While most distributors learned long ago to avoid managing for top-line sales revenue as a measure of results, many of today’s distribution businesses still believe that managing by gross margin is effective. In particular, sales compensation is typically rewarded based on gross margin for a particular deal. However, studies have shown that there is absolutely no correlation between gross margin and operating margin. This may be due to many factors such as the cost to serve, logistics costs, the costs of order processing, and hidden support costs, among others.
What if we could determine the true cost of doing business and which customers actually deliver the highest profit contribution to the business?
There are some very effective tools and systems to allocate true costs across customer transactions and help identify your best and worst customers from a true net profit perspective. We have seen significant success with customers who have implemented Waypoint Analytics for example.
But where should we start? There are many ways to use analytics to segments customers such as firmographic attributes, customer lifecycle, which products they purchase, etc. These approaches may be useful for guiding a variety of marketing and sales strategies such as marketing campaigns, sales channel priorities, and growth strategies. However, as important as traditional marketing analytics and strategies are for growing and maintaining your business, we have seen that Distributors can become even more successful when they identify customer segments by profitability.
There are relatively simple ways to use analytics to start increasing net profits by identifying which specific customers account for the highest profits compared with which customers are actually costing the business money, even though they appear at first to be profitable on a gross margin basis. This can be a first step towards a comprehensive system solution that enables maximum net profit and ongoing improvements by starting to measure your business performance and laying the groundwork for profit improvement strategies. One way to start using profitability to better manage customers is to group them as follows using classifications based on Waypoint Analytics:
- High Efficiency Accounts (HEA) – High cashflow accounts with low expenses relative to revenue
- High Potential Accounts (HPA) – High cashflow accounts that are profitable
- Service Drain Accounts (SDA) – High cashflow accounts that are unprofitable or with high expenses relative to revenue
- Regular Profitable – Small-to-medium cashflow accounts that are profitable
- Regular Unprofitable – Small-to-medium cashflow accounts and not profitable
To begin with “profitability” is not gross margin contribution or percentage. Instead, it must incorporate combinations of analyzed factors such as cashflow, gross margin, values and frequencies of orders and all of the expenses associated with fulfilling the individual customer completely. These attributes help to differentiate the most profitable customers from the average customers and from customers that effectively drain resources and end up costing more money than they yield. In order to accomplish this, a distributor must implement some level of analytics capability which captures the relevant information and uses the information to classify customers and transactions appropriately. We at Real Results Marketing have worked with numerous distributors to help them begin to analyze their customer base and implement an effective set of actions to take in order to maximize real profits.
Return on Focus
The main advantage of this approach is that it provides a way to focus the company on high priority business improvements. Specifically, this approach allows the Distributor to prioritize the focus and activities of sales resources, operations and customer support. It also establishes guidelines for how to maximize profitable business from the best customers, while improving the profits from other customers and identifying unprofitable customers which need to be remediated or jettisoned.
We will look at how to handle the majority of regular accounts and larger SDA accounts that actually cost more to serve than the revenue they actually generate in the next discussions in this series.