Channel Mapping for Profit

In my previous blog post, “Customer Intimacy vs. Operations Excellence: Why Not Have Both?”, I explained that leading companies are gaining market share and growing profits by focusing their resources on the customers that are giving them high sustained profitability, and finding new ways to coordinate with these accounts to increase these customers’ profitability.

When these astute suppliers increase their customers’ profitability, the customers give them much more share of wallet, and ease the pressure on the suppliers’ prices. Importantly, the improved operational coordination –  smoother order patterns, improved forecasting, elimination of redundant functions, lower inventories –  reduces the suppliers’ costs and increases the suppliers’ profitability as well.

This process creates a classic win-win: the customer wins and the supplier wins even more. The only losers are the competitors, who see their market share drop and are left wondering why.

This powerful profit dynamic is critical to profitability management, and a channel map is the key to success.

Mapping your channel

A channel map is one of the most important, but least used, elements of an effective profit improvement program. It is the key to big, sustainable increases in profits and growth, especially in your most important accounts. It also provides decisive competitive differentiation – building big barriers to entry based on customer knowledge, relationships, and trust. This enables you to secure and grow your most important customer relationships, and to penetrate and grow critical potential accounts.

The power of a channel map is that it gives you a detailed overview of the cost buildup as your products flow through your company, and into and through your customer’s company. The objective is to identify ways to increase efficiency and reduce cost. You also can use the same technique for coordinating with your suppliers to lower your own input costs.

The starting point in a channel map is to partner with a customer, and select a few representative products. I suggest that you “warm up” by developing a channel map with a relatively small, but very well-managed customer, in order to get comfortable with the process.

In developing the channel map, it is important to work with a willing, engaged counterpart manager from the customer. (This underscores the importance of developing relationships with your counterpart managers in key customers well before they are needed.) He or she will help you understand the customer’s operation and estimate the costs, and in the process you will develop a close working relationship with a customer manager who can help explain the process to his or her fellow managers, vouch for the results, and later help drive the change process.

The second step in channel mapping is simply to trace the product flow through both companies, identifying each step in the process. Very quickly, you will see important points of leverage. Typically, you will find a number of costly redundant functions, and you will be able to spot key points at which information that is readily available in one company will really help the other. This early, easy step is very eye-opening, and quickly shows everyone the value of the process.

The third step is to roughly cost out the steps in the process. As with profit mapping, “70% accurate” information is almost always sufficient. If you have developed an internal profit map of your own company, you will be very comfortable with this process, and it will go relatively quickly. My new book, Islands of Profit in a Sea of Red Ink, explains how to do this.

In this process, it is very important to be comprehensive in your view of cost. For example, channel maps were essential in the work that led to the development of one of the first, most widely-followed vendor-managed inventory systems, which Baxter developed in the hospital supply industry.

A work team from Baxter traced the product flow for representative products through a representative hospital, observing the steps in the process and roughly estimating the cost of each. The hospital’s management had simply assumed that they could gauge the cost of handling the hospital supplies by looking up the budget of the materials management department.

However, when the work team spent time in the hospital actually observing the process, they found that a surprisingly large portion of nurses’ time was spent in ordering and handling supplies, as well as in frequent trips to the hospital stockroom to obtain missing items. When they added in the estimated nurses’ time (based on interviews), it amounted to about half of the handling costs. This was a major issue because there was, and still is, a shortage of highly skilled nurses, and their time is really needed for patient care.

The channel map showed another critical hidden cost: Baxter’s sales reps had to spend an inordinate amount of time expediting product and addressing customer service issues stemming from poor intercompany coordination. In most companies, removing this needless problem in effect increases the company’s sales force by 20-30% – without any cost.

Opportunities for improvement

Once you’ve developed a step-by-step understanding of the intercompany product flow, and an estimate of the cost of each step, opportunities for improvement will literally jump off the page. Most companies are relatively efficient within their “four walls” internal operational processes, but they almost never see the true intercompany picture. This valuable new view almost always shows very easy, lucrative opportunities to quickly improve profitability for both companies.

Returning to the hospital example, the work team observed that the hospital’s metrics included inventory levels, but not handling costs, because the former was easy to measure and the latter was not tracked across multiple departments. Consequently, the hospital CFO managed the hospital’s inventory very tightly, but had no way to understand the essential trade-offs with other important costs. When the team completed the channel map, it became crystal-clear that by increasing hospital inventories slightly on low-value items, both the supplier and hospital could reduce their expensive handing costs enormously.

As another example, the work team was surprised to find that the order pattern for steadily-used products was very erratic, and this was causing very high costs.  They decided that the simplest solution was to set up a standing-order process, in which the supplier would ship a predetermined amount of the steadily-used products to the hospital every week. The hospital could alter this standing order if needed, and receive the  product promptly. This radically lowered the inventory and handling costs for both channel partners.

It also had other important benefits. Because the standing orders covered the same high-volume products each week, the supplier could pack the products on the pallets in the way that was best for the hospital, usually put-away order. This made the shipment very fast and convenient to receive and handle. This seemingly small change was a huge benefit for the hospital’s personnel, and they strongly supported the new process.

Continuing process, continuing value

Channel mapping is not a one-time event. It should become a core component of your profitability management process – especially for the key accounts in your “sweet spot.” This is how you secure and grow your islands of profit; it is one of the most important arrows in your quiver.

Every element in the process is hugely beneficial. As you work with your key customers on the channel map, your managers will develop close, trusting relationships with their customer counterpart managers. This trust is immensely important: it is the precondition to later change management and a huge barrier to entry.

As your managers and their counterparts use your channel map to discover opportunities for profit improvement, a broader set of managers in both companies will develop comfortable patterns for working together. They will have many opportunities for informal talks in which they will get to know each other’s deeper hopes and concerns. This will naturally lead both to work together to develop new ways to create mutual value.

In this way, channel mapping, which starts as a way to develop operating efficiencies, transforms naturally into a core element of an extremely productive strategic partnership. When you achieve this, both you and your customers will strongly and steadily grow your market share and profitability for years to come.

And remember, you can develop the same ultra-productive relationships with your key suppliers as well, harvesting huge profit and strategic benefits for years. Upstream or downstream, channel mapping is the key to ongoing success.

Customer Intimacy vs. Operations Excellence: Why Not Have Both?

Several years ago, popular business books trumpeted the importance of focusing your company by choosing a distinct business model. One best-selling book offered these alternatives: (1) customer intimacy – delivering what specific customers want; (2) operations excellence – delivering quality, price, and ease of purchase and use; and (3) product leadership – creating the best products and services.

While strategic focus is an appealing idea, my long experience working with companies on profitability management suggests that there are other dimensions that are much more subtle and powerful. And much more profitable.

Take the example of the choice between customer intimacy and operations excellence.

It seems obvious that a company cannot both provide individual service to customers and drive operating costs down. After all, individual service is custom-tailored and expensive, while operations cost-minimization requires extreme standardization. How can you have both?

Islands of profit

The answer lies in the central message of my book, Islands of Profit in a Sea of Red Ink. Every company I have seen is 30-40% unprofitable by any measure, while 20-30% provides all the reported earnings and subsidizes the losses.

The core reason why this occurs in so many companies is that managers so often serve all their customers in an “all the same” way. They standardize on a business model, and simply assume that it will fit all their customers (otherwise, they wouldn’t fit as customers).

Leading companies today, however, have shattered this approach to business strategy. And they are reaping enormous, lasting benefits – leaving their competitors in the dust.

Several months ago, I participated, along with the heads of operations of P&G, Chiquita, and Pepsi, on a panel on Supply Chain Transformation. These three leading companies have been creating enormous new profits and market share gains, even in the depth of the recent recession, by doing exactly what the old popular business books disparaged – combining customer intimacy with operations excellence.

All three companies are pursuing a similar strategy. They have analyzed their profit maps, and they clearly understand which customers are providing them with high sustained profitability – their islands of profit. They have the insight and discipline to invest considerable resources in securing and growing these customer relationships.

It turns out that the best way to secure and grow a key customer relationship is to integrate your operations with those of your customer – in a highly individualized and effective way. When you do this well, you lower your key customer’s cost and increase the customer’s profitability. This pulls through surprisingly large sales increases, often 35% or more, even in highly-penetrated accounts.

As a P&G vice president once observed in an MIT workshop, “We sell to Wal-Mart’s CFO.” That’s why P&G’s account team in Bentonville Arkansas includes a very strong component of financial managers. Their job is to calculate Wal-Mart’s increase in profitability created by P&G’s supply chain and marketing integration, and use this information to pull through even more product sales.

What’s happening here? Customer intimacy combined with true operations excellence driving customer profits, and creating big revenue increases.

Virtuous cycle

But that’s not all. At the same time that these three companies are creating huge customer gains through custom-tailored operations integration, they are radically lowering their own operations costs. How? By smoothing order patterns, tuning customer inventories, deploying substitutes in carefully-selected situations, and other measures.

These initiatives shift the focus of supply chain efficiency initiatives from optimization solely within the vendor’s “four walls,” to optimization of the joint vendor-customer supply chain. This shift creates enormous new efficiencies – for both companies.

Fortunately – well, insightfully really – all three companies invest a major portion of their operations efficiency gains into deepening their key account relationships, especially operations integration. This smart move renews the cycle, enabling them to create even more customer profitability, to further grow their market share, to gain new operational efficiencies for themselves, and to gather even more resources to invest in making their key customers ever-more profitable – renewing again this endless virtuous cycle.

The key to success: customer intimacy merged with operations excellence.

Sea of red ink

But that’s not the whole story. There are two keys to success. The first, described above, is the ability to use custom-tailored operations excellence to lock in and grow your most profitable business – your “sweet spot” in the market, your islands of profit.

The other key to success is to create differentiated serving models for your other segments. For customers who are important, but not willing or able to partner well, you can develop other, more appropriate relationships backed by clear, distinct service models. For yet other customers who did not warrant integrated relationships, you can offer more standard, menu-driven approaches. (I cover this thoroughly in the Operating for Profit section of Islands of Profit in a Sea of Red Ink.)

One major company even told its smallest customers that unless they could order a truckload of product a week, they would only serve them through master distributors (who specialized in serving small order customers very efficiently). This enabled the company to draw back a major portion of its resources, and channel them into more rapidly growing its “sweet spot” customers.

Multiple parallel service models

What does this mean for the profit-maximizing manager?

You have to move beyond the old “one size fits all” approach to business strategy, and understand that within your book of business, you have a number of very different types of customers – and that each type of customer, or market segment, requires a different, appropriate, cost-effective service model (and degree of operations integration).

For your most important “islands of profit” customers, you may need to customize individual, highly-integrated supply chains. For other customers, you probably need a relatively small number of standardized serving models tailored to each of your market segments. How many? Old Byrnes family recipe: perhaps 5-10.

This more subtle understanding of your business will enable you to secure and grow your islands of profit, and convert your sea of red ink into a very lucrative expanse of business.

Customer intimacy or operations excellence? False choice. The right answer is: the right blend in the right places.*

* Thanks to Brent Grover of Evergreen Consulting for pointing out this terminology when we participated, along with Klein Steel’s Laurie Leo, in a panel at the recent Waypoint Analytics Advanced Profit Management Conference.

What’s Wrong With a 95% Service Level?

Customer service level is a core measure of company performance. This measure seems completely obvious: after all, if you increase your line-fill or case-fill from 94% to 96%, your customers will surely be much more satisfied. And satisfied customers will buy more from you, increasing your profits. Right?

This seemingly simple logic has critical flaws that are very important for your company. Is your objective simply to maximize average customer satisfaction? Or is your objective to maximize your company’s profitability and growth? These are not necessarily, or even often, linked.

Think about the following questions, in the context of a company with a 95% service level.

  • Which customers get the bad 5% of your service measure? How would you feel if your best customers – the customers in your company’s “sweet spot” (those that produce the most profit and have the highest growth potential) – received unreliable service 10% of the time, while your marginal customers enjoyed 99% service? How would you feel if both your best customers and your marginal accounts received the same poor service 5% of the time – after all, this is what the measure indicates.
  • How bad is the 5% deficiency? Is it hitting key customers running a VMI or cross-dock system with one week delays, or is it hitting customers carrying ample inventories with an overnight delay? Is it hitting critical products or commodity-like products with many substitutes?
  • What price are you paying for making promises you can’t keep? If you always made realistic customer service (order cycle) promises that you could keep virtually 100% of the time, would your customers trust you with a slightly longer order cycle, or are they simply insisting on very tight cycles to give themselves “breathing room” for your service deficiencies?

When you focus on aggregate measures of customer service, in reality you are maximizing what’s easiest to measure, not what gives you the most profitability and lucrative growth. This is another artifact of the Age of Mass Markets, when companies distributed as widely as possible, customers had plenty of inventory, and computers were in their infancy.

Service differentiation is a much more effective way to frame and measure customer service. In a nutshell, you should make different order cycle promises to different customers depending on your customer relationship and the nature of the product.

Consider a simple 2×2 matrix, with core and non-core customers, and core and non-core products. A core customer is a significant steady customer, often one whose supply chain is integrated with yours. A non-core customer is a smaller, occasional customer, or even a large, high-potential customer that uses your competitor as its primary supplier. A core product is either a high-volume product or a critical product with no substitutes. A non-core product is a slow-moving product, not critical, and often with ample substitutes.

If you think about each quadrant of the matrix, it becomes clear that each quadrant’s customer/product characteristics logically suggest a different order cycle.

The core-core quadrant requires fast, completely-reliable service, and here a 95% service level is particularly deadly. For non-core customers ordering core products, you might offer guaranteed 2-3 day service, but always keep your promises. This will allow you to produce 100% reliable fast service for your core customers (from local stock), while gaining the leeway to source product from centralized stock to meet the occasional spikes in demand that non-core customers sometimes produce with occasional large orders. The alternative is to carry a huge amount of costly safety stock in the effort to treat all customers the same.

There are important exceptions. If a non-core customer is a high-potential account that a sales rep is working intensively, it can be bumped into the core category, as long as you reexamine this after a period to see whether the relationship has changed.

The service differentiation logic is similar for your non-core products. By definition, non-core products are those not needed urgently. When a core customer orders a non-core product, most of the time it can be sourced from local stock, with an order cycle of perhaps 1-2 days.

The big cost drain occurs when non-core customers order non-core products. Here, you will need a massive amount of local safety stock to meet an aggregate measure like 95% service level (with short cycle time). The correct course is to make an order cycle promise of perhaps 3-4 days, so you can source the product from a centralized pooled inventory.

Three important customer service principles emerge: (1) you should match your order cycle promise to the nature of the customer relationship and the product characteristics; (2) you should make different promises to different segments of customers for different segments of products; and (3) most importantly, you should always keep your promises.

The right measure of customer service is not aggregate line-fill and case-fill: it is always keeping your promises. Service differentiation will enable you to maximize your profitability and to develop high sustainable profitable growth. The classic dilemma of trading off between cost and service is an obsolete, misleading concept. It assumes that all customers and products are the same.

You can have your cake and eat it too if you have clarity, focus, and follow-through – and you let go of the tacit goal of trying to be everything to everyone.

Think about another common measure of customer satisfaction: net promoter score. This is a commonly-used measure that compares customers who would recommend you against customers who would not. The problem is that this is another aggregate measure with all the flaws of an overall measure of customer service level.  (Aggregate surveyed customer satisfaction has the same problem.) Clearly, the customers in your “sweet spot” should have net promoter scores off the charts, or your islands of profit will be sinking beneath the waves.

What about the rest of your customers? If you implement service differentiation effectively, they should also have a very high net promoter score. They will have a clear understanding of their relationship with you, they will trust you to always keep your promises, and they will know exactly what they have to do to change their relationship and therefore their order cycle.

In business, the worst news is not knowing what to expect.