Know Your Customers – Profitability
When I talk to food service wholesalers, a theme that frequently repeats itself is how much pride they take in knowing their customers. They know the entire history of each customer: how long they have been a customer, what they usually order and what drives their business – seasonal menus, everyday low pricing, expansion, or keeping the business in the family. But when I ask those same food service wholesalers which customers are profitable and which are not, the answers become much less clear. At best they will know the direct costs associated with each customer, channel and product. When I press for more detail, I am usually greeted by anecdotes about how long it takes to get information at that level of detail, or in some cases a direct admission, “I would really like to know.”
The reason digging out these costs is difficult is that it requires not only accounting records, but a project that is significantly more complicated than it seems. For example, it is relatively easy to determine which customers generate the most revenue. However, revenue does not equal profitability. Further, the analysis required to sort through the mix of customers, products, direct costs such as purchase price, and indirect costs such as allocation of administrative expenses is not only time consuming, it also identifies key decisions that need to be made across the entire company. In practice, most of these decisions are made by and for a single functional area. This sort of isolated decision making is often called being “stove piped”.
A stove piped analysis of profitability is a common mistake and easy to fall into. For example, the purchasing team focuses on obtaining high-quality products, marketing leaders on winning new customers, salespeople on meeting ambitious targets, and operations staff on fulfilling orders promptly. Each group can affirm meeting their goals from their limited perspective, but achieving these goals may not benefit the company as a whole. To be more effective, goal setting should align strategy and execution, and the analysis needs to have the same high-level view.
At this point you may ask, given the difficulty presented by digging out these costs, why do it at all? The answer is that this knowledge opens the door to improved margins by addressing functional areas across the company. Examples of the changes that can be addressed include: changing the sales-channel mix, increasing economies of scale through larger order size, and minimizing discounts and return rates. A tool set for “what-if analysis” would also allow the wholesaler to evaluate initiatives with the highest potential for improving the bottom line. When you look at it this way you can see that by improving margins, you can increase profitability without changing the basic business model.
With this common high-level view of profitability, purchasing managers can adjust the product mix, and marketing managers can target the customer segments, channels, and products with the highest profit potential. Sales people have solid data to underpin negotiations with customers, and operations managers have insight into cost drivers so they can benchmark activity costs and target the most effective distribution methods.
In addition, a common view of profitability allows the food service wholesaler to face head-on some crucial questions:
· Which products and customers are profitable and which are just draining resources?
· Which sales territories are delivering the best results and which the worst?
· Do discounting policies need to be adjusted?
· What activities have worked best with the profit makers?
· What should be done with the loss makers?
· Is there an opportunity to change the mix of channels for a particular customer segment?
This is where SAP’s Net Margin Analysis comes in. This module clarifies the cost to serve each customer and keeps a single view of profitability available to all decision makers. What this means in practice is that executives across the company can make informed decisions that impact indirect cost and net margin by customer, product or channel. With regularly scheduled and automated visibility into all of the elements that make up the cost to serve, decision makers can identify products, customers and activities that are profit makers and also those that are not. In this way, you can learn from both your successes and your shortcomings, gain a competitive edge, and adjust your contracts with channel representatives, modify the product mix and quickly assess new methods and practices.
Mike Thornton is a Solution Manager with the Wholesale Distribution IBU at SAP. He is based in Chicago.