Volkswagen is right to put profit before sales

Martin Winterkorn is a man with a lot of explaining to do. The German executive is widely considered the person ultimately responsible for ‘Dieselgate’. As the former CEO of Volkswagen Group from 2007 to 2015, he did not instigate the use of the ‘defeat devices’ that enabled VW cars to cheat global emissions testing, but it is alleged he became aware of them and did nothing in response, which he denies.

The former CEO has already paid €11m (£9m) back to VW and still faces a slew of charges from US prosecutors.

Dieselgate also served to fog up another significant problem attributable to Herr Winterkorn. Throughout his tenure, the CEO’s prime strategic goal was to ensure VW became the biggest car manufacturer on the planet. It was a mantle traditionally held by the Toyota Group, but not under Winterkorn’s watch. While operating profit, customer satisfaction and employee retention were also on his dashboard, Ziel Nummer eins was car sales.

During Winterkorn’s tenure, he doubled production from 6 million cars in 2007 to 11 million by 2016. That increase saw VW Group finally surpass Toyota to become the biggest car company in the world – two years earlier than planned.

The achievement was possible because VW Group is more than simply VW. The German holding company straddles more than half a dozen brands in addition to Volkswagen, in an automotive house of brands that includes Audi, SEAT and Skoda, as well as Bentley, Lamborghini and Porsche. It was also possible because Winterkorn pushed these brands to launch more models, aimed at more consumers, in more markets than ever before.

VW Group would often announce up to 60 new models a year. Niche brands like Bentley and Lamborghini saw production numbers increase by a factor of five. Bigger brands like VW and Porsche were pushed to sell record numbers of cars, year after year.

Profit vs sales

Sales are usually the ultimate corporate measure of success, not just at VW but at most large organisations. We celebrate when a company breaks a billion dollars in revenues. And yet, once you break that focus on sales down, it becomes embarrassingly evident just how dumb an objective it usually proves to be. I sense the shaking of hundreds of marketing heads, who think I am naively about to propose brand equity or customer satisfaction above sales volumes as the best focus for a company.

I am certainly not going to do that. My argument is that sales are of course important but that they are not the lifeblood of a company, profit is. Granted, to some degree operating profit is a function of sales volume. You have to sell X cars to make Y profit. But that should not justify the focus on X and the general ignorance of Y when setting objectives, shaping long-term strategy and directing marketing.

I tell marketers who want to move away from the softer measures of marketing towards more fundamental measures of business performance to take great care. There is a tendency to look for the signpost pointing to increased revenues as the unchallenged direction for corporate success. Before you start making strategic decisions, however, look for a second signpost: the one pointing to profitability. Note immediately that these two signposts rarely point in the same direction. In fact, they usually direct you to two completely different paths.

The profit signpost tells you to slow down and sometimes step back; to understand strategy as sacrifice.

The sales signpost points towards lowering prices, targeting the bottom of the funnel, running extensive sales promotions, making more products, creating more brands, geographic expansion and the relegation of the bottom line to an ancillary role within the business. I would argue each of these precepts makes perfect sense in a sales-orientated business, and yet each is very often a stupid move.

If you want a hero company to illustrate sales orientation, you can take WeWork as your exemplar. The company was not only ignorant of profitability; it presented its loss making status, and that of its founder in all his earlier business, as a 21st-century badge of honour.

When you look for that second profit signpost, it will invariably point you in a more difficult, but more successful direction. It directs you to maintain a price premium and the branded differentiation that justifies it. It compels you to look for more profitable, protectable target segments and higher-priced, profitable products to service them with. It tells you that most sales promotions are a slow suicide and that, if you do make a sale at a special price, you should feel bad, not good, about it.

The profit signpost tells you to slow down and sometimes step back; to understand strategy as sacrifice. It leads you to kill products and brands in massive culls that severely impact the top-line of the firm, while liberating the bottom. For the surviving brands, the signpost tells you to invest in big, long-term, TOFU-boosting efforts on their behalf. To follow the profit path does not mean we ignore volume, but it does mean we relegate it to page six in the marketing plan, and put gross margins and operating profit on page one. The purpose of sales is to provide profit, after all.

I learned this the hard way. A long time ago, I flew to New York City from California, where I had been working for a brand that had just broken the billion-dollar revenue target for the first time. I went into my meeting with my east-coast client still beaming from the Californian celebrations the day before. I was still talking about it with several of the senior marketers at my New York client as we set up for the day.

Suddenly the CMO of the company looked over at me and asked: “What kind of profit were they doing on their billion?”

I looked up and said: “Actually, I don’t know…”

“Then you should shut the fuck up about it,” he said urbanely. Half joking, half not. It was a painful moment but an important one for me. Any idiot can sell something. To sell it at a profit, a good profit, a sustainable profit, is a different thing entirely.

Exemplars of the profit path

If you are looking for a hero of the profit path you must bow to Apple. The company exemplifies almost every step in the profit path described above. Quarter after quarter, Apple’s results make the strongest possible case for following that path.

In terms of 2021 unit sales (or shipment share as it is often called in handset sales) Apple’s 12% share puts it among a pack of many competing players, finishing third behind bigger selling producers Samsung and Xiaomi (see top chart, below). In revenue share, however, Apple’s superior brand equity, high-end product focus and price premium ensure it took 40% of total global handset market (see middle chart). But it is only when you consider operating profit that the true magnitude and magnificence of Apple’s iPhone strategy is revealed, with the company enjoying 75% of the total global handset profits (bottom chart).

You are probably familiar with the famous bar chart showing Apple AirPods versus a host of other tech companies. It’s been floating around the interweb for several years. The chart is meant to show that even a tiny, insignificant product line from Apple is bigger than most of the vaunted tech companies.

It’s a bit of a ropey old apples-to-oranges chart but it does make quite the impression. Here is a single, tiny Apple product towering over whole companies. But, once again, it’s a chart that demonstrates the limits of revenue obsession and misses a much more impressive trick as a result. If you look at things from a profit perspective the optics bend even more outrageously in Apple’s favour.

Thanks to a gross margin of around 60%, Apple’s purported $23bn in revenues from AirPods probably delivered around $13bn in profit for the company in 2020. That’s not quite the same as operating profit because all the significant additional costs of running Apple still need to be accounted for and apportioned across its various products. But that means that, if you combined the profit performance of the other companies in the chart, it would be roughly the same total as that generated by AirPods. All eleven of them.

That’s partly because many big tech brands don’t make as much as you think and many more actually lost money. But it’s mostly because we look at the world through the lens of revenue, and Apple is one of the few companies that takes the deeper, more important profit perspective.

VW is no Apple. Hell, there are many examples where Apple fails to live up to its own reputation. But the automotive giant is finding its feet after the Winterkorn years. Dieselgate is in the rear view mirror and a new leadership team is now keenly aware of the fallacy of unit sales as its number one objective.

“The key target is not growth,” VW’s new group CFO told the Financial Times last week. “We are more focused on quality and on margins, rather than on volume and market share.” VW Group has just announced it will kill off at least 100 different car models, about 60% of its portfolio, in the coming years.

Kill, don’t just create

Killing off so many models aligns with the broader transition to electrification that VW, like all car companies, must now commit to. But it also bestows other, more immediate benefits on VW. When you kill products, you invariably take out the less profitable ones, leaving behind higher-margin and higher-potential products.

I should underline ‘less’, because this is not a naïve attempt to close down loss-making parts of the business. Any moron can do that. When you kill products and brands, you are usually shutting down things that turn a quite decent profit. They key issue is the resources required to generate that profit and how they might perform if freed to be invested elsewhere.

I remember dearly working with three brands in London and being dead set on shutting down the smallest of the three businesses. To this day, I remember the head of that business telling me it was madness to walk away from the £800,000 profit she was generating for the company.

“Yes,” I said with as much patience as I could muster, “but if I gave your marketing budget, and your sales team, and the capex to either of these big boys,” and gestured to the other heads of business sat in the room, “we’d be making a lot more than £800k. Isn’t that right gents?”

There was a pregnant pause while the two colleagues uncomfortably considered the question. “That’s right,” one of them finally confirmed in almost a whisper.

A good marketer should see their product remit not just as a licence to create, launch and grow but also to kill.

These survivors get more attention, more investment and more undivided long-term focus. That usually results in better, more satisfying products. Then in growth, profitability and – yes – new products. The companies following the profit signpost ultimately find themselves in a much better place than the ones still racing down the volume path.

It’s crucial for marketers to follow VW down that same profit path too. We often lose out to other departments in the managerial turf wars, but this is one area where we are uniquely well placed to kill and refocus product portfolios.

The sales-oriented senior management team rarely like killing – given it will inevitably result in a lower revenue number. And those members of the leadership team drawn from product development would rather create new stuff rather than remove any existing babies. But a good marketer should see their product remit not just as a licence to create, launch and grow but also to kill.

I spent my consulting career assiduously avoiding the creation of new products and brands. I found them to be unreliable and expensive distractions for the most part. But I got very aroused at the prospect of killing things. For me, that was the sweet spot and a place of immediate, easy and very profitable impact.

Learn to kill, not create. At the very least, learn to kill before you create. All these companies with long innovation pipelines usually have no plans to reduce their existing portfolio. That always ends badly.

One of my favourite ever chief executives was the brilliant Jean-Andre Rougeot at Benefit Cosmetics. He might even have been the best I ever worked for. He managed an incredibly diverse and creative product team at Benefit who were always brimming with new ideas and formulas. His stock response when anyone came to him with a hot, new, sure-thing product was to respond in two stages.

First, he congratulated the marketer on such an innovative new product and gloried at its likely impact. Then, he asked for the product SKUs in the portfolio that would be cut to make room for the new launches. It was a smart, systematic way to ensure that Benefit maintained a tight product portfolio and – with it – supreme profitability.

VW Group is no longer the world’s biggest car producer. Toyota once again wins that race. But marketers need to appreciate is that it is a race with no prizes and which should attract few spectators. The big race, the grand prix, is the one that chases profit. Fortunately, strong brands and well-trained marketers play a big part in that particular race – provided we look to the right signpost from the starting grid.

Mark Ritson is PPA Columnist of the Year and BSME Business Columnist of the Year. He teaches the profit path as part of his Mini MBA in Marketing which runs once more this year, in September.