The companies that have addressed their cost base and have put key strategies in place are best placed to take on the market with confidence
A RECENT PricewaterhouseCoopers survey of Irish chief financial officers indicated only 22 per cent expected growth to return to their business in 2010; 50 per cent expected a return to growth in 2011. Whereas 57 per cent of those surveyed are still focused on controlling the cost base, 42 per cent have turned their attention to growing market share.
Those companies that have addressed their cost base in 2009 are now better positioned to attack the market with confidence, knowing their operating model is fit for purpose and flexible enough to adapt to the dynamic opportunity the markets now present.
The approach to achieving and sustaining profitable growth needs to be strategic and focused, not tactical and reactive. Growing sales in non-core products, services or markets may increase the revenue line in the short term but it may may not generate the return on limited capital that other more strategic options may deliver.
Outlined are some of the key initiatives we see being adopted by leading companies as they position themselves for growth.
Core versus non-core
Companies are analysing and re-appraising the customers and markets they serve, and the products and services they sell. Product profitability, customer credibility, cost to serve, market growth: all are being considered in deciding if an appropriate return can be earned. Individual customers, products and services are being dropped, sales channels and being re-evaluated, and fixed costs are being re-assessed to determine the optimal model for generating profit. We have seen companies deliberately down-size their business model by more than 20 per cent to restore profitability.
Different strategies are being taken to manage non-core business areas. Companies are being sold, closed, run-down or outsourced to third parties to deliver a managed exit.
Capital released from non-core businesses is being reinvested in developing existing core businesses or investing in new growth markets.
Product/service profitability
In many cases, less than 20 per cent of customer-product combinations generate nearly 100 per cent of profits – they are effectively subsidising other parts of the business in generating the reported profit.
How do you assess the profit of each product/service sold? Is it at a gross margin level or does it take account of the fully loaded cost of providing the product/service?
Have stock obsolescence, stock holding costs, currency, distribution costs, installation costs, warranty costs, scrappage/ waste, etc been considered in assessing profitability? Is the product/service easily sold or is there significant investment required to make a sale? The true costs and associated profit of products/services must be considered in deciding the optimal range to market.
Customer profitability
How do you assess the profit of each customer? Is it at a gross margin level or does it take account of the fully loaded cost of serving each customer. Each customer is different and by extension, the cost of serving each is different, be it their location; product mix requirements; delivery frequency; “special requirements”; etc. Is your largest customer by volume or sales?
A detailed analysis of an engineering group’s largest customer revealed that due to discount levels, extended credit facilities, free daily shipments and small delivery loads they were in fact losing money on every order. Renegotiating the above factors eventually contributed to a positive margin.
Sales management
Through the growth era, when demand exceeded supply, did sales teams really sell or just take orders? In the last 18 months, we have seen many sales teams struggle. Disciplined sales management is now a fundamental requirement with many companies focused on sales training, pipeline management, sales forecasting, performance management and customer segmentation.
Sales teams are now being measured on margin, not revenue or volume and commission/bonuses for sales and product management teams are only paid when products and services are sold and the cash collected.
Sales forecasting drives materials management and can significantly impact the supply chain and associated profitability when inaccurate. The recent analysis of sales forecast accuracy for an international FMCG company revealed a spread of between -20 per cent and + 60 per cent for a four-week sales forecast. Clearly this is unacceptable and unsustainable.
Revenue leakage
The practice of giving something for nothing to optimise customer satisfaction is no longer sustainable. Companies must either stop providing or strike a fair price for free deliveries; extended payment terms; free technical advice; customs clearance; upgrade services; storage facilities; and so on.
Discounts, allowances and credit notes are also receiving microscopic attention. Are they valid, have they been accurately calculated, are discounts compliant with standard terms and conditions, do credit notes point to inefficient or ineffective processes? Where companies have addressed the issues associated with revenue leakage, the full benefit normally drops to the net margin line.
Pricing
Getting the price right is key to profitable revenue growth. Set it too high, you get high margin but lower volume. Set it too low and you’ll drive volume but at a lower margin. Each approach will be the right choice in different situations – getting the balance right is the challenge. Understanding your market, customers, cost base and product/service dynamic is imperative in striking the right price.
Does a particular service drive incremental revenue? A hotel recently realised that their bar receipts were directly proportional to their restaurant receipts, so in planning for new measures to attract more restaurant customers, they were able to calculate new pricing based on the combined contribution of both the restaurant and bar.
Route to market
For many organisations, getting their product/service to market represents a significant proportion of cost. Financial institutions in Ireland are continuously re-assessing the value of branch operations for services which can easily be sold on-line. Interestingly, one of Spain’s largest banks has reversed this trend and is opening multiple smaller customer facing units, reinforcing customer service through face-to-face contact. As firms continue to grow by acquisition, integrating their customer knowledge enables them to up-sell new products and services.
For distribution companies, evaluating the cost of getting smaller orders to remote customers in a time of declining sales can be insightful, highlighting the relative cost and return of existing structures. Shifting to more regional distribution models like leveraging local wholesalers or dropping customers altogether represent approaches now being adopted by leading Irish companies.
Know your customer
The recession has changed the way consumers think and has impacted their buying behaviour. Their perspective of value for money and how they structure loans and financing all impact the way businesses must react to service consumer needs. This in turn is affecting company behaviour, driving organisations to restructure their operating models to be more agile and fit for purpose.
Businesses need to invest in understanding the changing needs of their customer base. Leading companies are restructuring the manner in which they package goods and services to customers, tailoring these to various groups.
Business insight
All of the above is under-scored by the need for appropriate information upon which to base decisions. For many companies struggling to deal with the recession, the availability of information to support decision making has been deficient. This has arisen for a number of reasons:
Poor management information systems
Inappropriate or insufficient key performance indicators (KPIs)
Capacity to convert data into insight
Amateur analysts
The characteristics of companies that have succeeded include fully integrated ERP systems with appropriate business intelligence modules; a tight number of KPIs aligned with the annual strategy; “one version of the truth” reports (no amateur analysts); a finance team with business-partnering capabilities and a fully focused management team with strong cross functional business understanding.
Last year was the year of cuts, hopefully this will be the year for growth. A strategic, as opposed to scatter-gun, approach will be required to ensure growth converts to profit. Fully understanding the basis upon which profit is generated will be key to success.
Garrett Cronin is a consulting partner in PwC focused on Finance Operations Effectiveness
