Transparency of Profitability
The pinnacle of profitability reporting is understanding your item and customer profitability metrics for organizations selling goods. We’ve seen many times that either the organization’s system cannot capture this data, or the way the system was deployed did not enable both an item and customer profitability view. Depending on the business, they may have either item profitability or customer profitability, but rarely do they have both.
Often an investment into a business analytics system are necessary in order to pull your organization’s data and parse out profitability by item and customer. You really need to understand the customer profitability view and then be able to do a deeper dive into the items that customer is buying, and which are profitable or not.
An organization was selling products through retailers to the end consumer. They were approached by a partner company to supply ingredients to the partner’s products in the same retail channel that were complementary and not competitive. The new industrial supply business would require minimal capital with some bulk load out capability expansion. On the face this looked like a great opportunity to increase the utilization of their manufacturing facilities and enable the industrial business to share in the plant and corporate overhead that was solely borne by the retail business. The organization was forward thinking and set up this business up as its own business unit and therefore leveraged their system to track profitability for these industrial customers and unique items separately from their core retail items.
What happened over time is a testament to the power of customer and item profitability. At the start of this new venture the gross profit margins and operating profit were comparable to the organization’s retail sales. But as time went on and the venture expanded to other partners, the gross profit of the industrial business began to erode, which was readily apparent via the separate industrial business item and customer profitability metrics.
Two things happened to the industrial business over the years. The partners expectations were constantly being raised with regards to quality and timeliness of supply. The requirements became so onerous that significant product rework and waste was created due to these ever-tightening specifications. Additionally, the partners treated the organization as merely a supplier and upon every contract renewal there were heated negotiations on price and ultimately concessions to maintain the industrial volume.
Finally, after many years of supplying product to their industrial partners the organization found that this business was becoming a significant drag to the organization’s profits and was a hindrance to their retail aspirations. If the profitability of the industrial business had been buried into the overall business, it would have taken a lot longer to find, diagnose and socialize the issue. Even with clarity into the industrial business profitability it was still a significant paradigm shift as whole teams had been built around this business therefore creating a lot of angst within the organization.
Ultimately the organization discontinued the industrial business and was able to sell parts of this business to another organization that was strategically focused on the industrial supply chain. This move freed up precious resources that allowed for expansion of their retail line as well as mergers and acquisitions to bolster their retail presence.
This positive outcome highlights the critical need for transparency into your customer as well at item profitability.