There are two ways a company can increase profits: spend less or earn more. You spend less by focusing on the bottom line – the expense line – and trying to find ways to make it go down. You earn more by focusing on the top line – the revenue line – and trying to find ways to make it go up.
Spend less on the bottom line. You can do this by getting more efficient in your operations or by doing fewer things. As companies grow larger they can get more efficient by doing things at a larger scale. For example, Wal-Mart can reduce its cost per item by buying things in huge quantities. Companies also gain efficiency over time. As they do things over and over, they learn to do them more efficiently. This is known as the experience curve, first noted in 1930s airplane manufacturing. These scale and learning effects combined are known as economies of scale. Over time these economies get harder and harder to achieve. Each subsequent increase in efficiency requires more effort than the last. This phenomenon is known as the Law of Diminishing Returns.
Earn more on the top line. You can do this by getting more customers or by getting your current customers to spend more. There are lots of ways to achieve this. You can get more customers by entering new markets, by launching new products and services, or by better promotion. You can induce them to spend more by offering them more things, or increasing the value you deliver enough to justify higher prices. To stick with the Wal-Mart example: the company has grown not only by opening new stores but by continually offering customers more things inside the store, like groceries and prescription pharmaceuticals. And it’s paid off: Although Wal-Mart is a recent entrant in the grocery business, it is already the top grocery store in the US today.
Reducing the bottom line is about gaining efficiencies and economies. You get there by doing things efficiently and consistently. It’s about doing the things you are already doing, but doing them better and better.
Growing the top line is about moving into new markets, developing new product and service lines, and discovering new, sometimes breakthrough opportunities. You get there by being creative and thinking differently. It’s not about doing old things better, it’s about doing new things.
As many companies have discovered, these two approaches – consistency and creativity – are in fundamental conflict. Innovation leader 3M learned this painful lesson when they tried to implement six-sigma quality controls in the early 2000s. As they implemented new controls to improve efficiency, they found themselves systematically squeezing the creativity out of the business. “We all came to the conclusion that there was no way in the world that anything like a Post-it note would ever emerge from this new system,” said Michael Mucci, who worked at 3M for 27 years.
Six sigma gets its name from manufacturing process controls. A six-sigma process is one in which 99.99966% of products are defect-free. That translates to 3.4 defects per million. Great for quality and cost control, but not so great for creativity and innovation. The problem is that you can’t cut your way to growth.
Motorola, who invented Six Sigma in 1986, has fallen on hard times. In an ironic demonstration of service logic eating product logic, Google is acquiring Motorola’s mobile phones group for $12.5 billion.