Thursday, March 17, 2005

Customer Profitability

Contribution Management- CTS

In previous posts I have tried to hammer home the thought that the most important thing in your business is your customer’s order. Nothing else has value except that. It is, without exception the most important thing. As a relatively famous young singer would say, “Oops I’ve done it again”.

Once you decide that the order IS the most important asset in your company, then you need to find out how that order is taken care of. Not how you THINK it is taken care of, but how it is ACTUALLY taken care of.

Another one of my repetitions is know that you know, don’t think that you know. So many managers and executives have been out of the details for some time and they like to think things are as they were or as they should be according to them. Wrong! Get in the weeds and dig around once in a while to be sure, your customers and your employees will both benefit from your being back in the weeds for a time (that’s Living The Dream).

(For those of you who want to look into this area sooner than later I would recommend that you read “Staple Yourself to An Order” by Shapiro et al from the Harvard Business Review and for the article which is worth the $6.00 to download.

Now to the heart of the matter.: Are you familiar with CTS? Not the new Cadillac (though I love the “V” model which is much too fast), but the business CTS? The acronym means ‘cost to serve’.

Once your business is aligned on the customer order being the most important part of your business, and you know how that order is being handled end-to-end, then you can begin to work on understanding what the cost of that order is.

This is not about developing a complex activity based costing program, but knowing what the major direct and indirect costs are for an order. Don’t get paralysis by analysis here, just give it a rational approach and you will be able to come pretty close to the reality.

Once you have the cost to serve, preferably by product or service, then you can begin to understand profitability by customer. Of course this is an operating profit. Don’t try to build in regional, departmental, national or global overheads. Keep everything local. Then you know if the customers order is producing contribution to those overheads or not.

Too often we try to figure out national or global profitability and the information is not good, our ability to aggregate the information is suspect all the reasons that have kept you from going after many larger questions that required aggregated information. Draw your data from the transactional level (which is probably pretty good) and understand.

Studies have shown that between 20% and 40% of the customer orders a typical company services DO NOT cover the cost to serve and thereby do not contribute to overheads. Too often we apply the 80/20 rule, 20% of the customers produce 80% of the revenues or profits. In today’s environment that rule does not hold true as much as it used to. Smaller orders more often from more customers skews 80/20.

Even if 80/20 is true for your company, think of the 80% that produce 20% of your revenues and/or profits. Many of those produce nothing except cost. Break your customers into A, B, C, D categories.

The A’s are the big customers with large volumes and usually profitable but not the highest profit per order or by % of revenue, some might even be losses by the time CTS is applied. The B’s are the medium sized customers and it is here many times that you find the MOST profitable customers in terms of profit per order or % of revenue.

The C’s are marginal at best, they sometimes contribute something and sometimes may not. Could be order size, delivery costs, variability, amount of service required etc. The D’s are losers.

So now that you KNOW, what do you do? You look at the order process and make sure that you’re A’s and B’s get fabulous service and priority handling. Never miss on these for these are where your bread and butter are (with a little icing on top). Give a back order to a C before you don’t have stock for an A or B.

Also for A’s and B’s you need to be sure that your marketing, sales and customer service are building relationships with these customers if you don’t already have them. If you do, do more! For C’s you need to work on them to see if they can become A’s or B’s. Could be price increases, could be limiting services that you are giving away and not being compensated for or a number of things. Find out what they want and what they are willing to pay for.

For D’s, raise prices instantly to cover your ‘cost to serve’ plus a healthy margin. Some will accept it and become high C’s or maybe B’s. Some will leave and you need to let them go. They will become a drain on your competitors who are not using Contribution Management techniques and your profits and free cash flow will improve without their drain on your resources. Your people will have more time to spend on the A’s and B’s and begin to move the C’s into better positions.

Once this is done, you can drive it to contribution by product, by department, and the like. But first is to understand the contribution of your customers because you don’t want your most valuable asset (their order) to cost you money!



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