MASTERCLASS:If this analysis is done consistently trends will emerge that can be invaluable in helping businesses to set key benchmarks such as realistic selling prices, writes OLIVE KEOGH

MOST OF those running SMEs might assume they know exactly what makes their business tick. But it is easy to confuse familiarity with fact. Ensuring your organisation survives 2010 and beyond means being able to answer two key questions: “Do I really know my business?” and “Is what I assume to be the case actually the case?”

In a thriving economy many businesses prosper despite, not because of, their best efforts. It is relatively easy to identify and exploit growth opportunities and, while mistakes are made, market buoyancy means they rarely prove fatal if the core business is sound.

Once a downturn begins this changes. Sales slow and customers start tightening their belts. Companies respond by cutting overheads to get breathing space. But as the crisis deepens they have to find other solutions, such as increasing value to customers without adding cost and trying to use existing resources to offer a wider range of products or services. However, such knee-jerk reactions are not always productive in the long term.

Pioneer Security provides electronic security installation and maintenance to the upper end of the corporate sector. Generally the company would expect to see a surge in installations in the last quarter of the year as companies spend their capital budgets before the year end. “This did not happen at the end of 2008 and by early 2009 we recognised that much of this was not delayed expenditure, it simply was not going to happen at all,” says operations director, Jochen Riehn who founded Pioneer with Martin Whelan in 2004.

While it was tempting for Pioneer to try to make up for falling revenues by offering “budget” systems and service to a wider market, the partners resisted. “People opting for budget systems are far less inclined to take out maintenance contracts and all you end up doing is increasing your turnover with little or nothing to show for it,” Martin Whelan says. Pioneer’s response was to stick with its core business but to tweak its service offer to make it more cost attractive. “This has helped us maintain our reputation for high standards while increasing the options for customers,” says Whelan.

Understanding exactly which elements within an operation contribute to profits and which do not is essential. The same goes for customers. A customer may appear significant when the value of their business for a year is added up, but when this is balanced against the cost of servicing their account they may actually be costing money.

“Taking a look at how profitable the customer is allows you to make a confident decision when it comes to key strategic issues such as responding to pressure to reduce prices,” says Catherine Goodman of business development consultants, Goodman Associates. “To assess a customer’s profitability take sales less direct costs. Ask yourself; does this customer take up a lot of your or your staff’s time? Are they more demanding than other customers? What is the cost of the time and energy you expend on their behalf beyond what they pay you?”

The Pareto principle (also known as the 80-20 rule) states that for many events roughly 80 per cent of the effects come from 20 per cent of the cause. Translate this into a corporate environment and it suggests that 80 per cent of a company’s sales or profits will come from just 20 per cent of its customers.

This is a crude measure but the principal is sound. “Often when you assess the real cost of a demanding customer, you will discover that they are not contributing to the profit in the business. In these cases you are better off investing your time in finding new customers,” says Goodman. Looking at the true profitability derived from each customer means being absolutely clear about what is being measured.

Depending on the type of business a range of factors need to be taken into account, such as: product mix requirements; order size and delivery frequency; special requirements incurring additional costs; discount levels; cost of extended credit facilities; and apportioning of all business overheads.

This type of detailed analysis usually shows that customers who generate the greatest profit are those with the simplest requirements. Large customers tend to drive hard bargains and exploit their size to get perks such as special discounts and a premium service at no additional cost. Equally, fulfilling the requirements of a small customer may demand the same level of attention and cost as meeting the needs of a much larger one, but without the additional revenue.

Detailed analysis can also reveal what elements of its product or service range are the most valuable in terms of profit. This type of analysis should not be a once-off. Today’s management information systems facilitate the extraction of in-depth data at relatively low cost and give managers much greater clarity about where profits are being created and lost in their business.

If it is done consistently, trends will quickly emerge that can be invaluable in helping businesses to set key benchmarks such as realistic selling prices. Quality information can help ensure that the business model is both fit for purpose and sufficiently flexible to respond to changing circumstances.

For example, it can help a business clarify what its core business should be, based on criteria such as optimising return on capital employed. During a downturn driving sales through non-core activity may yield short-term cash benefits. But it may also ultimately prove to be a distraction. It may also tie up capital that could be used more productively in developing new opportunities, for example in export markets.

CASE STUDYLAST YEAR Regina Mangan took one of the toughest decisions of her commercial life. She stopped working with one of her companys largest clients because she could no longer make a sufficient margin on the business.

“We had already reduced our fees by 20 per cent and were subsequently told that we had to cut them by a further 30 per cent or we would lose the business,” says Mangan who set up her property rental and maintenance company, bookaroom.ie, in 1995.

“We had been working with this client for nearly five years and it involved a significant portfolio of properties,” said Mangan. “Initially it was very good business but after a few years there was an expectation that we would reduce our fees. Eventually that expectation was unrealistic. We were effectively being asked to provide the same service at half the price. It was a tough decision to walk away but when we evaluated the cost of servicing this client and looked at it versus the cost of other clients we decided we would be better off.

Mangan has been using the support of professional mentors, whom she first sourced through FÁS and her local enterprise board, to help develop her business over the last three years. “I’d urge companies to tap into the reserves of knowledge that are out there especially in the current climate,” she says.

Despite the recession, bookaroom.ie invested heavily in new information technology and software last year. “It has transformed our business,” says Mangan.

The new system allows Mangan to see exactly who are clients are and to target her advertising and marketing accordingly. “I was quite surprised to discover that the largest national group to whom we rent is Slovakian and the majority of our renters are male in the 24-32 age group,” she says. “Knowing your market that specifically means you can be a lot more selective about where you spent your promotional budget.

“One of the things we have done is analyse exactly how much time it takes us to secure a letting versus the value of that letting.

“This is crucial in determining fee levels. If you dont have a good grasp of all your costs you will end up losing money.”