While I have the luxury of representing the premier solution in the cost and profitability management market, it’s always nice to be on the receiving end of independent, unsolicited, corroborating evidence. I was in the audience for a discussion of global manufacturing and distribution business models when up on the screen popped the familiar Profit Cliff chart (familiar, that is, to practitioners of activity-based costing - ABC/M).
The speaker’s own experience with the model showed that their company had about one-third of their products ranked as profitable, one-third merely break-even, and one-third were definite money losers. He also shared the astonishment, also familiar to me, that the finance and business teams experienced at first learning about the profitability distribution of their product portfolio – at how few products were truly successful and at how many were below the break-even point. Without a proper activity-based costing approach, this is something you just do not know about your business.
If that was all there was to the discussion, however, this blog post would hardly be worth your time or mine, as I’ve been touting not just the benefits, but also the near necessity of adopting an activity-based approach for some time (“Activity-Based Management - The gift that keeps giving”). But where he took the discussion next was another one of those arenas of astonishment – how seldom a poor performing product ever actually improves despite often extraordinary management efforts to turn things around.
His product evaluation criteria utilized these four categories:
1) Fails to make money under any and all measures
2) Does not cover variable costs, but breaks even when future / downstream / derivative / service / after-market revenues are included
3) Covers its variable costs (which already includes standard direct and indirect costs, since he is assigning all costs via ABC)
4) Covers its variable costs and its associated cost of capital
Once you’ve segmented your products (or customers) by profitabiltiy, one of the basic tenants of activity-based management is to take the necessary actions to move the losers into the break-even column, and shift the break-even products into profitable territory. Yet his history showed that, once introduced, products tend to improve their profitability up to a point, then peak and level off there, no matter what actions R&D, manufacturing or marketing may attempt to propel them to the next level.
His prescription? We need to be better disciplined about terminating the losers. We are quick to make the initial go-to-market decisions, but slow to reverse course, when it should be the other way around. As I touched on in my “WYSIATI” post a couple of weeks back, we are not as rational as we imagine ourselves to be, our decisions are influenced by sunk costs and entrepreneurial delusion and our own personal investment.
You can likewise run the Profit Cliff on your customers, and get the same sort of distribution, and then take that and combine it with your customer intelligence data to migrate, upsell or cross-sell your marginal customers into profitability. This speaker’s experience, however, in the manufacturing realm, was that most of his customer profitability problems were rooted in product issues. True, there are always a handful of high-discount / high-maintenance / high revenue but nonetheless unprofitable customers, but he felt that moving the rest of them off of unprofitable and onto more profitable products was the key solution from the customer profitability perspective.
The group discussion later took one final twist that combined several of the product, customer, channel, market and profitability themes into one final gem of an insight for the day: that profitability and market success sometimes depends on the development and acceptance of a new business model by certain key members of the distribution channel. This is an especially significant factor for manufacturers that have minimal control of their channel.
The best example of this was provided by a manufacturer of solar panels. Who is the key member of the distribution channel between the manufacturer and the homeowner for photovoltaic solar panels? Roofers. No matter how beneficial the energy calculations might be, if you can’t come up with, or convince the roofers to adopt, a different business model for themselves, solar adoption is going to be much slower than it otherwise could be. (Likewise, geothermal heating/cooling immediately came to my mind, where different but related channel partners are key to adoption – plumbers and HVAC installers). Not necessarily products, and not necessarily customers, but the channel and channel profitability might be paramount in these new market situations (another aspect of activity-based management).
My takeaways regarding better product, customer and channel decisions? Four things: 1) the basic “ah ha” knowledge provided by the good, hard data of the Profit Cliff, 2) a fact-based/informed analysis of product histories and trends, so that you know if and when they may have reached their peak, 3) a disciplined policy and management approach to retiring unprofitable products, and 4) insight and imagination to extend the process into the associated channel and customer spheres.
By Leo Sadovy, EPM Contributor, from: http://blogs.sas.com/content/valuealley/2013/08/06/of-products-and-customers-cabbages-and-kings/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+ValueAlley+%28Value+Alley%29
Leo Sadovy handles marketing for Performance Management at SAS, which includes the areas of budgeting, planning and forecasting, activity-based management, strategy management, and workforce analytics, and advocates for SAS’ best-in-class analytics capability into the office of finance across all industry sectors. Before joining SAS, he spent seven years as Vice-President of Finance for Business Operations for a North American division of Fujitsu, managing a team focused on commercial operations, customer and alliance partnerships, strategic planning, process management, and continuous improvement. During his 13-year tenure at Fujitsu, Leo developed and implemented the ROI model and processes used in all internal investment decisions—and also held senior management positions in finance and marketing.Prior to Fujitsu, Sadovy was with Digital Equipment Corporation for eight years in sales and financial management. He started his management career in laser optics fabrication for Spectra-Physics and later moved into a finance position at the General Dynamics F-16 fighter plant in Fort Worth, Texas.He has an MBA in Finance and a Bachelor’s degree in Marketing. He and his wife Ellen live in North Carolina with their three college-age children, and among his unique life experiences he can count a run for U.S. Congress and two singing performances at Carnegie Hall. See Leo’s articles on EPM Channel here.