — and it almost always does, because you win the marginal deal on price — then growth is dilutive by construction. You are growing into lower profitability and calling it scale.

What are the most common misconceptions executives have about improving EBITDA?

I’d give you three.

The first is that people treat it like it’s cash. It isn’t. It’s an earnings number with a few things stripped out of it, and it will tell you nothing about whether there’s money in the bank.

You can improve it every single quarter and still run out of cash. I’ve sat with a management team that was genuinely bewildered by that — because the number they were watching had gone the right way the whole time.

The second is that you improve it by cutting costs.   If you cut the cost without removing the work that consumes it, the work does not disappear. It relocates — into overtime, into expedite, into rework, into the good people staying until eight o’clock, into quality escapes six months later. You did not remove cost. You deferred it and added interest.

Mostly, you don’t. Because most cost is capacity. It’s people, machines, space, and time.   If you cut the cost but you don’t remove the work that’s consuming it — the work doesn’t go away. It just moves. It moves into overtime. Into rush shipping. Into rework. Into your best people staying until eight o’clock and then quietly leaving in the spring. 

You didn’t remove the cost. You postponed it, and it comes back with interest.

The third one is the one I’d actually want somebody to hear.

Ask any management team this question: “Profit moved by a million dollars last year. How much of that was price? How much was volume? How much was the mix of what you sold? And how much was cost?”

That’s it. Four buckets. That’s all there is.

I have been asking that question for thirty years. I’ve gotten a real answer maybe four times.  And the answer, when we finally do the work, is almost always the same. Volume mattered less than they thought. And the mix — what they happened to sell, which nobody was managing at all — was the biggest single thing that moved the number, in either direction.

If you can’t answer that question, you don’t actually know why you made money last year. Which means you have no idea how to do it again.

What advice would you give leaders preparing their companies for acquisition or private equity investment? 

One idea, and everything else comes out of it.

The buyer is not buying your profit. The buyer is buying how much they believe your profit.

Take two companies. Same industry. Same five million dollars of earnings. One of them sells for thirty million and the other sells for forty-two.

The difference isn’t the number. The difference is whether the buyer trusts the number, understands where it came from, and can see how to do it again.  That’s twelve million dollars. And you don’t buy it with performance. You buy it with clarity.

So — three practical things.

Start two years out. Not six months. Everything that raises the price has a long lead time, and a buyer who has done twenty of these can tell from across the room whether you started last month.

Investigate yourself before they do. Go find your own bad news. Because there is an enormous difference between “we found this, and here’s what we did about it” and “the buyer found this.”  

Every surprise in the diligence costs you twice. Once for the thing itself. And then again — much more expensively — for the doubt about what else you haven’t shown them.  They don’t adjust the price for the one thing they found. They adjust it for everything they now suspect is still out there.

And the third — don’t dress the company up by starving it. Defer the maintenance, cut the sales team, stretch the vendors, run one hot year. A good buyer strips all of that back out in about a week. So now the price hasn’t moved, and they’ve learned something about you that they can’t un-learn.

You cannot manufacture credibility in a data room. You can only spend the credibility you built in the two years before it.

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