Dr. Sharon Gotteiner, CPA+ Create a New Idea
The firm’s profitability rate is a soup of margins, related to various product categories and customer segments. Diving into that soup is the key to improved profitability.
Are we in agreement that insufficient margins should not be tolerated? If so, you may be on your way to increase your profitability – even if your current profitability is reasonable. This is not obvious. In many cases, the overall level of profitability can be reasonable, although accommodating some segments’ negative margins. Many firms can afford that, and bear such margins for “strategic” justifications. Yes, “strategic” is pronounced with a wink. “Strategic” customers or products, in this context, are defined as customers or products on which you lose. Another example is the “One-Stop Shop” strategy, followed by many companies, although that may require the offering of some losing products too. That fine as long as a company can afford that. But many companies gave up on that strategy, after experiencing a crisis, which threatened their existence. Retreating such a strategy was actually found as an effective turnaround strategy. Therefore, you better identify challenging products, or customers, or segments, and respond – as soon as the overall level of profitability starts to decline.
How to do that? Think of any possible segment and get its margin. What you should look for is negative margins, for the sake of addressing them. There is a risk involved in such a simple exercise though: Wrong data can lead to mistaken decisions. What can be so complicated with extracting data? Surprisingly, quite a lot. There may be an inaccurate assignment of costs to revenues, due to some “system limitations” in recording data or loading it into the system. It could also be a matter of how your Information Entities (sorry, that’s how it is called) are organized, e.g., products, product categories, customers, customer segments, branches, geographies, agents, sales-persons, sales-teams, etc. Basically, you should be able to get the margin of each unit in those groups – unless your data structure does not support that. Usually, the case will not a binary, meaning either you have that or not. The case will often be “complicated”. For example, Yes, you can get the margin for each customer, but for many customers, we get specific quotations and discounts from suppliers, which are recorded separately and not assigned to any specific customer. Or some significant deals that involve several business units and sales organizations, and therefore managed on the headquarter level, without any allocation of higher resolution. It’s always “complicated”. In fact, I do not recall ever enjoying a simple analysis. That’s fine, the challenge is enjoyable, but be careful when analyzing data.
What do you do with such an analysis? Here comes in the role of the top management at its best. Each Information Entity having a negative margin should be considered: Can that item turn into a profitable one? What steps should be taken to achieve that? Otherwise – should that item be maintained? Eliminated? There are also opportunities to take “conditional-elimination” decisions. For example, increase the price of a losing product. If demand levels hold – it is saved from elimination. If not, the lower demand will lead to its self-elimination.
Stay responsive to margins. Use real-time data as much as possible.
The opinions expressed on this website are not suitable for all business circumstances.