Islands of Profit in a Sea of Red Ink Blog
This blog contains commentary on a variety of topics related to profit generation and profitability management. If you have comments or questions, please contact Jonathan directly at firstname.lastname@example.org.
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March 20, 2014
How to Turbocharge Your Strategic Account Management
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.
November 21, 2013
Profit-based Segmentation, Omnichannel Retailing, and Same-day Deliveries
Recently a friend, who is editor of a leading business publication, sent me this note:
I wrote back the following:
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.
October 4, 2013
Online Interview with Jonathan Byrnes
Recently, I was interviewed by Margaret Reynolds for Breakthrough Masters. The interview, on accelerating profitable growth, is now available on the web.
Here is the link:
I hope you find it helpful.
October 4, 2013
How to Double Your Market Share While Countering a Price War
Several weeks ago, I wrote a blog, “How to Win a Price War.” A number of readers sent me notes, including my former Harvard/MIT executive student, Tenglum Low. Tenglum was a top executive of both a major Malaysian steel company and a major brewery, and he related his experience doubling his market share in the face of a price war by focusing on turbocharging his company’s value proposition.
Here is his story (slightly edited):
Your article on “How to win a Price War” is great reading, and a reminder to corporate leaders on how to enhance profitability and market share through value creation and value capturing.
Sun Tzu had often reminded generals and sovereigns that the objective of war is not simply killing the enemy, but instead it is ultimately a means to gain power and kingdoms. The best generals know that the real victory is to win a war without the need to fight any battles.
The most effective generals seek to win a kingdom without destroying its resources, so as to fund their next battle. Hence, in the world of competition, we should destroy the enemies without destroying the industry profitability. When we become the market leader, we can command a substantial portion of the industry profit pool.
I remember fighting the Malaysian steel war in the 1990s as a young Head of Commercial of Southern Steel. Within three years, we grew from 30% market share to 60% market share in domestic wire rod. Many strategic moves were played in the near duopoly market.
Today, I would like to narrate our moves in response to steep price discounts by the market leader at that time.
The steel products were near homogeneous in quality. But despite this, the slight differences of the products of the steel mills – if synchronized well with the production equipment of the customers – can make great differences in customer productivity. Hence, if any steel mill became the dominant supplier to the users, it could “re-synchronize” its products with the customers’ equipment, and thereby significantly enhance the customer’s productivity. Then, if the customer used the same drawing process with another supplier’s wire rod, the customer’s productivity would drop significantly – and these losses would be much greater than any price discount offered. This essentially locked in a relationship with very high switching costs.
With this knowledge in mind, we evaluated the customers through a new paradigm. We looked at the concept of “supply chain versus supply chain”, and how we could focus on growing carefully targeted customers in order to grow our sales.
The customers, at that time, could be segregated into six areas of downstream products. We decided that we could not be a supplier to all the customers in each segment because each of them wanted to become the leader in its respective downstream segment. Customer competition was extremely intense. We decided instead to pick a few leading players in each downstream segment and nurture them into market leaders. These customers needed to buy more than 70% of their steel requirement from us in order for us to “re-synchronize” our products with their production equipment, thus giving them the great benefits of higher productivity, and, once this transition was made, the 30% supplied by our competitors would have an inferior value proposition.
To enhance this mutually beneficial relationship and generate more sales, we supplied them with very competitive prices for their export requirement, which filled up their surplus capacity.
Meanwhile, our competitors offered price discounts to their customers in the nail segment to disrupt our dominance.
At that time, nail customers used 0.12 carbon killed steel as their raw material, priced at RM1200/metric ton. (Killed steel is a lower grade of steel, which has a lower drawability than rimmed steel.)
Our competitors offered our customers 0.08 carbon rimmed steel at RM1250/metric ton instead of the usual RM1300/metric ton, which was a big discount.
However, we understood the following issues:
- At RM1250/metric ton on wire rod produced from imported raw material, the competitors barely made profit (Malaysian steel mills could only produce killed steel, while rimmed steel is imported);
- The 0.08 carbon rimmed steel is good for drawability, but being much softer steel, it is not suitable for the whole range of nails.
Instead of responding by simply following this value-destroying price war, we shifted the basis for the competition by creating a new product of 0.10 carbon killed steel, and sold it to our customers at a price of RM1230/metric ton. This better met our customers’ needs at a lower cost, and our competitors could not follow us.
We made more profit from these products, and the customers also saved more cost!
Eventually, through our “supply chain versus supply chain”, most customers bought more than 90% of their raw material requirements from us.
The moral of the story: The best way to win a price war is not to have one – by turning it into a value war; you will take the best part of the market, while your price-oriented competitors will not know what happened to them.
Many thanks to Tenglum Low, a very thoughtful executive and a great friend - JB