categoryCost and Profitability Analysis

5 Ways Finance Can Help Improve Company Profitability

Businesses in various industrial sectors are undergoing a fundamental transformation as a result of the effects of globalization, advancement in new technologies and increasing digitalization.  Apart from presenting a wealth of opportunities to help the organization soar to greater heights, these changes are also presenting a variety of challenges on the business model.

They are altering customer behaviours, placing increased pressure on existing markets and impacting financial performance.  In these trying times, the finance function is being called upon to help steer the organization in the right direction and improve profitability.

Popularly known as bean counters, accountants are now required to support business growth initiatives and help grow the beans within their organizations. The modern finance function has evolved from being a “just numbers” back-office function to a “strategic partnering” front-office role providing deeper insights and a clear direction for translating the numbers into effective actions for those operating on the front lines of the business.

Whereas in the past the finance professional spent his day behind the scenes, glued to his computer, producing and reporting the numbers, today’s finance professional is involved in the business interacting with the other organizational functions and helping drive business performance. There is a joke about an accountant without a spreadsheet being described as “lost”. In the past, this could have been true, but not today. The bean grower of today is a strategist, a motivator, a leader, a team player, a change agent, completely understands the drivers of business performance and drives improvements in respect of new revenue and value-producing opportunities.

It is no secret that the finance function is the custodian of the business profit and loss. In times of economic downturn when cost control is critical, the finance professional is called upon to help identify areas where the organization can scale back in order to improve overall profitability. In good times, finance helps senior management identify new opportunities (new markets, new products, potential acquisition targets, new services etc.) that need exploiting. Disrupt or be disrupted is the mantra in today’s ever-changing business environment. The business has to evolve with times.

The challenge on the finance function is to deliver more with less. This has led to many organizations to embark on ad-hoc cost-cutting programs hoping to improve the bottom-line. Unfortunately, cost control alone is not sufficient or effective enough to enable the organization realize the targeted gains. You can only cut costs up to a certain level. This is because each cost initiative reaches a point of diminishing return, after which, the company has to explore new ways of improving profitability. In order to grow its influence on company profitability, the finance function must:

  1. Understand the Drivers of Business Performance.  To be effective bean growers, accountants need to move beyond numbers and get an understanding of the company’s product s and services and how they affect the profitability of the business. This means finance teams lifting their heads up from their financial reports and obtaining a better view of the business itself. Instead of focusing only on where the business has previously failed, finance should provide strategic insights, competitive intelligence and analysis that enable effective decision-making by the senior management team. For example, finance should be able to provide data, metrics and analysis that helps transfer the function’s own understanding of the drivers of profitability to others throughout the organization, in order to ensure that profitability develops into a basis for action.
  2. Help Identify New Pathways Toward Profitability. When it comes to profitability improvement initiatives, many at times the focus is on the bottom-line. As mentioned earlier on, eliminating fat from the bottom line works up to a certain extent. Cost reduction is a short-term fix but not sustainable in the long-term, especially if the company is looking to grow. Management become misguided and believe that by laying-off people to contain salary costs or postponing capital investments they are placing the organization in a better competitive position. The opposite is true.  In fact, cost cutting by itself is counterproductive as it can lead to inefficiencies, missed opportunities and higher operational costs. There is nothing wrong in getting the business lean, but getting lean has to be linked to the business strategy, done the right way, at the right time and for the right reasons. Attention should also be focused on the revenue side of the business, for example, diversifying the business, internally growing existing business units, making additional productivity improvement, improving existing product or service offerings and making major business purchases.
  3. Invest in Modern Technologies. As the amount of data generated continues to grow, an enormous demand is being placed on finance to make meaning of this data, identify trends and develop the most effective responses that will help protect and improve company margins. Finance must know what information will have the greatest impact on profitability since having the right information is at the core of improving company profitability. Equally important is placing this information in the right hands. Relying on spreadsheets alone will not cut it. Finance must invest and make use of modern Business Intelligence and Analytics technologies in order to be able to identify accurate, reliable and relevant information and place it in the hands of the right people at the right times. These modern technologies help transform finance into a more flexible, responsive and forward-looking function. The modern finance function must have the ability to use technology to gain a more detailed understanding of the metrics underlying the company’s profitability.
  4. Develop Effective Pricing Capabilities. The sales organization is normally rewarded on revenue made and this sometimes results in the sales team being interested only in closing the deal at the expense of profitability. Not all customers are equally profitable to the organization; therefore sales should be tailored to optimize profitability. Getting the pricing wrong has negative consequences on the overall profitability of the company. Finance need to have an advanced understanding of the company’s different customer and product portfolios. By performing customer profitability analysis and product profitability analysis, finance will be able to understand the customer costs-to-serve and use these costs to segment customers, fine-tune pricing and manage profitability by helping direct efforts towards growing profitable product and customer combinations. Sales personnel can then use this cost-to-serve in negotiations as well as forward-looking analyses to drive effective decision-making.
  5. Collaborate With the Rest of the Organization. Although finance plays a central role, maintaining and improving company profitability is a team effort – it should be everyone’s concern. It is imperative that finance professionals work directly with their colleagues outside of finance (Sales, Marketing, Operations and R&D.) and develop a list of actionable items which impact profitability. For example, working more closely with the sales organization will ensure that sales personnel have all the information and tools they require to make decisions that support profitability goals, otherwise they will be ill-equipped to make the best decisions. Getting the buy-in and commitment of the C-Suite is also critical since the C-Suite is involved in setting the direction of the company. The C-Suite’s involvement will in turn lead to the establishment of a common goal and set of metrics shared with the front lines of the business through synergies with their finance teams. Remember Individuals don’t win, teams do.

If the organization is to succeed in maintaining and improving its margins, finance’s involvement is important. Finance helps make meaningful and measurable profitability improvements.  Look at the bigger picture and beyond quick fixes such as rapid cost reductions. Develop a more detailed understanding of the full set of your business’s profitability drivers and take full advantage of new technologies capabilities to uncover the organization’s key profitability levers and challenges.

Differentiating Your Company’s Products or Services

Have you ever wondered why your customers keep on buying your products or requesting your services? Why they are willing to pay more for some of the products and services and less for the others? Could it because you are the only supplier in the area? If so, suppose a new company in the same line of business as you opens up a shop in the area, would your existing customers still continue to buy from you or they would defect?

There are various reasons why your customers keep on coming back to do business with you but one of the most significant one is driven by the value that you are offering them. Value is the core driving force underlying every business decision.

Although managers talk of value when determining pricing strategies, unfortunately, very few understand the true meaning of value, what it is, why it is so important, how it should be communicated and its critical role in pricing products and services.

To many of us, value means different things. As a test, ask your colleagues what it is that they refer to when they talk of value? Chances are high that you will hear different definitions. For example:

Some people equate value to expectations. To them, value is getting more than what they paid for, be it for an item or service delivery. In today’s information and social media age, perception alone is driving purchases.

Prior acquiring certain products or services, customers are communicating with each other on various platforms about the organization’s product and service offerings. By the time the customer makes a purchase, he or she in his or her mind has already built up expectations on what the offering will be able to actually deliver.

Only at a later stage after completing the transaction is the customer able to reflect and conclude that his or her expectations have been met.

Other people view value as a fair transaction. They look at the limited resources at their disposal and how best they can use them to meet their expectations. When purchasing an item, a lot of sacrifice has to happen.

One has to set aside time to search for the right item and choose from among options, evaluate the cost of money to purchase, the price itself and any associated psychological risk factors.

This sacrifice goes beyond looking at the monetary costs and also reflects on the time and efforts invested in seeking out the good in question.

In this instance, value is therefore viewed as the worth of the item purchased at least being equal to and certainly not less than the sum of the sacrifices made in acquiring it.

While others view value as expectations and fair transactions, others see value as an improvement of the current situation. Customers are looking for investments that are capable of improving their lives significantly.

Likewise, business managers are not keen on throwing money and resources at investments that will deliver a poor return and put the business in dire situations. Instead, they are looking for investments that enhance the business’s competitive advantage.

If any investment derives a return that surpasses expectations and genuinely improves the current situation, then value is said to have been delivered.

The challenge on business managers is to look beyond pricing and make sure that their products and services are delivering value to the customer or to the end-user consumer. Making pricing decisions based on cost and competitors’ prices alone will not cut it through in today’s business environment.

Customers possess the buying power and can easily defect to new suppliers if they are not happy with the current offering. Businesses therefore need to keep on reinventing themselves, re-examine the reality of the value they are offering to their customers and find ways to enhance the value they deliver.

Focusing on value helps business managers to understand the actual needs of its customers and find unique and differentiated ways of meeting those needs effectively and efficiently. When we talk about differentiation, it is not just about doing something different. It is about doing something different in a way that really matters to your customer and not just offering price cuts.

So many at times, when confronted with a customer challenge on price, the sales response is often to discount which often leads to early product commoditization. Of course, your product may be heading toward commoditization.

If this is the case, a thorough assessment and evaluation of the product and its relevance in the market is necessary. This will help you craft a strategy to reposition the product in the mind of your customers and prolong its lifespan.

Focusing too much on price prevents useful discussion of the real value of the offer. As a result, the buyer fails to distinguish the merit of what he or she has acquired and fails to gain, through lack of awareness, the full benefits from the products and services purchased. You need to challenge any claim that your product or service is just like everyone else’s.

How are your products or services positively changing the customer’s overall product or service experience? Communicating your differentiated solution in a clear, compelling and persuasive manner is vital to persuading the customer do business with you.

Differentiating the organization’s total customer offer from competition means that this difference delivers real value that the customer can identify, understand, acknowledge and be willing to invest in.

Unfortunately, this is not the case for many businesses. What these organizations are referring to differentiation are merely differences in specification and nothing more. There are no critical differences between their offering and those of the competitors.

For instance, many are making changes that are resulting in easier production of the product or easier delivery of the service just because they have the technology or know-how to do so but not a differentiation from the customer’s perspective. What impact is the change you are making on your product or service having on the customer’s business, in terms of both economic and emotional considerations?

In today’s copy-cat environment, it is easier for competitors to emulate your products and services and surprise you. Despite this, many organizations are still of the assumption that their differentiation will make the competition irrelevant.

Never underestimate your competitors’ abilities to shock you. You need to find unique ways of influencing the relative value the customer perceives, make the customer choose your product and service and remain with you.

How good are you when it comes to listening and fully understanding the customer’s context, value-adding processes and pain and pleasure points? Are you able to consolidate this information and create a product or service that offers real differential advantage from that customer’s perspectives?

Gone are the days of pushing products and services to the market. To do well, the business has to be a good listener of its customers. You need to possess intelligent consumer and product insights that are capable of leading you to new ways of differentiation.

You can differentiate your service by ensuring that your customers receive consistently great service. Consistency is key to having dependable and reliable customers.

Convenience and customization are also key to successful differentiation. By improving the convenience to your customers of using your product or service through using methods that are difficult for your competitors to imitate, you may be able to lock them in.

With regards to customization, you need to deeply understand your customer’s value adding processes or production operations. Having this deep understanding will enable you to identify where your company’s unique skills can be applied for the benefit of both the client and the service provider.

By fully understanding the real needs and motivations of your customers and timely responding to them, you can differentiate your total customer offer and reap great benefits.

Although there are various ways the organization can choose to differentiate itself from competition, regardless of how it decides to do so, learning and understanding as much possible about the customer, her company and market is vital.

Where are the sources of pain and problems he or she is experiencing that no one else seems to be addressing? As a business, how can we leverage our unique capabilities, contacts, technologies or other resources to address the customer’s problems in a way that is difficult for our competitors to copy but at the same time make it easy for the customer to buy and remain with us?

You need to deeply know and understand your customer in order to build a powerful, persuasive and compelling value proposition. In this day and age of plenty information, you can never know too much about your customer.

Every single piece of information you collect goes a long way in helping you understand your customer’s business, context, strategy or desires. Value is different for every customer and even for the same customer under different circumstances. This value comes from knowing all the critical details about your customer.

Learn everything about their value drivers. In addition to understanding your customer, know your differentiation – how and why you are different from your competitors. This will help you identify your competitive advantages and disadvantages, develop effective business and pricing strategies and enhance customer value.

If you are unable to justify totally the value-adding elements of your product or service proposition, your total customer offer is highly likely to be rejected by your target market.

Not All Customers Are Profitable And Worth Keeping

Not all customers are the same. Some customers are profitable and others less profitable depending on the behaviour they exhibit. Some people believe that the customer is always right and should therefore be satisfied at all cost. I tend to differ on this notion. Although customer satisfaction is crucial, the organization’s long-term goal is to increase customer and corporate profitability.

Achieving this goal requires management to strike a balance between managing the level of customer service to earn customer satisfaction and the impact this will have on shareholder wealth. The best solution is to increase customer satisfaction profitably.

Some customers, suppliers and trading partners are extremely high-maintenance. Unlike customers who place standard orders with no fuss, high-maintenance customers demand nonstandard everything. They are always asking for that special treatment.

For example, they make unwarranted delivery changes and require more after-sale services. If that is not enough, you always hear from them and in most cases to inquire about and speed up their order, or return or exchange their goods. If you add up all these costs-to-serve plus the costs of the products and base service lines you will be surprised to discover the magnitude of the erosion happening to your bottom line.

Knowing who your troublesome suppliers and customers are and also how much they are eroding the organization’s profit margins is critical for effective resource allocation and decision making.

What kinds of customers are loyal and profitable? Of your existing customer profile, which customers are only marginally profitable or, worse yet, losing you money? Does the customer’s sales volume justify the discounts provided to that customer?

Using Activity Based Costing/Management (ABC/M) techniques helps managers and employees find solutions to these questions and take corrective actions. Through ABC/M analysis, managers and employees will be able to trace, group and reassign costs based on the cause-and-effect demands generated by customers and their orders.

With better cost data at its disposal, the organization will be able to decide whether to push for volume or for margin with a specific customer, to alter its product and service offering to improve profitability or to assess whether benefits can be realized from changing current strategies by influencing its customers to alter their behaviour and buy differently and more profitably.

This in turn enables the organization to become more competitive because it knows its sources of profit as well as understand its cost structure.

The whole idea of carrying out the organization’s customer and channel profitability analysis is to identify the less-profitable customers and suppliers. Having identified these troublesome suppliers and customers, then what? Should you immediately terminate your relationship with these customers? Should you continue business as usual?

What about the already profitable customers? Must you streamline your delivery processes to reduce the costs-to-serve? With the facts, unprofitable customers can be migrated to higher profitability through managing service costs, introducing new products and service lines, offering discounts to gain more volume with low cost-to-serve customer, reducing their services, renegotiating prices or shifting their purchase mix to richer and higher-margin products.

Remember customers with high sales volume are not necessarily highly profitable. Customers tend to cluster. Medium-volume customers can be much more profitable than large-volume customers. Each customer’s profitability level depends on whether the net revenues are sufficient to recover the customer-specific costs-to-serve.

It is therefore important to know the types of customers that cluster in the various profit or loss zones as this can be valuable in determining what actions to take.

Furnished with better cost data, the organization can protect its most profitable customers from competitors. Because so few customers account for a larger portion of the organization’s profit, management must focus on retaining these profitable customers and derive value from their loyalty.

For those customers who drain resources and time, yet provide negative financial return and are concluded impractical to achieve profitability with them, they should be terminated.

The Role of Finance in Driving Sales Effectiveness

These days customers are more equipped with more information about the company’s products and services before they have even talked to the salespeople. Unfortunately, in most organizations, the sales function normally lacks high-quality data to drive sales effectiveness. For example, sales managers lack data to help align sales incentives, overcome price pressures and become a strong competitor in the market.

In these organizations, finance can play a critical role in delivering the information required to maximize sales productivity. In today’s economy of big data, the difference between success and failure more than ever lies in the quality of the data that finance shares with the organization’s salespeople.

Taking advantage of its analytical skills, the finance function can assist salespeople obtain the most relevant information about the company’s customers which ultimately helps transform the selling process and cultivate new relationships with the right customers. For any organization, sales costs are a major component of the expenses hence the importance of managing sales processes and improving sales performance. It is therefore imperative that you improve the way your company gathers and uses sales activity data in your planning, budgeting and forecasting processes. How do you rank the quality, timeliness, accuracy, transparency and completeness of the sales information used to forecast top-line revenue?

The quality of sales data at your disposal determines the usefulness of that particular data and your company’s ability to plan. In a world where technology is constantly evolving and aiding successful decision-making, to maximize sales force effectiveness, company’s should invest in analytical and modeling techniques in order to find out what changes would bring the best improvements in outcomes. This also includes improving management’s ability to use sales reporting tools such as dashboards. Getting hold of high-quality data for revenue forecasts requires you to match sales resources to changing opportunities and business objectives. This will help you retain customers from the jaws of aggressive competitors.

By gathering and integrating timely information about the company and its industry, salespeople will be able to gain insights about changes in customer behaviour which in turn leads to smarter pitches, shortened sales cycles and opening up of new opportunities.  Data that reliably reveals valuable selling processes and practices as well as patterns in customers’ buying habits is effective for improving sales force effectiveness.

As market competition continues to intensify, managers must improve the effectiveness of their salespeople as quickly as possible to avoid losing market share to rivals. Improving sales performance involves improving existing sales methods and processes, better training, better hiring, better sales management and making use of refined selling behaviours such as cross selling, bundled selling, targeted discounting and focusing on sales profitability.

In many organizations, salespeople are regarded as catalysts for growth and profitability. For salespeople to successfully fulfill their role, they need high-quality data and analysis. Thus sales must partner with finance in order to gain better insights necessary for effective decision-making. Instead of just reporting on the periodic sales figures, finance can educate salespeople on data gathering and analysis and provide them the relevant information so that they become better informed prior engaging current and prospective customers. Improving collaboration among finance, operations, sales and marketing and human resources enables the company to reach its stated objectives.

As the guardians of the company’s finance data, the finance function is in a better position to supply salespeople with the information they need to take a more strategic and data-driven approach to winning over customers. Finance is able to provide more analysis, more insights and more recommendations so that people are aligned with what drives the business forward. Thus with quicker and better information, as well as accurate forecasts and targets, salespeople are empowered to make more informed decisions about which customers to target and interact with.

To successfully deliver on their business partnering role, finance people should move beyond their isolated number crunching and routine transaction processing roles and partner more with other functions of the organization. Finance must become more proactive with data. More than projecting into the future, finance could use the information in the present to improve market and competitor insights and build better selling tools. Making data-driven decisions helps managers deliver more customer value with less, outperform rivals, target the right profitable customers, design the right value proposition and create value for the company. The key for finance is therefore to provide better information that is actionable to improve sales.

If salespeople are lacking in high-quality data about their company’s costs and price competition, they can and do end up working in complete opposition to management’s goals. Selling is not about selling products that are considered legacy products but no longer support the company’s strategy. Instead, selling is about selling products that are targeted to grow top line revenues. Salespeople should therefore not be encouraged to close deals that weaken the bottom line. Pricing controls should be implemented to ensure minimum levels of profitability while remaining sensitive to market competition. Find more profitable customers and avoid negative margin deals.

Furthermore, finance can also help educate sales managers redesign sales incentive compensation plans by better linking rewards with the salesperson’s achievements and the company’s strategic objectives. However, there has to be a mutual understanding between sales and finance of what success looks like so that incentives line up with the organization’s performance measurement systems. By utilizing ABC/M techniques, finance can provide salespeople with quality information that helps them understand the various cost components of their activities, their drivers, whether they can be influenced or not and their ultimate impact on bottom line.

With the right data, salespeople will have answers to their various questions. For example, “Whether to sell to existing customers through cross selling”, “Whether to use leads to tap new markets”, “What price is no longer worth making the sale”, and “What the financial impact of  sale is.” Finance therefore plays a critical role in helping the sales function achieve its effectiveness.

As sensibly as the sales function may plan and implement its strategy, it will not produce better leads, attract more customers and generate higher profits if the data is not used dynamically by finance. Finance ensures the timeliness of sales and sales-activity reporting. Finance is also capable of responding quickly to changing business situations with relevant reports and analytics.

How else can finance drive sales effectiveness?

I welcome your thoughts and comments.

ABC/M vs. Conventional Cost-Cutting

Business leaders always spend a lot of time thinking about costs and how they can reduce them, free resources for investment and improve the bottom line. The pressure to reduce costs is normally driven by cash flow position, shareholders, uncertainty, investments and the need to improve business performance. In light of the aftermath of 2008 global economic crisis, there has been increased pressure on business leaders, especially financial executives, to achieve more with less. The finance function has had to transform itself in order to improve productivity and efficiency.

If not managed properly, cost-cutting exercises may prove to be an unnecessary enemy that the company does not want to deal with. In some organizations, cost-cutting exercises have taken precedence resulting in the business becoming weak and more limited. On the contrary, if managed properly, cost reduction using activity-based costing and management techniques leads to better performance.

Cost-cutting measures should not be considered in isolation. Instead, cost-cutting should form part of the organization’s overall strategy because every investment, whether good or bad, is important. If the organization is not able to contain unnecessary costs, the impact will reflect in lower profits and cash flow problems. It is therefore important for managers to understand that no strategic planning process is complete without a close analysis of costs. At the same time, no cost or strategy project is complete without a closer look at its impact on the company’s capabilities system.

As Paul Leinwand and Cesare Mainardi clearly state in their book, The Essential Advantage: How To Win A Capabilities-Driven Strategy, the management’s approach to cost control is a key indicator of how coherent the company is or is not. Cost-cutting is meant to free up resources for strategic investments that are aligned with the organization’s capabilities system and way to play. If managers have no clear way to play and are cutting costs randomly, this fuels incoherence.

Unfortunately, some business leaders are still using the conventional approach of cutting costs with the hope of achieving positive results. So many at times, these leaders receive satisfaction only in the short-run. Adhoc across the board cuts, where a percentage of cost reduction is shared equally between functions, normally fail to free up the much needed investment.  This is so because adhoc across the board cuts negatively impact some parts of the company that are strategically aligned by stripping them off of the resources they desperately need to perform better. Also, most of these exercises are a benchmark of the competitors’ cost levels which by far are not linked to the company’s strategic priorities.

Using ABC/M techniques can help managers avoid the mistake of focusing on the short term. ABC/M helps identify cost drivers of different processes, activities, products, channels, customers etc. and this in turn help reduce waste by eliminating non-value adding activities. In 2008-2009, many companies across national borders implemented across the board cuts which were misaligned with their capabilities system and way to play. They instituted adhoc layoffs and cost reductions without considering the long-term implications on business performance and competitiveness.

As the global economy started to rebound, these companies found themselves in not so favourable positions of lacking the capabilities and skills essential to drive growth. In turn, they were forced to embark on massive recruitment sprees at huge costs to replace those skills lost during the downturn. On the contrary, those companies that implemented talent management strategies aligned to their overall strategies have managed to come out of the economic slump much better and stronger. This just shows that if the root cause of unnecessary costs is not identified and dealt with properly, they will come back again as if nothing was learned.

To cut costs and grow stronger, the conversation about costs needs to change to a more productive one. The starting point requires you to categorize your costs into costs you need to incur to keep the business running; costs you must incur to maintain your industry position even though your business might run without them; costs that support your capabilities system and way to play and lastly all other costs which are those that do not specifically fit into the first three categories. This distinction of costs helps evaluate the downside that the business would face if it makes cuts or changes in either one of these categories.

Today, many managers are facing the challenges of huge overcapacity and steep loses. The best way to react to these challenges is start looking at their businesses with fresh eyes. For example, to reduce operations costs, they need to start looking at operations as a single network and reconfigure production flows as needed to more flexibly serve customers.

Having eliminated unnecessary costs, the challenge for leaders is to deal with expense creep. It is important to ensure that cut costs do not come back because if these costs manifest again, this is a sign of strategic incoherence. The best way to avoid expense creep is to continuously evaluate costs relative to the organization’s capabilities system and way to play. Only by assessing costs regularly and consistently can the organization become aware of the relationship between its capabilities system and other expenses. In the long run, this will ensure a viable good cost position.

 

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