By Glenn Busby, President & Partner, SPG Management Consulting
Our trade spend is going through the roof. I hate selling to that customer. We have no idea how profitable one customer is compared to another. There is too much variation in our pricing. Every sales team wants more resources, but where should I invest? Should I customize for that account? Do any of these thoughts sound familiar? They probably do, because customer profitability and resource allocation are consistent concerns for companies ranging for owner-led start-ups through to the largest multinationals. Fundamentally, all of these thoughts and questions can be boiled down to one absolutely crucial strategic question you must address to achieve sustainable, profitable growth: “Are you investing the right resources against the right customers?” There are three key factors in answering that question; (1) understand “true” customer profitability; (2) invest for opportunity & impact; and (3) manage risks appropriately.
(I) “True” Profitability…..It’s all In How We Measure It
Any discussion of customer investment should begin with understanding customer profitability.
It’s decision time: offer the deal or not? Out comes the calculator, and we figure out what we make if the sale goes ahead. At this point, we are holding everything else constant, and really just figuring out what the variable revenue less variable cost is equal to. This is useful as a one-time decision-making calculation, but unfortunately we sometimes build our longer-term business models based on a history of these “one-offs” which are now “baked into the base” and are accepted as givens. Effectively, these short term choices have a tendency to erode long-term customer, and therefore corporate, profitability.
Stepping back and thinking longer term, we often look at customer profitability as the price, less trade spend and standard product costs, summed up for everything we sell to that customer. This is effectively the gross margin we realize on a given customer. This is an easy calculation, usually quickly facilitated by what our accounting system can provide. Unfortunately, this calculation ignores everything below the gross margin line on the P&L, and it does not take into account some of the subtleties of what happens in the supply system.
The best decisions take into account all of the best data. Unfortunately, sometimes that data is not available or it is harder to access, so we simplify. In the case of customer profitability assessment, gross margin should be the starting point, not the end point. There are a number of additional factors that should be considered:
- Logistical Cost to Serve – a customer which orders full pallets and full truckloads of one item is significantly cheaper to supply than one which orders a range of items on mixed pallets in an LTL (less than full truckload) pattern.
- Transactional Cost to Serve – every transaction carries a processing cost in terms of staff workload. Inevitably, fewer larger transactions are more profitable.
- Sales Cost to Serve – how many sales people (field and HQ) are required to support the business?
- Support Staff Cost to Serve – what support or multi-functional resources, including leadership time and attention, are required to support the business?
- Working Capital Cost to Serve – cash upon delivery beats payment in 90 days. If you need to carry additional working capital to support a given customer, that has a real cost to the business.
- Cost of Customization – is there something unique about their order? Whether the product(s) or how it is packed or shipped, every time we customize, we inevitably incur cost.
- Other Unique Costs to Serve – beyond simple customization, does a particular account require unique or special terms, support, handling? Do they have higher or more costly levels of damages and returns? Any tangible costs should be captured.
Some factors are hard or impossible to quantify, but should be considered when making decisions about a given customer’s sales, particularly when considering dramatically increasing or decreasing the sales level of a given customer.
- Factory implications – does one business subsidize another? Are efficiencies inherent in certain businesses which are difficult to measure, but which, if removed, would hurt overall cost? This can be particularly challenging to assess when more than one P&L is in play (e.g. a split supply vs. market P&L or a parent vs. subsidiary P&L split.)
- Consumer implications – does being associated with a particular customer have a major impact on image, trial, or loyalty? Does a low cost retailer drive market pricing favourably at other accounts?
(II) Opportunity & Impact….Where to Fish
With “true” profitability as a basis for quantifying the impact of decisions, we can now turn to other factors that should influence customer resource / investment allocation decisions.
Cost to Play
It will never be possible to equalize profitability across accounts. Instead, the focus should be on creating an acceptable band or range. Why? Every account will have some base level of investment (i.e. “cost to play”) required to do business with them. This investment will come in the form of acceptable pricing, minimum trade spending levels, and logistical and staffing requirements. If you want to do business with a particular account, this basic level of investment must be made, and it will vary by account.
Ability to Impact Results
Yes, size matters, but investment should not always be in proportion to the size of the account. Why? Beyond “cost to play”, it is better to invest resources based on their ability to impact results. There are several factors to consider here:
(a) Is the right resource deployed against the right part of the customer?
For example: retail or field resources may be better used against a smaller, decentralized customer, versus one that is large, but highly centralized, with all decisions being driven from HQ.
(b) Will the customer deliver? Will they make commitments and can they execute on them?
For example: a retailer that will commit to a minimum order and which has strong operational systems is more likely to deliver against an investment of resources than one which does not.
Fish Where the Fish Are….And Where They Will Be
Most companies will (and should) overinvest in a few, large customer who will represent a high percentage of their sales. In addition, smart companies focus incremental investment in growth customers (today’s winners) and in promising new entrants (tomorrow’s winners).
(III) Risks to Manage
Understanding “true” customer profitability and the opportunity and impact of investment choices are crucial to decision-making. That said, there are a few other cautionary considerations to keep in mind:
As every company in an industry focuses their investment “where the fish are”, this actually tends to increase the concentration of sales in the hands of those few, larger players. That can lead companies to have a high percentage of sales in their top 3-5 customers. In this case, it may make sense to spend less “efficiently”, by also investing in targeted second tier accounts, so as to mitigate the risk of over-concentration of sales with too few accounts.
Reduction Can Mean War
No one likes to lose something they have. Customers are no exception. Reducing investment in an account, if visible to the customer, can be highly provocative, even if the reduction appears small. Remember than your investment level may directly impact the scorecards of personnel at your customer. A general rule of thumb is that if you plan to make a visible change, make one big enough to be worth the inevitable pain that change may cause and plan for time “in the penalty box” where sales may suffer.
People Talk…And They Change Jobs
While account investment, including pricing and trade spend, do not need to be equal, they should have a degree of fairness and equity and they should be defensible based upon outcomes. Many companies have been burned when a key player moved from Customer A to Customer B, taking with them the knowledge of the secret special deal that A was getting.
Plan to Hold Equals Plan to Lose
Sometimes in annual planning, we decide to shift or reduce resources at a given account, and plan to “hold” rather than grow that account. Planning to hold an account, segment, region, brand, etc. almost never works. Instead, have off-setting actions or activities with the account and plan to grow, albeit more slowly than at other accounts.
Have a look at how your company is investing to sell to and service your customers, thinking about the broader view presented here. Are you making the right choices to drive sustainable, profitable growth? If not, what needs to change?
© Glenn Busby – 2012