3 Ways Finance Can Help Improve Operating Margins

One of the challenges facing today’s finance executives is improving operating margins for the business. Top-line growth is very slow, inflationary pressures are causing higher input costs, and customers are pushing for innovative new products and services, albeit at discounted prices. All these factors, among others, are significantly squeezing company margins left, right and centre.

Uncertainty is the norm today, rendering tried and tested ways of creating value unfit for purpose. Thus, finance executives and their teams have to come up with new innovative and agile ways of capturing value and striving in this environment, while at the same time keeping costs down. Look no further than the number of profit warnings, earnings miss and business closure announcements by companies of all types and sizes. This just shows how the pressures on margins are considerably increasing, and also not expected to abate anytime soon.

When it comes to improving operating margins, many finance executives normally make one of these common mistakes. Implement across the board cost-cutting initiatives (mostly focused on reducing employment costs), raise products/services prices, or offer steep pricing discounts with the hope that the discounting will boost revenues and translate into higher operating margins. The problem with these approaches is that they fail to take into consideration the value-add to the customer.

So what must finance do?

Think and Act Differently

Most of the time the finance executive’s focus is on improving specific elements of the Income Statement, instead of the entire business. This in turn results in the finance organization embarking on one-off cost reduction initiatives, that fail to differentiate and understand the difference between good and bad cost.

Instead of focusing on cost reduction, heavy discounting and price increases, the CFO and the team must apply innovative, non-traditional thinking to margin management. They need to have a deeper understanding of the forces (both internal and external) driving the business margins. Many finance executives are aware of the factors influencing their margins. But, do they really know the significant drivers at granular levels for each product, channel, geography, segment, market, or business unit?

Thinking differently and making use of ABC/M, Customer Life-cycle Value and Customer/Product Profitability Analysis techniques can help CFOs understand their organization’s costs and their drivers. It also helps them to think beyond historical top-line focus and current constraints, and focus on doing the right things. For example, the CFO will be able to ask and answer the following questions:

  • What does our customers value most?
  • Is our current value proposition delivering customer value?
  • Do we need to change our current business operating model?
  • Should we sell all the under-performing assets or not?
  • Should we exit all the under-performing businesses, brands, markets or channels?

In order to improve operating margins, it is critical that executives consistently apply margin management to the entire business. You need to manage margin the end to end processes of the entire value chain, and find a more integrated way of driving overall results as opposed to one element of the income statement or business. This helps eliminate waste and also leads to more transparent and informed decision making.

Make Insight-Driven Decisions

Although information systems have improved significantly, many organizations are still struggling to benefit from their use. For instance, there is an organization class that is still reliant on primitive systems that are no longer fit for purpose in today’s data driven-economy. Then there is another class of organizations who have implemented modern technologies to enhance decision making but are struggling to integrate these with existing systems or have experienced dismal implementations with far-reaching consequences.

The modern finance organization must leverage data and analytics to inform margin decision-making. For instance, CFOs can make use of advanced predictive modelling and simulation tools to identify drivers of margin, calculate margins under different scenarios and evaluate ways of improving the margins.

Care must be taken that you do not embark on a data-hoarding spree without first understanding why you need that specific data. You need to make sure that you are collecting the right data to analyse and extract meaning from, otherwise you will end up wasting your time, energy and resources analyzing wrong data and generating ineffective insights. Information is only as valuable as the decisions it drives.

Wrong data collection often results in ineffective analysis and generation of misleading insights which ultimately leads to slow and ineffective decision making. This also causes the business to react slowly to new opportunities and threats. Instead of being proactive, overall decision-making is mostly reactive.

When margin decisions are made based on insights, more emphasis is placed on adding value to the customer and not on quick fixes such as slashing more costs. You can cut costs only up to a certain extent, long-term this is not sustainable. Hence the need to find alternative ways of boosting margins. Evidenced-based decision making also enables executives to develop a more detailed understanding of the full set of profitability drivers for the company.

Cultivate a Margin-Focused Culture

Delivering improved margins also requires the organization to develop a common understanding of the meaning of margin management and why this is crucial.  This is necessary to promote accountability, drive the right behaviours across the organization and ensure that margin optimization remains a key priority.

Successful fostering of this culture depends on senior management buy-in and involvement. If the drive is coming from the very top, it becomes easier to embed the culture into the business and make margin improvement an everyday part of the decision making processes. Senior executives have to therefore show a commitment to margin improvement otherwise the middle and lower level employees will also not be committed.

CFOs are better placed to drive this culture because of their constant engagement with the business – Sales, Marketing, Operations, R&D etc. By collaboratively working with other business units, finance executives can provide them with the information and the tools they need to make decisions that support profitability goals. They can also help put in place metrics that are not focused on volume alone but also drive the right behaviours and stimulate growth.

Furthermore, CFOs have to ensure that they are consistently reporting and reviewing margin performance across all brands, product categories, channels, segments and markets on a monthly basis. This will enable margin management to get embedded in the fabric of the business, and also be fully integrated with the broader strategy of the business.

Improving operating margins is not the responsibility of the finance organization only. It should be everyone’s concern. However, finance must lead the conversation. The CFO must ensure that the right operating model and capabilities have been developed to identify areas of margin leakage and define improvement actions.

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Leading in Uncertain Times

One of the biggest challenges facing business leaders today is making the right decisions that will ensure their organizations succeed, survive, and remain competitive in an increasingly uncertain and complex environment.

A recent post, The best way to lead in uncertain times may be to throw out the playbook, by Strategy+Business has several good points.

The article is about the COVID-19 pandemic, how global companies navigated through the crisis, and how best to prepare for future disruptions. Here are some key points and my comments.

  • Rather than follow a rigid blueprint, executives must help organizations focus on sensing and responding to unpredictable market conditions.
    • Comment: Senior leaders play a vital role in providing clarity about the organization’s strategic direction, creating alignment on key priorities to ensure the achievement of enterprise objectives, and ensuring the business model is continuously evolving to create and capture value in the face of uncertainty. They must not rest on their laurels and stick to the beliefs and paradigms that got them to where they are today and hope they will carry them through tomorrow. Regulatory changes, new products, competition, markets, technologies, and shifts in customer behavior are upending many outdated assumptions about business success. Thus, the businesses you have today are different from the ones you will need in the future hence the importance of continuously sensing changes in the global economy. Employees and teams often feed off the energy of their leaders and tend to focus their attention where the leader focuses attention. If the leader is comfortable with current business practices and rarely embraces the future or challenges the status quo, then the team is highly likely to follow suit.
  • When it became clear that supply chains and other operations would fracture, organizations began scenario planning to shift production sources, relocate employees, and secure key supplies.
    • Comment: Instead of using scenario planning to anticipate the future and prepare for different outcomes, it seems most of the surveyed organizations used scenario planning as a reactionary tool. Don’t wait for a crisis or a shift in the market to start thinking about the future. The world is always changing. As I wrote in The Resilient Organization, acknowledge that the future is a range of possible outcomes, learn and develop capabilities to map out multiple future scenarios, develop an optimal strategy for each of those scenarios, then continually test the effectiveness of these strategies. This does not necessarily mean that every change in the market will impact your business. Identify early warnings of what might be important and pay closer attention to those signals. In other words, learn to separate the signals from the noise.
  • The pandemic forced the organization’s senior management team to re-examine how all decisions were made.
    • Comment: Bureaucracy has for a very long time stood in the way of innovation and agility. To remain innovative and adapt quickly in a fast-changing world, the organization must have nimble leadership and an empowered workforce where employees at all levels can dream up new ideas and bring them to life. Identifying and acting on emerging threats and potential opportunities is not the job of the leader alone but every team member. To quote Rita McGrath, in her book Seeing Around Corners, she writes, “Being able to detect weak signals that things are changing requires more eyes and ears throughout the organization. The critical information that informs decision-making is often locked in individual brains.” In addition to the internal environment, the leader must also connect with the external environment (customers, competitors, regulators, and other stakeholders), looking for what is changing and how.
  • It’s worthwhile for leaders of any team to absorb the lessons of sense-respond-adapt, even if there is no emergency at hand.
  • Sensing: Treat the far-flung parts of your enterprise as listening stations. The question leaders must ask is, “What are we learning from our interactions beyond the usual information about costs and sales?” Train your people to listen for potentially significant anomalies and ensure that important information is not trapped in organizational silos.
    • Comment: Cost and sales data are lagging indicators that reveal the consequences or outcomes of past activities and decisions. Although this information can help leaders spot trends by looking at patterns over time, it doesn’t help understand the future and inform what needs to be done for the numbers to tell a different story. In addition to lagging indicators, pay attention to current and leading indicators and understand the relationship between these indicators and outcomes.
  • Responding: Improve communication across intra- and inter-organizational boundaries. Leaders should view business continuity as an essential function that acts as connective tissue for the enterprise.
    • Comment: In addition to creating mechanisms that allow the free flow of information both inside and outside the organization, decision-makers should also be comfortable receiving information that challenges their personal view of the world, even if it’s not what they want to hear. Create a culture of psychological safety where people are not afraid to share bad news for fear of getting punished, but rather are acknowledged and rewarded for speaking up. Leveraging the diversity of thought enables leaders to anticipate the future as an organization, decide what to do about it collectively, and then mobilize the organization to do what’s necessary.
  • Adapting: Challenge assumptions, and question orthodoxies. There’s always the temptation to mitigate threats simply by applying existing practices harder and faster. One way to get at those deeper issues and encourage double-loop learning is to ask, “What needs to be true for this to be the right approach?”
    • Comment: In an increasingly uncertain environment, it’s difficult to survive and thrive with an old business model or outdated technologies. Many businesses fail because they continue doing the same thing for too long, and they don’t respond quickly enough and effectively when conditions change. As a leader, stay curious and connected to the external environment, look for market shifts, understand what needs to be regularly refreshed and reimagined, adopt new technologies and capabilities, and adapt in ordinary times but also during times of transition. Unfortunately for many leaders, it’s just more convenient for them to continually downplay the fact that conditions are changing than take the appropriate course of action that drives business success.

How are you preparing your organization for potential future disruptions?

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The Collaborative Organization

These days the term collaboration has become synonymous with organizational culture, creativity, innovation, increased productivity, and success.

Let’s look at the COVID-19 pandemic as an example. At the peak of the crisis, several companies instructed their workers to adopt remote working as a health and safety precautionary measure.

Two years into the pandemic, they are now asking their employees back to the office full time or are planning to adopt a hybrid model.

The need to preserve our collaborative culture and accelerate innovation are two of the top benefits being cited by organizational and team leaders for bringing workers back.

Collaboration is indeed essential for the achievement of team goals, functional objectives, and the overall success of the organization.

Today’s breakthrough innovations are emerging from many interacting teams and collaborative relationships.

When teams, functions, and organizations collaborate, the whole is greater than the sum of its parts; group genius emerges, and creativity unfolds.

But, what makes a successful collaboration? What are the key enabling conditions?

  • It extends beyond the boundaries of the organization. Business success is a function of internal and external relationships. Instead of viewing your business in vacuo, understand that you are part of an ecosystem. External to your organization, who do you need to partner with to enhance your value creation processes, achieve/exceed your objectives, or successfully execute your strategy?
  • Ensure the objectives are clear and there is shared understanding by everyone. Unclear objectives are one of the topmost barriers to team and organizational performance.
  • Foster a culture that encourages opinions and ideas that challenge the consensus. People should feel free to share their ideas and not hold back for fear of others penalizing them or thinking less of them. Collaboration is hindered when one or two people dominate the discussion, are arrogant, or don’t think they can learn anything from others.
  • Groups perform more effective under certain circumstances, and less effective under others. There is a tendency to fixate on certain topics of discussion amongst groups which often leaves members distracted from their ideas. To reduce the negative effects of topic fixation, members of the group should be given periods to work alone and switch constantly between individual activity and group interaction.
  • Effective collaboration can happen if the people involved come from diverse backgrounds and possess complementary skills to prevent conformity. The best collective decisions or creative ideas are often a product of different bodies of knowledge, multiple opinions, disagreement, and divergent thought processes, not consensus or compromise.
  • New technologies are making collaboration easier than ever, enabling us to increase our reach and broaden our network. Although new technology helps, it will not make your organization collaborative without the right culture and values in place. First, define what you want to achieve through collaboration then use these tools to promote creative collaboration.

How else are you championing collaboration within your organization to create value and succeed?

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Preparing for Geopolitical Shocks

Geopolitical instability has steadily increased over the past years, and uncertainty in the global economy is at an all-time high. Thanks to globalization and advances in technologies, we now live and work in a tightly interconnected world, one in which the boundaries that previously separated domestic from global issues have disappeared.

Threats are no longer confined to traditional political borders, social structures, and geographic boundaries. Geopolitical shifts have dramatically altered the global economic landscape and brought politics and business together.

The rise of China as an economic and politically influential power has threatened the dominance of the United States as the world’s largest economy. Although the opening of China and a market of 1.4 billion people have benefited both countries, it has also intensified competition and sparked U.S. economic and technological espionage accusations against China, leading to strained relations between the two giants.

U.S. companies operating from China have felt the impact of this tense relationship. The opposite is true for Chinese companies in the U.S.

Across Europe, national populism is on the rise and now a serious force. In 2016, the United Kingdom shocked the world when it voted to leave the European Union, generating reverberating effects across markets.

Banks and financial services companies that once benefited from the EU passporting system have had their cross-border banking and investment services to customers and counterparties in the many EU Member States impacted, causing them to reimagine their value proposition models.

The recent invasion of Ukraine by Russia is another example of a geopolitical event that has had devastating effects on human livelihood and businesses. Although the conflict between the two countries has risen over the years, I think it’s fair to say that few political analysts, governments, and businesses predicted a war to happen.

The war has created a humanitarian crisis, rattled global commodity and energy markets, caused prices to soar, and forced many international companies to temporarily suspend their Russian activities or completely cut ties with the country.

Global supply chains which are already fragile and sensitive due to the COVID-19 pandemic are now facing new challenges in the aftermath of the Russia-Ukraine crisis. Multilateral economic sanctions have been imposed on Russia. A state of affairs that was unthinkable months ago and is now threatening to derail the nascent global economic recovery from the COVID-19 pandemic.

Given the global domino effect of geopolitical events and the shrinking of the distance between markets and politics, the need to better understand and more effectively mitigate geopolitical risk has become more urgent. The business impacts, whether direct or indirect, vary by company type and industry sector.

Your company may not be able to prevent wars between nations, but you can anticipate and better prepare for geopolitical shocks:

  • Integrate strategy, risk, and performance decision-making. Consideration of risks to business success is an important part of the strategy selection and execution process, not an afterthought.
  • Develop a better understanding of geopolitical trends and how they are changing. For example, what are the megatrends in business, politics, and technology that are making geopolitical risks more diverse, prevalent, and consequential?
  • Assess the links between these geopolitical events and business performance. What are the events that matter most to your business? For example, how might current global political trends pose physical, business, and reputational risks to your parent organization?
  • Anticipate how these trends are likely to play out in the short, medium, and long terms, and develop mitigation strategies for each geopolitical scenario. Proactively anticipate and plan for radically different worlds, instead of reacting to problems as they arise
  • Review your mitigation strategies as the world changes. Are they effective enough in case of a major shock?
  • Develop capabilities for continuous learning to anticipate, address, and recover from geopolitical crises.

What do you think?

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