CategoryCost and Profitability Analysis

Achieving True Cost Transformation

Suppose your business is facing significant competition from traditional and non-traditional competitors. Demand for your company’s products and services is tepid and customers are deserting you. Revenues are in sharp decline and the impact is beginning to show in shrinking margins.

To increase revenues and alleviate shrinking margins you try to cross-sell and up-sell your products and services, but all your efforts are in vain. You ultimately decide to embark on a company-wide cost transformation initiative.

Do you cut back on equipment investments, reduce marketing and IT spend, sell some of your business assets, lower inventory levels, lay off certain employees, freeze salaries, shrink transactional administrative costs or eliminate all cosmetic travel and training?

Although the above cost reduction measures are all necessary, they are basically short-term wins which are difficult to sustain in the face of new technologies, changing customer expectations and increasing competition from new entrants and other disruptors.

Cutting costs for the sake of it

Many organizational cost transformation initiatives fail to deliver lasting gains because they are often implemented in isolation without the context of the broader strategy of the business. You need to understand that cost transformation is not simply a matter of cutting costs randomly.

Rather, gainful cost transformation is linked to strategy and drives the effective execution of that strategy. In my experience, I have realized that majority of cost initiatives are more inward focused and less outward focused.

It’s all about increasing the bottom line as opposed to making sure the business remains competitive. More backward-looking and less forward-looking.

Because cost management is misaligned with business strategy, there is little focus on generating capital to fund strategic growth initiatives or diverting resources from low performing business units or unviable markets towards higher value and return opportunities.

Partly to blame for this misalignment is lack of understanding of strategy by employees across the organization. As a result, employees are unable to distinguish necessary costs (essential to meet customer expectations and deliver the organization’s value proposition) from unnecessary costs.

That is why it is important for employees across the organization to have a clearer understanding of the strategy of the business, its objectives and how these will be achieved, including the costs.

The devil is in the detail

Given that there are necessary and unnecessary costs, implementing across the board cuts will only yield marginal gains. Ultimately, high performing business areas or markets end up badly impacted because of such mediocre management decisions.

Instead of channeling resources towards investments, projects and markets which matter, or customers who matter, lackluster business performance areas tend to receive the limited resources.

To obtain customer, product or channel profitability visibility and optimize costs, you need to understand the key drivers of each. Implementing activity-based costing principles and techniques can help you answer any cost transparency and visibility questions you might have.

For instance, basing cost reduction decisions on consolidated gross margin alone obscures the reality that your business is actually making losses on particular products, customers or in certain markets.

You therefore need to drill down and understand the costs-to-serve each customer, service line or product and their drivers. This will in turn help you explain why costs are unnecessarily higher in certain business areas and make informed decisions.

Thanks to advances in technologies, companies are now able to leverage advanced analytics to analyze customer, product, market and channel data and generate insights into costs and where savings opportunities exist.

Use it or you will lose it

This culture is prevalent in organizations that are yet to break free from the shackles of the traditional annual budgeting process. During the financial year, business unit managers underspend their budget allocations.

However, towards the end of the year, to avoid losing the unused budget allocation in the forthcoming year, they willy-nilly spend the funds resulting in unnecessary costs. These funds could have been deployed somewhere for profitable return.

Unfortunately, such scenarios do little to transform the cost structure of the business and transition to a value-based model.

To avoid the culture of “use it or you will lose it” spreading over, leaders need to foster a culture of accountability, performance reporting and continuous improvement.

Hence the need to align cost transformation initiatives with strategy. Cost reduction targets must clearly be defined, both at enterprise and business unit levels, then hold leaders accountable for achieving performance improvement goals.

It’s therefore imperative to educate employees on the future financial needs of the business. They need to understand the costs that really add value in your business, and those that don’t.

Cost transformation is not a one-time initiative. Instead, it is a continuous improvement approach for leaders seeking to transform the cost structure of their companies and deliver a sustainable business advantage.

This does not necessarily mean that leaders should entirely focus on cost reduction efforts. You need to maintain an appropriate balance between achieving cost reduction targets and supporting necessary innovation and process improvements that drive effective execution of strategy and the ultimate success of your business.

Prioritizing cost optimization initiatives with only short-term goals in mind can cause unanticipated problems.

The Role of Finance in Pricing Decisions

One of the key financial metrics constantly measured and monitored by the business is the level of profitability growth.

For any company, profit and positive cash flow, are both critical and with a company that does not initially have investors or financing, real and not paper profit may only be its capital. Without sufficient capital or the financial resources used to sustain and run a company, business failure is imminent.

The bottom line is that no business can survive for a significant amount of time without making a profit. That being the case, the measurement of a company’s profitability, both current and future, is critical in the evaluation of the company.

In an environment where competition is intense, customer loyalty is diminishing and business growth is not a guarantee, the scramble for the profit pie is far from over.

Faced with these mounting challenges, businesses embark on cost transformation initiatives to boost profit margins. Normally, the exercise starts by looking at the company’s Profit and Loss historical spend, analyze the cost drivers, justify the spending and then make the decision to wield the axe or not.

Sometimes an across the board approach is pursued whereby an equal percentage cut is applied to all business areas. The drawback of such approaches is that they only allow you to extract limited savings that are not sustainable in the long term.

Also, business areas that have future potential for growth and require continual attention and investment are sacrificed for short term gains.

In other cases, the focus is more on increasing revenues, either through new business development, growing the existing product line, up-selling or cross-selling. Provided there is demand for your new offerings and recurring costs are not significantly high, the results could be different.

However, there is another focus area, in my experience, I have noticed is often not granted adequate resources and effort despite its massive potential to grow both revenues and profitability.

Effective Pricing

Pricing has a substantial and immediate effect on company profitability and any significant price changes in either direction can have unexpected effects on the bottom line. Managing pricing is therefore a vitally important lever to increase profitability and generate funds for investment.

With margins increasingly getting squeezed due to costs escalations, using the wrong pricing model for your business increases the risk of losing money on some customers or contracts by applying the same pricing approach and margin across the board.

Although companies differ noticeably in their approach to price setting, the goal should always be to get the price right across all customers, channels, segments, products and service lines. The challenge today, especially for B2C businesses, is meeting the constantly evolving needs of consumers at a reasonable profit.

Consumers are increasingly demanding quality, immediate availability and superior after-sales service at a much lower cost than before. On the other hand, input costs are not declining. In such an environment, the effectiveness of traditional cost-based and competition-based pricing approaches is challenged.

Since these approaches are reactive in nature, perhaps the competition has raised prices or perhaps the COGS has increased, can you afford to raise prices without losing business to a competitor?

Finance and Sales & Marketing Collaboration

In a number of organizations, pricing decisions are the remit of sales personnel in the field. The absence of robust pricing processes in these organizations often result in sales personnel basing pricing decisions on gut feel.

Additionally, because of the pressure to bring in new deals and reach the sales quota, heavy discounting is widespread and chaotic.

Working hand in hand with sales and marketing teams, finance can help fix the broken system and bring transparency and discipline to pricing decisions.

  1. Clarity on customer sensitivity to price variations: With so many factors affecting a company’s profitability, it can be difficult to determine the best way to price your products and achieve the desired profit levels and customer loyalty. However, disciplined pricing execution is highly dependent on the specific products’ price sensitivity, or customers’ willingness to pay a different price for a product without affecting demand. Leveraging their commercial acumen and analytical strengths, finance personnel can help develop business rules and sophisticated tools that quantify customer price sensitiveness and willingness to pay and improve price levels.
  2. Document and implement new processes: In the absence of robust processes to ensure discipline in price setting and prize realization, the organizational consequences of not following pricing guidelines are too big to ignore. As process improvement specialists, finance can help put into practice processes and tools to document, monitor and communicate incentive systems, acceptable discount levels and price variances to sales and marketing teams and other decision makers. As a well-run business, you want to ensure that the price the company gets is a close as possible to the price the company wants. Thus, any price changes have to be justified and documented for approval.
  3. Define pricing boundaries: Companies usually use historical heuristics, such as cost information, to set prices. At the anniversary of each contract and during pricing review, very rare do most of them calculate the customers’ costs-to-serve. A standard increase is applied to previous pricing rates with the objective of getting a certain ROI or a certain markup on costs. This simplistic approach ignores the customer’s perceived value of the product as a critical factor for determining the final price. Finance can look to see whether or not the price points are too low, too many, or are at least profitable and value-based enough to be implemented. Through scenario planning practices, finance can run test-and-learn plans that help define pricing boundaries. New approaches are piloted, and prices are then optimized based on what works and what doesn’t.
  4. Drive change throughout the company: Evolving from pricing based on cost or competition (me too) to pricing based on customer value is a continuous learning process that requires a shift in culture. The process requires top management buy-in, sponsors and change agents who are committed to improving the organization’s pricing capabilities and overall system effectiveness. Finance business partners are well positioned to act as change agents, internalize value-based pricing and motivate the organizational changes required to support it. They are able to help colleagues understand the value reflected in prices. In turn, sales teams are empowered to address customer or client questions related to price variances and walk away from unprofitable deals.

Customer Experience and Customer Perceptions

It is vital for businesses to develop a deep understanding of their customers’ needs, perceptions of value for money and how any shifts in prices alters their willingness to pay. At the core of value-based pricing is having the ability to balance costs and the benefits attributed to your product or service.

One of the grave mistake you could make as a business is falsely assume that customers will immediately recognize and pay for your innovative and superior product. Today, rather than base their purchase decision solely on price, customers first want assurance that your product is the right one to fulfill their Jobs-to-be-done.

Instead of asking, “How can we achieve higher prices in spite of strong competition?” you need to start asking, “How can we generate additional customer value and increase customer willingness to pay, in spite of strong competition?”

Driving Profitability Through Enhanced Expense Management Policies

I don’t know of any private or publicly listed organization that is in business only to break-even. Among others, the main goal for these entities is to deliver a profitable return to the owners of the business. This desire to make profit with the least resources inherently makes cost management across the business a strategic imperative.

As strategic business partners, finance teams are suitably positioned to help their organizations manage costs and focus spending only on those activities and/or initiatives that enable business performance.

In my experience of working with diverse organizations and business leaders, I have come to the realization that quite a number of them lack a precise understanding of what “cost management” really involves. There is a common perception that managing costs is all about cutting costs or merely a matter of buying fewer goods and services. This is seldom true.

Cost management is not simply a euphemism for “cost cutting”. The discipline is about understanding the true cost drivers of the business and ensuring that a company acquires only goods and services that it needs to execute its strategic priorities at a known and managed cost. One of the areas I see organizations often struggle with is identifying those activities, processes and investments responsible for rising cost levels.

Because of this misunderstanding of the real cost drivers, many companies end up taking the obvious route of cost control: they reduce payroll-related expenses, cut direct costs and capital expenditures. Rarely do companies focus their attention on improving indirect expense management to drive savings and boost profitability with the same resources.

Inadequate Spending Information Acting as a Barrier Against Savings Delivery

In today’s digital-enabled business environment the ability of an organization to consolidate and analyze its indirect spending patterns is key to acquiring crucial insights essential to pursue better deals with vendors. Simply having information is not enough. What golden nuggets are you harvesting from this sea of information and you are able to use them as sources of leverage when dealing directly with suppliers?

Unfortunately, in my dealings with diverse finance teams, many of them are not analyzing their organization’s spending data and are therefore losing out on achieving substantial cost savings. One of the reasons often given by these teams on why they are not able to do so is lack of time and resources needed to analyze spending data and recognize the benefits. A significant amount of their time is spent on balancing the books and justifying the numbers.

I was surprised with the manner in which procurement reports are generated and delivered in one of the companies I recently worked with. Their procurement processes are still highly manual, all invoices are stored in lever arch files and there is no spend visibility across the organization. Each business function records its own spending and there is no overall aggregation of this spending information.

As a result of these highly manual processes, it is seemingly impossible for the finance manager to obtain a clearer picture of how much is being spent on each vendor and on what, say per month, quarter, half-yearly or yearly. Technology and e-procurement systems have evolved and because of these advancements CFOs and their organizations can gather this procurement information in an accessible, easy-to-use format and in real-time.

Lack of financial resources should therefore not be given as an excuse, there are now cheaper tools that an organization can invest in and achieve its spend analytics ambitions and these SaaS and/or cloud-based solutions do not require huge initial capital outlays.

When you have ready access to information and are able to analyze your company’s’ major spending categories, you will be able prioritize the use of your scarce time and resources, consolidate spending with selected vendors, negotiate better terms and realize substantial benefits.

Close Scrutiny of Discretionary Spending

Many at times I have heard people say in order to make money you have to spend money. As much as we would like to accept this statement in its entirety and pay attention to the advice, I think we should heed the advice with a pinch of salt. Not all spending is necessary. In addition to direct expenditures which are linked directly to the goods and services a company is producing or providing there will always be discretionary expenditures not tied to business performance.

However, uncontrolled spending simply for the sake of spending often leads to depleted margins and cash woes. Am I therefore advocating against discretionary spending? No. Responding to business opportunities often calls for flexibility and judgement. There are times where the organization has to leverage its cash position, take advantage of emerging opportunities to enhance its competitive position and improve productivity.

Close scrutiny of discretionary spending on things that are perhaps nice to have, but not enabling business performance is therefore critical. Finance business partners can help instill spending discipline and good judgement across the enterprise by educating employees on the How, What and Where of spending carefully as well as setting up spending policies to encourage productivity and enhanced performance.

Spending policies play a significant role in directing employee behaviour and generating useful information on what goods and services are purchased, how and where. For example, they help an organization drive savings through documenting and substantiating purchases, discouraging excessive acquisitions and prescribing exactly where and how employees may procure items.

Any off-policy spending patterns are quickly identified and addressed. However, in implementing these spending policies care must be taken that a right balance between control and latitude is struck. You want your employees to have a sense of empowerment and responsibility.

In other words, the company’s spending policies should not be viewed as punitive measures, but rather, allow employees the appropriate degree of flexibility, and nothing extra. This fosters compliance.

The Effectiveness of Any Spending Policy Rests on Its Widespread Adoption

Implementing the right spending policies is only part of the equation. In order for policies to be effective, employees must comply with them. In most cases you will realize that an organization has well-defined policies on spending, the finance executive is leading the pack garnering support for its enterprise-wide adoption and yet despite all his efforts the positive message falls on deaf ears.

Compliance often falls short and as a result the organization fails to achieve the intended benefits. As with almost every other aspect of everyday running of the business, senior management support is central to the success of any organizations’ spending policies. Senior management determines company culture and sets the tone for employee behaviour.

No matter how hard the finance executive tries to convert the positive message of disciplined spending, if the other senior leaders are failing to set a good example then we shouldn’t be surprised to see significant low levels of employee compliance.

Many organizations often suffer from a lack of consistent approach when implementing and upholding spending policies. For instance, you will find out that there is a clear prescription of the exact steps to follow when dealing with employee expense reimbursements. By default, the approach should be the same across the enterprise but then you start noticing some employees getting reimbursed for expenses that other employees are not.

Moreover, the senior manager approves the reimbursement of an expense without seeing the backing documentation even though the policy clearly specifies that a physical receipt or invoice must support the expense claim. This inconsistency sets a bad precedence resulting in finger-pointing as well as favoritism gestures. Rather, management should take the lead by enforcing policies uniformly throughout the employee hierarchy, and by demonstrating good compliance behaviour.

Furthermore, in order to ensure effective compliance, senior management should also communicate policies effectively as well as the business rationale and the more tangible benefits that the new spending policy would provide. Employees need to know what policies they will be held accountable for and why they are being held accountable.

I don’t believe there is an employee acting in their normal capacity who would join an organization just to do wrong. Employees, generally want to do the right thing and what a better way to support this ambition other than explaining to them all the nitty-gritty of the company’s spending policies.

Ideally, once the policies are enforced it is a good idea to regularly provide employees with feedback on their performance, the benefits that are being realized as a result of the policy changes and offer rewards where necessary. Following this approach bolsters the rationale for making the decisions and gives employees an interest in the company’s performance as well as a greater incentive to do well.

As finance executives step up to an expanded, more strategic role and seek to drive profitability across their organizations, it’s critical that they establish efficient and effective means to provide employees with the right tools, processes and structures they need to successfully perform their jobs without opening the door to spendthrift behaviour, poor controls, and irregular expenditures.

4 Tips for Improving Customer Profitability

Despite increased focus on customer centricity and putting customers at the core of the business, many organizations do not have an accurate understanding of which customers are profitable and which are unprofitable. With markets increasingly becoming competitive and consumer behaviours constantly shifting, investing in customer relationships is the key to long term sustained profitability.

Gone are the days of unrelenting customer loyalty. Today’s consumers are actively pursuing brands and providers who deeply understand their struggles for progress, why they make the choices they make and then create the right solutions and related set of experiences to ensure they solve their Jobs to Be Done. In other words, customers are looking for companies that are able to deliver unrivalled experience. Failure by the company to meet these expectations means the customer will simply choose to spend their money elsewhere.

Companies that are able to deliver this first class customer experience are better placed to acquire and retain more profitable customers, and increase the profitability of customers that are low or loss-making. Thus, as more companies increasingly focus on customer centricity, customer profitability analysis (CPA) should become a top priority for all businesses. CPA helps you identify which customers are profitable and which are unprofitable. Not only does CPA tell you the profitability status of each customer, done properly, it also helps you develop an understanding of why certain customers are more or less profitable than others.

Develop a Deeper Understanding of Your Customers

In the past accessing customer data was a big challenge. However, in today’s technologically driven and networked economy, detailed customer profiling is now possible. Thanks to advanced analytics, huge data sets can now easily be collected, stored and analysed to reveal strategic insights, and to a large degree, predict future customer behaviour. All this is achieved in real time.

Having a broader understanding of your customers empowers you to start offering products and services that communicate directly to various customer groups and deliver your brand promise. It also enables you to focus on one-to-one or personalized customer marketing as opposed to adopting a one-size-fits-all approach. Take time to understand what is it that your customers value about their relationship with your business and what are the experiences they are seeking in order to make progress.

So often businesses ignore the social, emotional and functional attributes of their product or service offerings and spend significant time on generics, resulting in frustrated customers and lost revenues. Customers are now hyper connected. Social media platforms are continuing to gain prominence as communication channels for customers to discuss brands, ask questions or raise issues and complaints. Millions of these voices should not be ignored at any one time as doing so leads to higher churn rates. Every social conversation is a real-time reflection of your brand promise and potential.

When companies engage and respond to customer service requests over social media, those customers end up spending more with the company and are also most likely to recommend the brand to colleagues. Do you know what customers are saying about your products and services and how to change the conversation if you need to?

Developing a deeper understanding of your customers means moving beyond the basics of income, age, gender, race or geographical location. Take a comprehensive and holistic view of your customers. Fusing different data sources, structured and structured will help you unlock key customer insights and differentiate your company from competition. Today, we have more data about customers, that is growing increasingly complex and dynamic. Gathering data is not the main problem. The real challenge is transforming information into insights that we can leverage to provide customers with a superior experience.

Know The Costs-to-Serve Component of Your Business

The core idea behind customer profitability analysis is that companies can improve their profitability and reduce their operating costs by being more customer focused. Emphasis should not be on acquiring a large number of customers, rather, on acquiring high-value, long-term customer relationships. Quality versus Quantity. Not all customers are profitable. On the face of it, they might all look profitable but when we dig deeper to assess their worth, you will be surprised to find out that a handful of them are margin leakers.

Knowing which customers are costing your business more to serve in comparison to the revenues they generate helps you channel focus and resources on this group in order to try and convert them into profitable buyers. When it comes to measuring customer profitability levels, using aggregate measures of profitability, such as gross margin, is misleading. These measures ignore the nuances of serving particular customers, segments or other populations of interest. One other common practice which is also misleading involves applying a flat cost-to-serve percentage to each transaction’s gross margin in order to calculate the transaction’s profitability.

Companies should analyse the profitability on a transaction-by-transaction basis and examining each transaction’s profitability based on its pocket margin – the actual profit earned after deducting all the costs related to a transaction. It is no secret that the majority of customers are after a superior product or service at the lowest price possible. Although at times it is possible to grant them concessions, long-term this is not sustainable.

When making pricing decisions, it is important to consider all of the things you are giving away that add value to the customer, and don’t forget they shrink your pocket margin and take money from your pocket. There is always that group of customers that is difficult to serve, constantly nagging you and making unreasonable requests. Because the majority of businesses are only interested in boosting top-line revenues and want to preserve the relationship, they are repeatedly giving in to these unreasonable demands.

We have to try by all means not to set a precedence for our customers and make them believe that they can get away with anything. There are times when concessions make sense, and other times a very bad decision.

By clarifying the impact of customer requests on individual cost-to-serve elements, a customer profitability analysis can help your company avoid leaking pocket margins through such slip-ups. At the same time, it gives you an opportunity to educate and empower your employees to negotiate more profitable prices and terms of service. ABC data can be used to calculate the overall profitability of serving a customer with a product.

A detailed breakdown of costs-to-serve can help you identify opportunities to improve profits by altering buying behaviour in ways that are relatively unimportant to the customer, but drive large cost-to-serve savings for you. By examining customers’ historical transaction details, a company can determine which products are likely to drive profitable add-on-sales. Up-selling and cross-selling opportunities are far more likely when the customers are happy.

Evolve Existing Customer Relationship Management (CRM) Systems

Digital transformation is a journey that’s well underway for many companies, and the connected customer is at the heart of it. It is no longer a case of whether a company should embrace digital, but rather, how soon. IoT and Industry 4.0 technologies are reshaping business models for the better, enabling companies across all industries to boost business performance and consistently deliver unique shopping experiences across multiple channels.

As companies adopt these new technologies, it is critical to drive data integration across the business and ensure that existing systems are capable of communicating flawlessly with other software. This will further enhance your abilities to collect and analyse data, and gain strategic customer insights at a very detailed level.

It is also important to acknowledge that the ultimate goal of CPA may not, in some circumstances, mean selling a product or service at a higher price, but providing a pleasant customer experience. Greater customer service also has a commercial value, even if it doesn’t deliver an immediate commercial benefit. Thanks to new technologies, companies are now able to discover new insights from previously unimaginable sources. Notable examples are speech and facial recognition applications. Through these applications, companies are now able get a better view of their customers, identify irritated or unhappy customers and stem some troubling trends way before they become uncontainable.

No doubt advances in computing power are presenting new strategic performance improvement opportunities for the business. However, care must be taken that the company does not end up investing in unnecessary systems. It is easier for the company to jump on the investment band wagon without first clearly answering why. Successfully and consistently identifying what information is the most relevant and generates the most value is key to selecting the right tool. Technology is an enabler of higher performance.

Transforming Customer Profitability is an Evolving Journey

For the business to obtain the greatest commercial benefit from CPA, there is need to transform not only the company’s management systems, but also the company’s attitude towards its customers. Customer experience is significantly differentiating leaders from laggards. How you engage with customers before, during, and after a sale will dictate future success. Additionally, CPA must be aligned and implemented together with the strategy of the business. If there is a divide between CPA’s stated goals within the business and the way this is actually delivered to the customer, the whole process will succumb to its knees.

Also important to note is that customer profitability analysis is an organization-wide exercise, and not an isolated exercise embraced by one department or segment only as this will not deliver the required levels of cost reduction and profit increases. However, due to resource constraints, you can start small, focusing first on a portion of revenues or a single product line, business unit or geography, and then expand the effort as resources allow. In the long run, these pilot projects can act as proof of concept and also generate profit increases that can be used to fund further improvements. It is better to start small than do nothing at all.

Customer profitability analysis gives a company a clear view of how much revenue each customer generates (what they buy and how they buy), how much it costs the company to generate that revenue, and, most importantly, when and why these costs are incurred. This information is then used to guide efforts to transform the company’s less profitable relationships into improved profitable buyers. Firing customers should be your last resort after you have exhausted all reasonable efforts.

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.

I welcome your thoughts and comments.

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