The Head-Scratcher: Revenues Up, Profits Down?

It doesn’t take an MBA to know that when sales go up, usually so should profits. That is, at least, until COVID-19 appeared.

As the peak earnings seasons continue, analysts are noticing that some companies, particularly essential delivery and healthcare firms, are struggling to keep costs below a surge in demand. Everything from half-running warehouses to broken supply chains have been offsetting some impressive revenue gains—and threaten to hurt any gains the firms may see as they return to business. Call it a COVID-crisis conundrum: revenues soar—but profits sink.

Benjamin Frost, a solutions architect in Korn Ferry’s Products business, says the situation underscores a critical financial issue the pandemic poses to companies: cost optimization. It isn’t simply a matter of cutting costs to preserve revenue, says Frost. The challenge, he says, “is figuring out how to rapidly ramp up capacity in the face of demand spikes in a profitable way.”

Last week, for example, Amazon reported revenue of $75.5 billion through March 31, a 26% gain from a year earlier, on a 32% increase in products shipped. Still, profits fell 29% to $2.5 billion. The profit drop is directly related to the fact that Amazon had to institute social-distancing guidelines for its warehouses, paid for COVID tests for its workers, and hired more delivery workers to help ship products.

Nathan Blain, a senior client partner and global leader of organizational strategy and digital transformation at Korn Ferry, says the pandemic highlights the cost inefficiencies of e-commerce. “There is so much cost that goes into a package of one delivery model,” says Blain, noting that instead of delivering a large volume of products to a centralized location, the e-commerce business model essentially revolves around delivering a single product to multiple locations.

It isn’t just the way people are shopping now—e-commerce over in-store—but also what they are buying, which is essentially low-margin products, says Craig Rowley, a senior client partner in Korn Ferry’s Global Consumer Markets practice. Grocery sales soared in the immediate aftermath of the pandemic, as people stockpiled enough toilet paper, paper towels, and food, such as pasta and canned vegetables, to last a month. But, says Rowley, “grocery retailers make most of their margins on meat, produce, and deli items, which was not what people bought more of.”

Another virus-related cost challenge is how unevenly business lines are affected. While some areas could be seeing a surge in demand, for instance, others could be experiencing a decline. One example: demand for emergency services is surging at most healthcare providers—while elective surgeries have declined sharply.

That dynamic represents a big test for workforce planning functions, says Blain. “Surges and declines across the entire portfolio create big challenges around talent redeployment.” Too often, says Blain, leaders make the mistake of cutting in the depressed area and hiring in the surging area. Usually, however, by the time the cuts are done, demand comes back to the slow area and diminishes where it had escalated. Instead, he says, leaders should try to quickly shift workers out of up-and-down areas.

Even with that ability, however, Frost says training and other costs associated with redeployment would likely wipe out much additional profit in the short term. “Cost optimization in this environment is so dynamic and nuanced,” says Frost.