Managing Your Business Transformation
Several years ago, the front page of The New York Times reported that two Columbia University geophysicists found clear evidence of ancient villages lying beneath hundreds of feet of water on the seabed of the Black Sea, just north of Turkey. Their investigations, later narrated in a fascinating book, Noah’s Flood, revealed that a sizable portion of the current Black Sea had once been a giant freshwater lake, filled with meltwater from Asian glaciers as the last ice age waned.
About 7,600 years ago, as ocean waters rose, the Mediterranean breached the mountain barrier that separated the ocean water from the freshwater lake, and a monumental flood rushed through the Bosporus valley (which runs through today’s Istanbul), and poured into the lake with historical force, destroying and submerging all life in the area, and forming the Black Sea. This was the actual event that storytellers memorialized as the biblical flood.
Today, business is transitioning from one major era, the Age of Mass Markets, to another, which we call the Age of Revolutionary Change. The two ages could not be more different, and the transition is as abrupt and disruptive as Noah’s flood.
Revolution in Business Today
A revolution is now sweeping through industry after industry: a revolution which is as pervasive and powerful as those that swept through – and are still transforming – retail, telecommunications and healthcare. In those industries, many of the major players, which had been household names for years, disappeared through bankruptcy or takeover. But a number of the major – and formerly minor – players, along with a smaller number of new entrants, managed to craft strategies that enabled them to transform and reposition into industry dominance.
In our experience across a range of industries, these successful companies have achieved sustained 10% to 30% year-on-year profit growth, and long-term industry strategic leadership.
This introductory chapter focuses on the revolution now sweeping through our economy, disrupting industries, and creating historical new opportunities for accelerated profitable growth and strategic dominance, along with abrupt catastrophes for those who fail to adapt.
The first section of this chapter illustrates the broad, quantum nature of the change by offering, as an example, a synopsis of the changes that are transforming the distribution industry. The second section briefly outlines what we call “Managing Profitable Growth” (MPG) – the essential elements and strategies that enable managers to respond to these changes in order to stay on top in their evolving industries. The third section describes the quantum changes in business management needed to respond and adapt. The fourth section explains and illustrates briefly the critical metrics and analytics of what we call “profit resource planning™ (PRP™)”, which we explain below and more fully in Chapter 3, that are essential to develop and manage programs of accelerating profits and renewing change. The final section suggests a set of diagnostic questions and progress milestones that will help guide you through the process of managing change.
The Case of the Distribution Industry
What is causing this disruptive change sweeping through industry after industry today, and what can a management team do to stay on top? The case of the distribution industry provides a clear example of the forces that are reshaping our business landscape, and the management imperatives for winning in today’s Age of Revolutionary Change.
Forces of change
The pervasive change that is sweeping through business is powered by tectonic market changes, and fundamentally new company and technology capabilities. The distribution industry revolution is emblematic of this. In distribution, the forces are already in play and are accelerating. They affect all aspects of company strategy, competitive positioning, management, sales, and operations.
This section provides a brief overview of the forces of change, illustrated by the revolution now occurring in the distribution industry. The next section outlines the essential elements of managing profitable growth. We will explain these much more fully in Chapters 2 and 3, respectively.
Figure 1-1: Forces of Change illustrates the forces in play. These can be clustered into five categories (most of these forces are transforming a range of industries; the subheadings represent, as an example, how these forces are affecting the distribution industry):
- New blurring of industry and channel borders
- Manufacturer direct sales – Increasingly, manufacturers are engaging their customers directly, primarily by building intercompany ties with their best customers, and by engaging other customers through the internet. This is raising the prospect of disintermediation (eliminating the intermediaries), as manufacturers move both to lock in their best customers and to serve directly a variety of smaller scattered customers.
- Powerful new competitors – Powerful new companies like Amazon are storming through industry after industry, taking market share from incumbent firms. At the same time, innovative established companies, like the transportation company, CH Robinson, are moving from their traditional business bases to enter new markets.
- B2C and B2B converging – B2C companies with very sophisticated analytical capabilities, often rooted in artificial intelligence (AI) and machine learning, are increasingly bringing these extremely powerful capabilities to B2B markets.
- New buyer behavior
- Rise of millennials – A new generation – millennials – has developed fundamentally new patterns of buyer behavior, both as customers and as employees purchasing products for their companies, disrupting traditional go-to-market strategies.
- Pricing transparency – Today, the internet’s ubiquitous presence, coupled with the widespread availability of mobile devices, makes it possible for customers to check prices across multiple suppliers seamlessly and in real time.
- Service expectations – Customers increasingly expect rapid, customized service, including same-day delivery, mass customization of product features, and customer-specific product recommendations.
- New technologies and processes
- Additive manufacturing – This new manufacturing process, which completely changes how products are made, is transforming the roles and strategies of firms in a number of important industries.
- Robotics – These innovations are sweeping through virtually all industries, from manufacturing to distribution to service to retail, transforming operational economics and changing companies’ cost structure and strategic differentiation.
- Artificial intelligence and machine learning – A number of complex processes characterized by big data and constant changes are becoming much more efficient and effective with the application of these newly-emerging mathematical techniques.
- New company functions
- Changing value of marketing – Big data availability and increasing market complexity, coupled with revolutionary AI and machine learning analytics, is enabling companies to develop customized marketing programs for individual customers based on their evolving buying behavior.
- Changing value of sales force – The increasing role of the internet, EDI, and integrated supplier-customer operations like vendor-managed inventory and vending are radically changing the traditional role of virtually every sales force.
- Changing value of supply chain management – Supply chains are transforming radically as well, with increasing integration becoming a mandatory feature of premier customer relations, and with companies developing a variety of relationships with differentiated service that matches the cost to serve with the profit potential of their customer segments.
- New profit metrics, analytics, and profit acceleration processes
- Transformational metrics – Revolutionary “transaction-based net profit (TNP) metrics”, that are at the heart of new PRP systems, link the revenue of each transaction (invoice line) with the all-in cost to produce that revenue increment, enabling managers to identify powerful new profit levers (i.e. specific profit improvement actions that address your specific profit improvement opportunities, ranging from stabilizing customer order patterns to optimizing each customer’s product mix), and seize critical profit opportunities.
- Transformational analytics – Powerful, practical analytics like profit maps, described below, are allowing managers at every level to target their most lucrative opportunities and to match each customer’s relationship, product mix, and service with its profit potential, dramatically increasing revenues, profits, and strategic differentiation.
- Transformational management processes – Legacy management processes, centered on ERP, are not sufficient to maximize profitability in today’s Age of Revolutionary Change. Instead, a new, fundamentally different set of management processes, rooted in PRP metrics and analytics, enables managers to systematically identify, prioritize, and capture their most important profit opportunities, many of which are “hidden” from ERP-based metrics.
Together, these forces of change are as disruptive as the changes that occurred when roads were paved and rails first crossed continents, creating the prior era’s mass markets. Today’s forces of change are moving at blinding speed, transforming the fundamental nature of markets and strategic opportunities throughout today’s industries.
The most critical success factor
The biggest determinant of success or failure for managers in responding to the revolutions now sweeping through our economy is creating a sense of urgency for the systematic, paradigmatic change that is needed to win. The revolution has already started, and companies today are experiencing the effects. Several industries, like retail and distribution, are deep in the transformation process, while in others, companies now are increasingly feeling the effects.
The most critical management problem is creating a clear pivot point that views these as accelerating forces of change requiring paradigmatic response, rather than as minor disruptions that invite tactical initiatives.
Already, activist investors are moving into virtually every industry, and major stock price swings hinge on rumors of powerful new entrants with disruptive technologies and business models. Managers that move fast will have an opportunity to carve out a dominant strategic position for decades to come, while those that lag will be in serious danger of losing their companies. This is the single most critical foundation factor determining success or failure.
Timing is everything at this point. In our experience, the timeframe for paradigmatic change today is four to five years, from conception to development to implementation to fruition. If a company does not initiate serious planning efforts this year or next, it will be very difficult to catch up. If a company waits more than a year to start, it will be in danger of irreversibly falling behind.
Managing Profitable Growth
Managing profitable growth (MPG) is a process that encompasses profit resource planning (PRP), profit-action strategies, and the PRP profit cycle, which are necessary to win in today’s Age of Revolutionary Change. Profit resource planning develops the profit metrics and analytics needed for successful company transformation. Profit-action strategies shape these into a coherent set of integrated strategies, and PRP profit cycles are comprised of management processes and actions that transform these capabilities into sustained profitable growth and a dominant industry position.
Managers who put these components in place as the core of their management processes will turbocharge their profitability and capture their industries’ strategic high ground.
This will create a double win: they will dramatically improve both their competitive positioning and their financial performance from the start, even while they are building their future success. And, in almost all companies, no net new investment is required – most of these components start generating cash from the start.
Figure 1-2: Managing Profitable Growth shows this set of vital components, which we describe and explain in subsequent chapters.
- Profit-action strategies – In the Age of Revolutionary Change, companies face a much more complex set of strategic and market positioning issues because markets are rapidly fragmenting. In this context, the splintering customer segments require a much more diverse set of integrated products and services. Managers today need to specify in detail and coordinate their competitive positioning, market positioning, customer relationships, and service provision decisions to seamlessly meet these emerging needs.
- Competitive positioning strategy – This is a process that sets a company’s competitive context. It consists of data-grounded risk management and strategic paradigm management. While virtually all companies deal with risk and strategy, PRP metrics and analytics enable managers to set make these critical decisions in a much more effective way based on a granular view of company profitability.
Together, data-grounded risk management and strategic management enable managers to stake out a clear, crisp competitive positioning, and a base for sustainable profitable growth, capitalizing on the forces of change, rather than being overwhelmed by them.
- Profit-based market segmentation strategy – This is comprised of profit-based customer strategy and product strategy. Customer strategy includes account selection, account management, pricing and other related factors. Product strategy includes product selection, strategic and operational product and category management, product mix management (company-wide, and for specific customers), and other related factors. Most companies today still assume that the objective of these activities is revenue maximization, but PRP metrics and analytics now enable managers instead to set and manage these activities to directly maximize profitability.
PRP analytics show a set of very actionable areas of current and projected high profits and low profits (which we call “profit peaks” and “profit drains”, respectively). This enables managers to understand and manage their profit-based market segments – for example, drawing the critical distinction between large high-profit customers (which we call Islands of Profit customers) and large low-profit customers (which we call Coral Reefs customers).
- Customer relationship strategy – This strategic element encompasses two components: (1) defining and offering a relationship hierarchy comprised of a clear set of four or five customer relationships ranging from arm’s length occasional to highly integrated, with each relationship having well-defined measurable value for each party, and an explicit to-do list for each party; and (2) forming a team comprised of sales, marketing, and supply chain managers (throughout this book, the term, supply chain, will also apply to the service provision chain in service companies) that will systematically examine and qualify each customer, or set of customers, matching each customer to the relationship that it should have. The job of the account management team is to move the customer from the relationship that it currently has, or wants to have, to the one it should have.
- Customer service strategy – This consists of supply chain strategy and channel strategy. The objective of supply chain strategy is to construct a carefully specified set of cost-to-serve models, one for each relationship in your relationship hierarchy, which match your cost to serve with each customer’s profit potential. The objective of channel strategy is to match your channel mix to your customer segments, and to manage your channels as an integrated package that maximizes customer and product profitability.
- PRP Profit Cycle – In order to convert a company’s profit opportunities into accelerated profits, managers need a concise, effective set of management processes based on PRP, and specifically designed for profit acceleration in this Age of Revolutionary Change. These processes are structured to take place at the three management levels of a company: executive management, VP/director-level management, and sales/operating-level management. Together, they create a powerful, integrated profit management system, which we call the PRP profit cycle. (Chapter 5 presents a three-stage schedule for phasing in the elements of the profit cycle: initial stage, traction stage, and acceleration stage.)
Profit feedback loops are very important. PRP is extremely effective relatively quickly, and it will rapidly change a company’s profit landscape. This means that your sales file has to be updated constantly, ideally daily or weekly; your profit landscape has to be re-costed frequently, ideally monthly; and your profit initiatives and other profit acceleration plans and activities have to be reviewed frequently, ideally quarterly. We discuss this at length in a later chapter.
- Executive management processes – In a nutshell, top management is responsible for analyzing and setting the company’s strategy and risk management; establishing and overseeing the core MPG components; and for selecting and overseeing the company’s major cross-cutting profit initiatives (which we call MPG profit initiatives, managed by MPG initiative teams) and profit rivers (the company’s key profit-based business segments (e.g. high-profit categories in low-volume stores, low-profit large accounts, small customers with the potential to be grown into Islands of Profit customers) managed by multi-capability profit river teams. In essence, top management team is responsible for using the MPG process to transform the company.
- VP/director-level processes – The VP/director-level managers, acting through their MPG Committee, are responsible for: (1) analyzing the company’s profit landscape in order to identify, prioritize, and manage a small set of MPG profit initiatives pursued by MPG profit initiative teams under the supervision of executive management (plus a “profit metrics team” that is responsible for installing PRP metrics in appropriate company reports), that will raise profits by 10-30% in a year; (2) creating and managing a company’s set of profit rivers (defined below) managed by profit river teams, under the supervision of executive management; (3) creating and overseeing set of profit streams, to be managed by operating-level profit stream teams; and (4) installing and overseeing a set of profit-maximizing PRP systems for sales/operating managers, including profit opportunity pathway toolkits (POP toolkits) and the profit crossroads, also defined below.
- Sales/operating manager-level processes – The sales/operating managers are responsible for operating the company on a day-to-day basis. As we will see below, in the Age of Revolutionary Change, customer markets are becoming increasingly heterogeneous, and this increasingly requires sales and operating managers to combine into multi-capability teams (which we call “profit stream teams”) focused on specific customers or sets of customers, which we call “profit streams”. These managers have two core PRP systems that are essential to their success: POP toolkits, and the profit crossroads.
(Note that profit streams are comprised of a customer, or a set of customers, with similar characteristics; while a profit river is essentially a “profit-based SBU” comprised of a relatively large, important segment of the company, such as high-profit national accounts.)
We will describe these systems in detail in later chapters, but in summary, a POP toolkit serves as (a) a personal repository of relevant profit generation information; (b) a highly focused planning tool with system-based processes that enable each manager to identify, prioritize, and capture his or her specific profit opportunities; and (c) a performance monitoring system, with the ability to pinpoint performance strengths and weaknesses. Figure 1-3: Profit Opportunity Pathways summarizes the POP toolkits, which are described in later chapters.
The profit crossroads is a company-wide system that enables managers on diverse teams to share profit information and coordinate with each other. Together, these systems enable your operating and sales managers to bring all their customer, product, and business process activities up to your own company’s demonstrated best practice, thus making the 10-30% year-on-year profit increases sustainable.
These MPG components constitute a tightly-related system. With these essential components in place, you will accelerate your profitability and dominate your industry.
Two reminders are important. First, the clock is ticking. If you put these in place quickly, you will win big – there are many cases of smaller competitors catapulting to industry dominance by capturing the strategic high ground quickly – but, if you stall, you will lose big. Treading water by focusing on tactical improvements will put your company further and further behind. Second, profit metrics are a critical part of the MPG process, but they are not sufficient to create sustained profitable growth without the other action-oriented process components.
Please note that we have written this book to be a guide to managing profitable growth in today’s Age of Revolutionary Change. We have worked in this field for over 30 years, accelerating the profitability of tens of billions of dollars of client revenues across several major industries. In this book, we describe and explain the best practices that we have observed and developed, and we illustrate them using the PRP systems and other MPG elements that we developed in Profit Isle, our profit acceleration solutions company.
Quantum Change in Business Management
The prior Age of Mass Markets was a time of homogeneous, growing markets. The key management imperative was to settle on a viable business model and get big as fast as possible. Economies of scale ensured that as companies increased their sales, their unit costs would drop, giving them ample profits to invest in getting more sales and in further reducing their costs by increasing the efficiency of their stand-alone production and distribution departments.
The current era is a time of heterogeneous markets, characterized by a wide diversity in pricing, product variety, customer relationships, and service packages, which together create both an opportunity and a need for mass customization. Parts of today’s markets are growing incredibly fast, while others are dwindling rapidly. This is the Age of Revolutionary Change, and it is flooding every industry at near-biblical speed and impact.
This fundamental change in business requires a quantum change in the way that businesses are managed. That is the core message of this book.
Here’s a helpful way to think about the change required. Visualize two companies: Company A, a brewery producing a major brand like Miller or Budweiser, is in the business of mass production of a relatively simple set of products sold to largely homogeneous customers in growing, predictable mass markets; Company B, a fabricator, is similar to a job shop operation, producing a variety of sets of products with allied service packages, sold to a heterogeneous set of customers with changing, unpredictable demand.
The management imperative for Company A, the brewery, is: (1) to determine the best business model, and to set each functional area’s activities to align with this model; (2) to invest in each functional area’s productivity, paying special attention to continuous improvement, largely through a constant stream of tactical improvements; and (3) to keep the functional areas separate, with interfunctional coordination primarily occurring at the top management level.
In this traditional mass-market mass-production management model, the classic silo-oriented organization and management processes, supported by ERP systems, were well-designed for the job. Because prices and cost to serve did not vary much across the customer, product, and distribution vectors, it was appropriate to focus primarily on sales and gross margin, and secondarily to monitor each function’s separate set of stand-alone key performance indicators (KPIs).
The management imperative for Company B, the fabricator, is completely different. Company B will not survive with Company A’s organization, metrics, and management processes. Moreover, in the Age of Revolutionary Change, even Company A – especially with the increasing variety of craft beers – will need to respond to its changing market conditions by adopting the new way of managing.
Instead, Company B’s management needs to form sets of tightly-integrated multi-capability profit stream teams, with mid-level, and even operating-level managers with diverse functional expertise working closely together to understand each customer or customer segment’s needs, to design and deliver appropriate packages of products and services for each customer or segment, and to create ever-improving innovative packages of products and services that expand the company’s value footprint (i.e. the value you create for a customer), especially for its Islands of Profit (high-profit high-revenue) customers.
This is a classic Age of Revolutionary Change management model, and almost every element of the mass-market organization and set of management processes are inappropriate, even counterproductive, for this environment. Instead, the company needs an organization, metrics, analytics, and management processes oriented toward understanding, evaluating, and managing each team’s performance as a team – both to select the jobs or segments that have the highest profit and growth potential, and to improve each team’s performance.
Proctor & Gamble’s original account team resident at Wal-Mart in Bentonville, Arkansas –comprised of four co-equal managers with capabilities in sales/marketing, supply chain, IT, and finance – provides an example of the management model that characterizes successful companies in the Age of Revolutionary Change.
The ability to prioritize customer or segment profit opportunities, maximize team performance and productivity as a team, and continuously improve your customer value footprint through a multi-capability process is the fundamental requirement for winning in today’s Age of Revolutionary Change. Focusing mostly on aggregate sales, gross margins, and functional department KPIs – the key success factor in the mass markets era – is the way to lose.
As industries shift from the Age of Mass Markets to the Age of Revolutionary Change, and as this shift sweeps through industry after industry at accelerating speed leaving scores of major companies with household names in its wake, managers must turn to this new mode of management not only to win, but simply to survive.
Managing the telecommunications revolution
We remember working with one of the nation’s largest and most successful telephone companies in the early days of regulatory change, when new competitors were first entering the market.
We had the privilege of working with the Executive Vice President (EVP) of this telephone company, helping guide the company’s transformation into its new world of competition. We had earlier worked with the prior EVP, who had just retired. The prior EVP was legendary in the industry. Every morning, when he arrived, he had on his desk a “trouble report” showing outages throughout the system. If the responsible lower-level manager did not clear the trouble in two hours, a report was escalated to the regional vice president, and if the trouble was not cleared in four to eight hours, it wound up on the EVP’s desk.
First thing in the morning, at 5:00 am, the EVP called the responsible manager – and no one ever wanted to take that call – then the EVP personally called the customer to apologize. That is how the company was run.
Think about how the EVP defined his job. Certainly, it is very important for a telephone company, especially in the very early days of wireless and private networks, to be extremely reliable, but a lot was happening in the background that was pushed aside. This telephone company had in its territory one of the largest, most important cities in the country.
At this time, a competitor, a large capable construction company, had targeted the downtown area of the city, and was laying optical fiber spines along all the main streets, which were lined by skyscrapers full of the company’s Islands of Profit (high-profit high-revenue) customers. The competitor simply hired a number of young sales reps who went door to door along each main street selling the new service, which was steadily capturing the company’s most lucrative Islands of Profit customers.
Meanwhile, the prior EVP was managing the telephone company as if it were a monopoly – replacing the oldest assets first, and marketing to increase sales equally in all areas, regardless of whether an area was a highly competitive urban business district or a rural region. The result: profits dropped through the floor. In essence, this was Company A management confronting a newly-forming Company B Age of Revolutionary Change business environment.
The prior EVP retired, and a new EVP was named. The new EVP saw clearly that managing the telephone company in the old monopolistic mass-market way was leading to the loss of the company’s Islands of Profit customers. This led him to redefine the company by dividing it into smaller geographically defined “business blocks”, such as a downtown business area, a busy suburb, or a rural area, which were essentially profit streams.
He could then use PRP metrics and analytics to analyze, prioritize, and manage each area across the company, essentially changing the fundamental management process from a Company A mass-market mass-production management mode to a Company B Age of Revolutionary Change management mode.
This underscores the fact that the first step for top managers is to understand the difference between these two very different business situations, and to develop the Company B mode for your company.
Today’s industries are experiencing life-threatening sweeping changes, necessitating a fundamental shift in metrics, analytics and profit-accelerating business processes. First and foremost, effective managers today need to manage business processes that are rooted in PRP metrics and analytics. The aggregate metrics and ERP systems that were appropriate in the Age of Mass Markets still work for reporting aggregate financial results, but they do not have the granularity or flexibility required to address the very different requirements of profit maximization in the Age of Revolutionary Change.
Islands of Profit in a Sea of Red Ink
In over thirty years of analyzing and accelerating the profitability of client revenues, we have found that gross margin is not correlated with net profits. Because gross margin is a dominant business metric, we have consistently found a problematic pattern of profitability which we call “Islands of Profit in a Sea of Red Ink” – the title of Jonathan’s award-winning prior book – in which 20-40% of a company is unprofitable by any measure, while 20-30% provides 125-200% of the reported profits, with a surprising portion being drained off to cross-subsidize the unprofitable portion of the business.(See Figure 1-4: Islands of Profit in a Sea of Red Ink.) Here is an actual example.
We worked with a company that sells certain process control equipment. The company had two main customer groups: semiconductor fabs and university laboratories. The sales reps strongly favored the university laboratories over the semiconductor fabs because the laboratories had much higher gross margins.
However, when we looked carefully at the company’s customer profitability patterns, using PRP metrics and analytics, and created separate views for the semiconductor fabs vs the university laboratories, we saw that the company made a huge amount of money on the fabs and lost their shirt on the university laboratories.
When we looked closer, it turned out the semiconductor fabs had very low sales costs, as they negotiated annual blanket contracts; had low shipping costs due to stable, predictable order patterns; had no returns; and, had no need for ancillary services for engineering or technical support. The university laboratories, on the other hand, were extremely costly to serve, because nearly every order was for a unique experiment – and every experiment required significant sales time and lots of engineering time, and had many returns and unpredictable orders.
The answer was to define each of these customer segments as a profit river, and to create a high-impact set of profit levers for each profit river.
First, devote a lot more sales resources to obtaining the low gross-margin, high net-profit semiconductor fab business. Second, hire and train a set of graduate students in each major university to be “product representatives” – who could help the researchers identify the right equipment – pay them $10-15 per hour, and let them serve free pizza to the researchers.
The fab business skyrocketed, the laboratories business became much more profitable, and the company’s net profits went through the roof. This is the power of managing with profit resource planning.
Profit resource planning
TNP metrics, which form the heart of PRP systems, are the foundation capabilities in which all key management components are rooted. They are at the core of the new management imperatives that will enable you to win in today’s Age of Revolutionary Change.
This section provides a brief overview of several key elements of PRP. This system is critical, both for managing your profitable growth, and for successful strategic positioning. Chapter 4 explains these vital metrics and analytics more fully, and illustrates them with a number of concrete examples.
The reason why PRP is so important now is that in virtually every industry, we have entered a new era of business. In the past, both prices and cost to serve were relatively uniform and stable from customer to customer, and certainly within customers. Today, this situation is radically different: both prices and cost to serve vary widely from customer to customer, and often within individual customers.
The problem is that the traditional accounting categories aggregate revenues across many customers and transactions, and also aggregate costs, and overheads. This is reasonable for financial reporting, but it is extremely problematic for management control and decision-making today. Instead, a new set of fundamentally different metrics is needed, one which correctly and practically matches every element of revenue with the actual cost to produce it in a complex company. (Activity-based costing does not accomplish this objective, as we describe in detail in Chapter 3.)
Since the transaction (invoice line) is the financial atom of the company – the lowest level of business activity that can be fully costed – effective metrics today need to match the revenue for each transaction with the specific all-in cost to serve for that transaction. We have developed and perfected a unique, proprietary, methodology and set of cloud-based systems to do this, along with a comprehensive understanding of the revealed profit levers, and a set of very effective profit management processes that will maximize your profitable growth and your strategic advantage.
Each transaction has a full, all-in P&L, which we call a “profit stack”, including carefully assigned overheads, and each transaction has a set of identifiers by customer, by product, by supply chain, by channel, and by other characteristics. Together, these constitute a company’s core set of profit metrics, and the sum of all of the transaction profit stacks equals the company’s overall P&L.
The transaction profit stacks are embedded in a very powerful custom-architected data structure that enables a manager to see the exact profitability of any portion of the company – a customer, a set of customers, a set of customers of a particular product, the profitable set of transactions of an unprofitable product vs the low-profit set of transactions for that unprofitable product, and so forth – for every nook and cranny of the company, from broad profit rivers to individual transactions.
PRP provides the answer to the all-important question of how managers can make and implement key management decisions that will reliably produce strong profitable growth. Profit maps, a central PRP analytical element, enable managers to quickly see and work with their profit-based market segmentation.
Figure 1-5: Customer Profit Map shows a relationally correct but highly disguised profit map for a very successful company. The vertical axis shows profits, with the upper section representing high profits (80% of positive net profits). The horizontal axis shows revenues, with the right side representing high revenues (80% of revenues).
In Figure 1-5, the Islands of Profit quadrant (high-profits high-revenues) comprises a mere 17% of the customers, but they are generating 47% of the company’s revenues and fully 130% of the company’s profits.
The Coral Reefs quadrant (low-profits high-revenues) comprises fully 28% of the customers (almost twice the number of Islands of Profit customers), contributing 32% of the revenues, but draining away a shocking 47% of the company’s profits.
The Minnows quadrant (low-profits low-revenues) comprises a whopping 54% of the customers, contributing 20% of the revenues, and only 8% of the profits.
The Palm Trees quadrant (high-profits low-revenues) comprises only 1% of the customers, contributing only 1% of the revenues, but a relatively strong 3% of the profits. Note that the Palm Trees customers provide over one third as much profit as the Minnows customers, even though the latter comprise over fifty times as many customers.
It is important to note that PRP is a decision-support system, not a cost-accounting system. PRP costing functions must be appropriately accurate. Our working definition is that costs that will make a material difference (we typically define this with the client as a percent of company net profits) in important decisions have to be accurate enough to produce the right decisions, while sensible approximations will suffice for other costs. The objective of PRP is to recognize patterns of profitability, to identify profit levers that will have a significant impact on company profits, and to create ongoing management processes that accelerate profitable growth while building a dominant strategic position.
For example, in the profit map above, 17% of the customers are producing 130% of the profits, while 54% of the customers are contributing only 8% of the profits. Here, PRP would appropriately focus in how to double the Islands of Profit, and how to recognize the Islands of Profit prospects from among the Minnows customers, not on determining whether the 8% Minnows customer profit contribution really was 7.98% or 8.01%. (A cost-accounting system feeding into financial reports, on the other hand, would seek the exact Minnows customer contribution number.)
In this case, we worked with management to establish an MPG profit initiative team that conducted a brief internet survey of the Islands of Profit customers vs the Coral Reefs customers. They found that the Islands of Profit customers were very homogeneous, as were the Coral Reefs customers, but these two groups of customers were completely different from each other. In essence, the Island of Profit customers were very supplier loyal: they asked for new products and services, and they were relatively price-insensitive. The Coral Reefs customers, on the other hand, were price shoppers, bouncing like bumble bees from supplier to supplier to get the best bargain.
When the team saw this, they made sure that each customer’s profit map quadrant designation appeared on each sales and customer service rep’s iPad account page. They developed a training program to teach the sales reps and order takers to respond completely differently to each customer, depending on the customer’s quadrant. They also instituted a program to build their private label offerings, which had much higher markups and were actually preferred by their Islands of Profit customers. This is MPG in action.
At the same time, the team developed a program to probe the Minnows customers using social media and digital marketing in two ways. First, they probed for potential alignment of each Minnows customer with the Islands of Profit customer profile provided by the survey, and when they discovered a likely fit, they devoted resources to move the customer into the high-profit high-revenue group. Second, they analyzed each Minnows customer to look for which of five “profit maladies” (e.g. excess discounting, cherry picking, volatile orders) was causing the low profits, and slotted the customer for a remedy protocol, carefully tracked, to reverse the profit drain. In essence, this was mass customization of account development and customer care.
In overview, a manager’s priorities are:
- First and foremost, secure and grow your Islands of Profit customers by devoting an appropriate amount of management resources to this critical customer segment – if you can double the revenues of this group, you will more than double your profits – and this group of customers is almost always woefully under-resourced because management has no way to identify them, and they are not complainers.
- Second, secure and grow your Palm Trees customers. Understand why they are not Islands of Profit customers, and, where possible, work to develop them into Islands of Profit customers.
- Third, probe your Minnows customers to identify the potential Islands of Profit candidates, and move them into the Islands of Profit quadrant; if just 20% of the Minnows customers in Figure 1-5 became Islands of Profit customers, net profits would rise by over 50%.
- Finally, analyze why your Coral Reefs customers are performing so poorly. Some of the causes, like excessive discounting by a few sales reps or overly frequent small orders by a few customers, can be remedied fairly quickly. But many other issues, like distance from the distribution center (DC), are thornier and take more time to fix.
Please note, however, that in a few companies with huge economies of scale, the Coral Reefs customers provide the volume needed to reduce the overall cost of production. In the past Age of Mass Markets, this was a major consideration in most companies. Today, however, it is an unusual situation. In any event, you can model this in your profit map cost functions.
Figure 1-6: Product Profit Map shows the profit-based market segmentation for the same company based on product profitability.
In the product profit map, we see that the Islands of Profit products, a mere 5% of the products, provide 53% of the revenues and contribute fully 158% of the profits. The Coral Reefs products, on the other hand, constitute only 7% of the products, but contribute 27% of the revenues while draining fully 40% of the company’s net profits.
The Minnows products produce a whopping 87% of the products, but only 19% of the revenues, with a surprisingly large 25% profit drain. In contrast, the Palm Trees products comprise only 1% of the products and 1% of the revenues, but contribute a surprisingly high 7% of the profits.
This profit pattern is very characteristic of even a very well-run company, and it invites a host of further questions like:
- Do the sales reps know the relative net profits of the products, and if they do not (as almost all reps do not), who is managing the product mix and substitutes both for individual customers and for the process of product/category management?
- Are the Coral Reefs products uniformly unprofitable, or for a particular Coral Reefs product, are some customer purchases highly profitable while the others are terrible, and if so, why?
- How many Minnows products are mostly bought by Minnows customers, and how many are integral parts of a bundled purchase that is overall profitable?
- How can we build a set of services that insulate our Palm Trees products from competitors?
Importantly, remember that your Islands of Profit customers should have, and generally do have, higher costs to serve – costs which are a great investment.
Diagnostic Questions and Progress Milestones
The essential management components, which we explained above, provide a proven guideline on how to win in today’s Age of Revolutionary Change. Here is a set of diagnostic questions and progress milestones that managers and board members can use to gauge their respective companies’ readiness to change and progress in moving into a long-term leadership position in their rapidly changing industry.
Profit resource planning (PRP)
- Does each operating/sales manager have granular metrics on the profitability of every element in his or her domain of responsibility (e.g. every product in every customer)? Are they produced on an ongoing basis, not one-time?
- Is there actionable, comprehensive information on the company’s best practice, clustered by similar products and similar accounts (“profit peer groups” – defined uniquely by each company’s managers)?
- Does your company have profit feedback loops for its profit rivers and profit streams, and a set of multi-capability teams managing their profit acceleration?
PRP profit cycles
- Does your executive management team have a company transformation checklist and dashboard enabling them to track the creation and productivity of each MPG process element?
- Does your company have a distinct set of profit rivers, each managed by an appropriate profit river team?
- Does your company have a select set of company-wide MPG profit initiatives that are rooted in the highest priority profit levers (plus a profit metrics team)? Is each initiative being developed and implemented by an individual MPG team? Do you have a clear, effective process to identify and manage new profit initiatives, as prior initiatives are accomplished?
- Does your company have a well-functioning MPG Committee?
- Is there a well-managed process (POP toolkits) for each operating/sales manager to plan and accomplish moving his or her transactions to company best practice? Does your company have a systematic process (profit crossroads) for your sales, product, and operations managers to coordinate with each other?
- Is your company systematically focusing its resources on its Islands of Profit customers, products and sales reps?
Competitive positioning strategy
- Is your company committed to developing and initiating a comprehensive data-grounded program this year to position itself for success in today’s Age of Revolutionary Change? Has this commenced yet?
- Does your company have clarity on how to identify your profit peaks and profit drains? Does it have a systematic, highly quantified process for identifying and reducing its emerging risks, and for identifying and realizing its emerging strategic opportunities? Does it systematically say “no” to business that does not fit?
Profit-based market segmentation strategy
- Does your company have a profit-based process for managing your account selection and account development processes?
- Is your pricing process designed to optimize your all-in profitability?
- Does your company have a profit-based process for strategic category managment and managing your customers’ product mix?
Customer relationship strategy
- Does your company have a small number of clearly defined relationships that it offers to customers, each with a well-defined value footprint? Is a specific manager in charge of developing and monitoring this process?
- Does each relationship have clear to-do lists for each partner? Does each have explicit, reported value/success metrics? Are these reconciled these with any conflicting legacy functional measures of success?
- Is there an effective process for the sales/marketing group and the supply chain group to coordinate to match individual customers to the relationships that each should have?
- Do you have an explicit, well-managed process to continuously improve your set of value footprints?
Service differentiation strategy
- Does each relationship have a distinct, efficient supply chain strategy that matches your cost to serve to customer profit potential? Is it coordinated with your sales process?
- Is there a process with metrics to monitor each supply chain for efficiency and compliance?
- Does your company have an effective, profit-based omnichannel management strategy? Does it incorporate AI and machine learning?
Progress milestones – gauging performance
- First year – clear objectives and plans, granular profitability and risk metrics, “profit-showcase projects” (discussed in Chapter 5), improving current financial performance
- Following year – comprehensive transition pilot, decentralized all-in profitability metrics and analytics, tested roll-out plan, stronger current financial performance
- Two years hence – transition executing full steam with clearly improved competitive positioning and strongly accelerating current financial performance
Great for Now – Even Better for the Future
Managing profitable growth produces huge benefits for a company’s managers. As you build a dominant winning strategic position in your industry, your current performance will improve rapidly and strongly as well – you should expect a 10-30% year-on-year profit increase, even in the first year. Importantly, the process is non-disruptive and generates cash from the start.
These diagnostic questions provide you with a baseline understanding of where your company is today. In subsequent chapters, we guide you through the steps of developing your own process for managing profitable growth, both to accelerate your profitability today, and to build an industry-leading competitive positioning for the future.
Figure 1-7: Managing Profitable Growth: Correspondence with Selected Chapters describes how Chapters 3 – 11 correspond to the Managing Profitable Growth process: the ERP data inputs are explained in Chapter 3; the PRP Solution is explained in Chapter 4; the PRP Profit Cycle is explained in Chapter 5; Competitive Positioning Strategy is explained in Chapters 10 and 11; Profit-based Market Segmentation is explained in Chapters 6 and 7; Customer Relationship Strategy is explained in Chapter 3; and Customer Service Strategy is explained in Chapters 8 and 9.
The other three chapters provide introductory and concluding materials: Chapter 1 gives an overview of the book’s essential points; Chapter 2 describes the forces of change that are transforming industries throughout our economy today; and Chapter 12 provides a set of concluding observations that tie together the book’s themes.
The following section provides more details on each chapter.
Chapter 2, Harnessing the Forces of Change, explains how to analyze your company’s current strategic situation, and helps you develop an understanding of how to build a dominant industry position with strong, accelerating profitability. It discusses the revolutionary changes sweeping through industry after industry today, and illustrates it by systematically analyzing the revolution that is already transforming the distribution industry.
Chapter 3, Managing to Stay on Top, outlines and explains the management process that will enable you to accelerate your profitable growth and achieve strategic dominance in your changing industry by developing an understanding of your strategic options, assessing your profit opportunities, and managing your profit cycle to maximize your profitable growth.
Chapter 4, Managing Profitable Growth: PRP Metrics and Analytics, explains in detail PRP metrics and analytics, discloses how to construct them, and outlines how to identify and prioritize your most important profit levers. It provides case studies that illustrate these all-important foundational management tools.
Chapter 5, Managing Profitable Growth: PRP Profit Cycle, describes the core management processes of the PRP profit cycle that are needed to convert your understanding of your profit opportunities into consistent, sustainable profitable growth and dominant strategic positioning.
Chapter 6, Creating Customer Profit Levers, describes how to identify and deploy your customer profit levers for strategic advantage and profitable growth. These include account selection, account management, profit-based price optimization, and integrated account strategy. The chapter provides specific examples of each.
Chapter 7, Creating Product Profit Levers, covers profit levers for product selection, strategic category management, and extended product creation and management. It includes specific examples, along with tips and pitfalls in product and category management.
Chapter 8, Creating Supply Chain Profit Levers, addresses how to identify and develop the profit levers associated with supply chain selection (including structuring your product flow pathways), supply chain operations, and supply chain strategy. Again, the chapter provides a number of specific case studies.
Chapter 9, Creating Channels Profit Levers, details the profit levers associated with channel selection, channel management (including omnichannel management, and managing in the context of increasing disintermediation), and integrated channels strategy, illustrated with case studies and examples.
Chapter 10, Managing Risk, systematically develops a next generation paradigm for what we call “data-grounded risk assessment and management” (DGRM), including identifying and gauging risk for both revenues and costs, reducing and managing risk, reporting risk, and developing effective risk management processes. Specific examples are shown
Chapter 11, Managing Your Strategic Paradigm, covers direction-setting, intensive and extensive strategic initiatives, strategic what-ifs, planning, and budgeting, with specific examples.
Chapter 12, The Age of Revolutionary Change, ties together the components that will enable you to effectively manage your profitable growth and strategic dominance in today’s Age of Revolutionary Change.
My father used to tell the story of an elderly couple living in a small New England town.
The husband had worked his entire career polishing the cannon on the town green every day. One day, as he neared retirement, he came home and announced to his wife, “For twenty years, I’ve worked for the town, and now I’m going into business for myself.”
“I bought a cannon.”
Stop polishing the cannon
Strategic account management in the most forward-thinking companies is undergoing a transformation that is increasing sales effectiveness and company profitability by 33% or more.
The most effective strategic account managers are shifting their focus from maximizing sales and gross margins, to going directly after major net profit increases in key accounts – without the false assumption that more sales equals more profits. In fact, nowhere is this false assumption a bigger mistake than in major account management.
Strategic accounts certainly have the scale and scope to provide critical revenues and gross margins. They are very important to revenue growth. However, major accounts also have massive power to reduce prices and to extract costly service packages. For most companies, and certainly for most strategic account managers, this pressure is very hard to resist.
This major account power leads to the extremely difficult situation in many companies, in which major account revenues increase while net profits actually decline. All too many strategic account managers find themselves in essence polishing the cannon.
What can a strategic account manager do?
Sell profits, not revenues
The most important factor in strategic account management is the vast difference between selling revenues and selling net profits. Most selling systems simply assume that these are equivalent, but nothing could be further from the truth.
In years of work on maximizing profitability, and in the billions of dollars of annual client revenues that run through Profit Isle’s, my company’s, analytical systems (see www.profitisle.com ), I have found that a surprisingly small portion of a company’s business provides all the reported earnings, and even subsidizes the losses on the remainder of the business.
For example, one very successful, industry-leading company earned over 150% of its profits from about 15% of its business, and an amazingly large portion of these profits were simply eroded away by the majority of the business.
Importantly, a number of the strategic accounts were providing most of the profits, but a shockingly large number of major accounts were key profit drains. And, it was not at all clear at the onset which accounts were “good accounts,” and which were not. This is very typical.
Good accounts, bad accounts
The key to sorting your good accounts from your bad accounts – and your good products from your bad products – is profit mapping. I have explained profit mapping in my Harvard Business School Working Knowledge columns, in my blog posts, and in my award-winning book, Islands of Profit in a Sea of Red Ink.
In essence, you can build a profit map by doing an all-in P&L on every invoice line. This yields a very detailed picture of the company’s profit landscape by account, product, vendor, service, cost factor, and numerous other dimensions. Profit Isle has very powerful software to do this, and to create game plans for profit improvement.
The reason it is critical to do a full P&L by invoice line is that accounting systems aggregate revenues and costs in separate buckets. This makes it impossible to match each of your revenue sources to the cost of generating it.
Think about this: Are all your products priced the same in every account? Is the cost to serve all accounts equivalent? If not, you need to understand how to match specific costs to specific revenue streams on a very granular basis, and this is especially critical for major accounts with substantial bargaining power.
Islands of Profit – profit levers
If, as with nearly all companies, 15% of your accounts are providing 150% of your profits, your most important objective is to secure and grow these Island of Profit accounts. Yet if they are providing only 30% of your revenues, in most companies they will be getting only 30%, or less, of your “love.”
These high-profit key customers are your most important asset. In fact, they probably are not even getting as much attention as your large accounts that are unprofitable, because your big, low-profit customers are always pushing and complaining.
As a strategic account manager, you have three very important “profit levers” to turbocharge the profitability of your Islands of Profit strategic accounts: (1) profiling and account selection; (2) pricing and product portfolio; and (3) supply chain integration.
Profiling and account selection
Think about this: How does your company select new products or new marketing approaches?
Odds are that you do a survey and let all customers have a vote. Alternatively, perhaps you give your big accounts more votes than small accounts. But do you give your Islands of Profit customers, which are giving you all your profits and more, enough votes?
In building profit improvement game plans for our clients, we very often specifically and carefully survey their Islands of Profit accounts. The results are astonishing.
In most situations, the Islands of Profit customers have remarkably similar profiles, needs and views – and these are very different from the overall customer base, and even from the other major accounts. By aligning your company’s products, services, and positioning with your most profitable customer segment, you can directly drive strong profitable growth from the start.
Just as important, when you have a clear profile of your Islands of Profit customers, you can identify their critical characteristics and buying triggers. This enables you to increase profitable sales to existing Islands of Profit customers, and to rifle shot your sales and marketing efforts to identify and land new accounts that have the highest potential for strong, fast, high-profit growth.
In this way, you can shift resources from low-payoff business to high-payoff business. No more polishing cannons.
Pricing and product portfolio
Once you have identified your Islands of Profit customers, you can look at your own business’s best practice in pricing and constructing a product portfolio for these customers.
Here, you can do a comparative analysis of what you are selling to the different market segments of your most profitable customers. Every sales rep is different, and every customer interaction is different. Yet very clear best practices emerge, and nearly always raise a revealing “aha moment.”
For example, many sales reps are afraid to price high, especially for a major product in a major account. One top client manager likened this to a fear of getting a “speeding ticket.” Yet, in practice, the sales rep is much more likely to get a “ticket” in a price sensitive, unprofitable major account than in an Island of Profit account. By understanding the difference in best practice pricing in the accounts in the respective categories, reps are much more likely to price their Islands of Profit customers at market.
The result: very fast revenue growth that is all profit.
Product portfolio – the question of what to sell to an account – has a very similar solution to the pricing dilemma. By identifying the Islands of Profit customers and analyzing best practice set of products bought, you can construct very powerful guidance for the sales reps. Here, again, you are analytically removing the sales to large, unprofitable customers (which we call Coral Reefs) that muddy your understanding of your most profitable (real net profits) strategic accounts.
This creates a clear best practice pathway to fast sales growth in key highly-profitable accounts.
Moreover, we have found that the real super-sweet spot for high profit growth is selling Islands of Profit products in Islands of Profit accounts. By really digging in and understanding these two critical categories, you will be able to laser-focus your selling efforts on where they will pay off fastest and strongest.
Supply chain integration
For strategic accounts, supply chain integration is a prime sales and profitability weapon. I have explained this in my writings (for example, see Profit from Customer Operating Partnerships).
Supply chain integration gives you three critical benefits.
First, you reduce your key customer’s cost of operations, often by 40% or more. These savings stem from reduced inventories, duplication of services, and other factors.
Second, your own sales grow, often by 35% or more in your highest-penetrated accounts. This very fast, massive sales growth is driven by the huge customer cost savings, and by the operating level relationships that develop between your grass-roots operations staff working in the customer, and the customer’s counterpart operations managers.
Third, your own cost of operations drops, often by 30% or more. These savings occur because you now can control and stabilize your key customers’ order patterns, enabling you to reduce inventory, shipment frequency, and expedited movements. Importantly, this major saving enables you to keep your prices stable, and still strongly grow your profits.
This leads to a crucial question: Why not do this with all your key accounts?
The problem is that supply chain integration takes time and resources to develop. And, if your customer is a transactional buyer with a weak capability to partner, your costs will blow up and your profits will plunge. This leads many companies to be very hesitant to enter into these relationships at all.
Which customers should you approach for supply chain integration? The answer is clear: your long-term Islands of Profit customers.
Yet, if you can’t identify your Islands of Profit customers, you should rightly fear simply responding positively to any large customer request for supply chain integration – especially since your Coral Reef customers (large and unprofitable) are most often the ones that are most aggressive in pushing for these advanced services with no intention of adequately paying for them.
And if you devote your precious resources to supply chain integration with your Coral Reef customers, you are not only buying a cannon – you are walking into quicksand.
Strategic account management’s ultimate prize
Strategic account managers are vital to a company’s success. When you identify and deftly manage your Islands of Profit accounts, you create fast, powerful growth in both revenues and profits – strategic account management’s ultimate prize.
This is the essence of turbocharged strategic account management.
The critical question for all strategic account managers is: Can you identify, secure, and grow your Islands of Profit Accounts, and laser-target new accounts that belong in this group?
If so, you have an opportunity of a lifetime to build really fast, strong profitable growth.
Recently a friend, who is editor of a leading business publication, sent me this note:
Another question for you. How valuable do you think segmentation is for omnichannel retailers?
Should every retailer do this type of analysis before deciding whether it should engage in same-day fulfillment and delivery?
Appreciate your thoughts.
I wrote back the following:
Thanks for the note. Great question.
Profit-based segmentation is absolutely critical for retailers, both for traditional business, and for omnichannel and possibly same-day deliveries.
In virtually all companies, the majority of transactions and customers are largely unprofitable, while the minority are highly profitable. Most of the cost and inefficiency comes from the unprofitable portion (which I call the Minnows and Coral Reefs). Why give unprofitable customers enhanced services that make them much more unprofitable – and remove resources that should be spent on making the Islands of Profit customers even better served?
Major changes are sweeping through retailing and distribution, upsetting traditional ways of operating. These changes bring huge new risks and enormous new opportunities. If managed well, a company can leapfrog its competitors, carving out a leading position for years to come. But if not managed thoughtfully, they can cause costs to explode, service to drag, and market position to falter in a surprisingly short period.
What are the key elements of success?
Over the past several months, I have worked with a major retailer that is a leader in its segment. This highly-successful company increased its already-strong profits by nearly 300% using profit-based segmentation in combination with a range of powerful enhanced services including omnichannel retailing and same-day deliveries.
The core to understanding how to craft a powerful, multi-dimensional, enhanced service strategy is profit-based segmentation, which is rooted in profit mapping. I’ve written about profit mapping in my book, Islands of Profit in a Sea of Red Ink, and in many of my blog posts. The underlying methodology is to create a full P&L on every transaction, or invoice line. You can aggregate these in a database, and unravel a company’s complex profitability picture along any dimension – customers, products, vendors, segments, sales reps, and others.
For example, we have developed a very powerful, sophisticated system that does big data profit analytics, including profit mapping; for more, please see: www.profitisle.com .
Profit maps are critical to developing and deploying new enhanced services like omnichannel retailing and same-day deliveries. They tell you where you are making money, and therefore where you can and should invest in enhancing customer service because you will get much more in return. They also tell you where you are losing money, and thus what parts of your business will become even more unprofitable if you continue to layer on more and more enhanced services.
Consider the following example, a disguised version of a very-successful company:
This is a very typical picture of a successful company’s profit landscape.
Islands of Profit. Only 9% of the customers are Islands of Profit – the company’s high-revenue, high-profit sweet spot – yet they bring in 47% of the revenues and a whopping 142% of the reported profits.
Your prime business objective is to secure and grow this segment of your business by building loyalty and providing terrific value, while attracting more customers who fit the profile. You should provide a full range of enhanced services to this segment because the payoff is very high, because it builds very strong competitive advantage, and because these services will enhance this key group’s loyalty.
Coral Reefs. On the other hand, Coral Reef customers – high-revenues but low-profit – represent 26% of the customers and 30% of the revenues – but only 6% of the reported profits.
These customers are large, but marginal or unprofitable. They don’t warrant provision of enhanced services unless you have a very well-managed program to convert them to Islands of Profit.
Note that most marketing analyses would treat both the Islands of Profit customers and the Coral Reef customers as the same because they focus on revenues, not profits. In fact, nearly all marketing analysts do not have the sophisticated analytics necessary to sort this out. In fact, because there are over three times as many Coral Reef customers as Islands of Profit customers, most services aimed at this combined group will be dissipated on unprofitable and marginal customers.
Minnows. These customers – low revenues and low profits – account for the majority of the company’s customer base, and 20% of the revenues – yet they actually eat away 50% of the profits made from other, primarily Islands of Profit, customers.
Minnow customers are small and unprofitable, yet in most companies they account for a majority of the business activity and a disproportionate amount of the costs. Simply offering enhanced services to all customers will mostly benefit the Minnow customers, with little return and wasted resources. Offering enhanced services only on larger purchases is similarly flawed because the purchase may well be unprofitable, and because an Island of Profit customer with an occasional small purchase surely warrants enhanced service in light of the overall relationship.
Your objective for this group is to minimize your cost exposure, unless you can convert them to Islands of Profit customers. For the most part, providing Minnow customers with enhanced services merely throws a lot of good money after bad.
It might be argued that some Coral Reef and Minnow customers might be enticed to become Islands of Profit, and thus should receive enhanced services like same-day deliveries. Often, this becomes a strong marketing argument. The right way to handle this situation is to offer the service on a trial basis, and to monitor carefully whether the customer’s purchase pattern changes and the customer actually becomes an Island of Profit.
Palm Trees. This company has only a few Palm Tree customers – low revenue but high-profit – with 3% of the customers generating 3% of the revenues and 3% of the profits. This is a small group, but important to the company’s prospects for future profitable growth.
In this way, profit-based segmentation enables a company to offer a powerful range of enhanced services, gathering huge benefits from its high-profit customers, while keeping its costs under control.
Powerful new services
What does this mean for the development and deployment of new enhanced customer services like omnichannel retailing and same-day deliveries?
It makes all the difference between success and failure.
Most companies simply assume that these enhanced services are new capabilities that they should offer to all their customers. This is a huge mistake, and it is rooted in a fundamental misunderstanding of customer service.
Customer service is correctly measured by how often you keep your promise to your customers. But you do not have to make the same promise to all customers. Here’s the dilemma: if you try to give the same fast or enhanced services to all your customers, your costs will explode – or your service will degrade across the board, unless you pour inordinate amounts of resources into customer service.
Better to define different levels of order cycle time or enhanced services for different groups of customers, with your Islands of Profit customers receiving the highest level of service, but with all customers consistently getting what they were promised. This way, you will be able to keep your service promises to all customers at a reasonable cost. For more on this, see my blog post on service differentiation, The Dilemma of Customer Service.
Thus, service differentiation is the key to linking profit-based segmentation to provision of enhanced services like omnichannel retailing and same-day deliveries. For example, think about omnichannel retailing, which many companies are considering in response to moves by Amazon and others.
Omnichannel retailing is a very powerful marketing approach that is now emerging. Many companies see this as necessary to stay competitive. Yet, it can be enormously expensive and unproductive if not constructed in a thoughtful way.
Profit-based segmentation is the key to getting it right.
Let’s return to the profit map. The omnichannel issue is analogous to the same-day deliveries issue, in a very fundamental sense. The question is whether a company simply assumes that its omnichannel resources (and same-day deliveries) should be spread across all customers and potential customers, or whether they should be concentrated where they provide the highest returns – the Islands of Profit customers.
Certainly, all-purpose websites are open to all potential and actual customers. However, really effective omnichannel retailing entails much more than that – enhanced services ranging from recognizing who is coming onto the website, to offering select customers custom views and online chat, to following up by email and phone, to enabling the customer to receive expedited shipping or priority on local store inventory.
The decision of how much to invest in enhanced services like omnichannel retailing and same-day deliveries should and must be determined by profit-based segmentation: it is not a question of whether to offer these services, but rather to whom to offer them. And, if the answer is effectively everyone, your best customers will wind up getting very thin gruel indeed.
As we saw before, Islands of Profit customers warrant the enhanced services that characterize really effective omnichannel retailing because they will generate ample profits that defray the cost and provide a strong return. If an Island of Profit customer occasionally consumes services but only has a small purchase, the overall value of the relationship still warrants great service.
On the other hand, in the absence of profit-based segmentation, companies most often fall back on simple segmentation based on overall customer revenues or order size. Both of these segmentation measures are fundamentally flawed, and will create major profit drains that result in the inability to build great services aimed at those who really count.
Offering full omnichannel service, and similarly offering same-day deliveries service, to all customers simply dissipates resources faster, and leads to even less for the Islands of Profit customers who generate the company’s core profitability.
The worst case
The worst case scenario is that a company offers omnichannel services, same-day deliveries, and other costly enhanced services to all customers, quickly runs short of resources, and winds up with a meager, uncompetitive offering.
The biggest danger here is that if a smarter competitor develops a service differentiation strategy rooted in profit-based segmentation, and offers really state-of-the-art services to its Islands of Profit customers – with satisfactory services to its other customers – the competitor will pick off the best Islands of Profit customers from the other firms in the business. This will leave the other firms with only the marginal and losing portions of their businesses.
The smarter company that rooted its strategy in profit-based segmentation will leapfrog into a leading position, while the less thoughtful companies will see their key sources of profitability dwindle away.
The lesson? The key to success in this new competitive world is to shape and focus your strategy using profit-based segmentation. You will sprint to an early competitive lead, and harvest the enormous first-mover advantages for years to come.