Strategic Insights # 9
BUILDING
A COST MODEL TO DETERMINE CUSTOMER (ITEM) NET-PROFITABILITY
An
8-step journey to faster growth with much greater profitability begins with the
management team reading and discussing the book: Islands of Profit in a Sea of Red Ink by
Jonathan Byrnes. The book explains why most companies lose most of their
profits through cross-subsidies between profit-making and profit-losing
customers and items, and what to do about them. (See stellar reviews at
Amazon.)
The
second step of the journey is the most important and difficult one: build a “Cost-to-Serve” (CTS) model
for your distribution-type business (or division) to determine customer and
item profitability. To add to Byrnes’ advice on how to do this, here are a few
design guidelines:
1.
Make sure the model includes all of your
operating costs, so that net profits match financial reporting results.
2.
Develop a model that is optimally complex
and sufficiently accurate. Simple models limit insights and action plays.
Complex ones collapse under their own weight. And, no model (including existing
financial reporting) can perfectly mirror the dynamic complexity of a business.
3.
Make sure initial, profitability-ranking
results pass the “gut-check” test – do they tend to support your instinctive
knowledge of what’s really going on. When the results later expose the
inadequacy of revered operational practices and incentive plans, the model must
be credible.
4.
The net-profit gain or loss for every line
item (“quantum profits”) must be able to flow into higher level reports that
support the next 6 steps of the journey.
STEPS
3-8 OF THE JOURNEY:
The
fact that a small percent of both customers and items turn out to be
phenomenally profitable and others unprofitable are symptoms of what root
causes? And what’s the roadmap for the rest of the journey? Here are brief
summaries for steps 3 through 8:
#3:
Create profitability ranking reports and “whale-curve” graphs for:
customers, customer niches, items, item groups, suppliers, and sales
territories.
#4:
Investigate the extreme winners and losers on the ranking reports by doing a
“5-why”
root cause analysis
for why the extremes are so profitable or unprofitable. The investigation will
require cross-analytic, deep-dive inquiry capabilities. What, for example, are
the most unprofitable items and orders that our biggest losing customer is
buying? Why? How then are you both losing? What is a win-win, “precision supply
chain solution” you might borrow from another channel?
Warning! The investigations will trigger
“allocation-cost filibusters” from people who will fear making less and/or
being proven incompetent for over-servicing losing accounts or buying/promoting
losing items from losing suppliers. They will want to stay with the much
less-precise, status-quo world of margin dollars and assume “all of our costs
are fixed”.
Critical-mass
support for the new, net-profit paradigm will be vital. Reading Byrnes’ book
together and doing case studies of pairs of similar accounts with same sales
but widely different profitability will help to educate and comfort everyone.
And, reassure the best people that compensation will not fall, but only go up
in the future with measurable, “net-profit improvements”.
#5:
Develop the simplest, most focused, profit-improvement “plays”, backed
up by “profit-improvement teams”.
Put everyone you can on a team.
#6:
Develop tracking reports for the specific plays to monitor “net-profit
improvement” year-over-year for every: customer, customer niche, item/supplier
and territory.
#7:
Create a separate, tracking-report system for measuring and improving all of
the service process metrics that add up to basic service brilliance for
each target niche of customers. All front-line employees should be engaged with
this.
#8:
Develop a profit-improvement incentive-compensation reporting
system that allows every employee to track how “net-profit-improvement
plays” contribute to overall net-profit improvement for the company and
everyone’s incentive/gain-sharing bonus. DON’T RE-INVENT THE WHEEL; RENT
IT!
Waypoint
Analytics has done CTS model building for dozens of different types of
distributors that also range from single-location operations to large chains,
with nearly every type of rebate and processing step and service. Clients then
continuously fine tune these models. Why not request a demo to specifically see
how they do all of this?
Waypoint
can put your cost-modeling / profit mapping project on the fast track, with
results in three to four weeks, and a report inventory that would take years to
build. The economics of renting the total service – fast, inexpensively and
risk-free – versus building your own system in-house will become self-evident.
Why not benchmark what you have now versus what Waypoint is offering today?
(And, consider my extra Step #9: Attending the Fall Profit Management in
Chicago. Contact me to be included on the invitation list.)
Bruce
Merrifield
mailto:bruce@merrifield.com
*All
Strategic Insights are posted at: http://www.merrifield.com/insights/
**For
more go to: www.quantumprofitmanagement.com
