A few years ago, I was invited to attend the year-end operating review of a major company. The vice presidents were seated around a large mahogany table, with the president at the table’s head.
One-by-one, the VPs said, “I made budget.” Finally, the president looked at the group and said, “I guess I’m the only one in the company who didn’t make budget.” What happened?
When I looked into it, the Sales VP beat her budget, but the new customers were buying products that were not available in the nearby distribution center and had to be expedited from a distant central warehouse. The Supply Chain VP beat his budget by negotiating a discount on the freight rate to bring the products in from across the country. Both beat their budgets, but the company lost money.
The brewer’s dilemma
This incident came to mind a few months later, when I was invited to meet at MIT with the top operations executives of one of the largest beverage companies. The issue at hand was how to reduce the skyrocketing costs at the company’s breweries. When we looked at the operation’s numbers and learned about the situation, the top managers blamed the sales group for selling constantly changing, unpredictable mixtures of products. This was causing havoc at the brewery, which could not stabilize its production scheduling.
By coincidence, a year earlier I had the opportunity to spend time helping one of the company’s major distributors with sales force productivity. I spent a few days riding with several sales reps to understand their situation. It turns out that these sales reps were having serious problems with the company’s accelerating pace of product innovation.
The sales reps were being bombarded by an endless stream of changes. A few were large, like the introduction of an important new product line. But most were small, almost trivial, like a new point of purchase display for a minor product.
What was most striking about this situation was that each innovation, large or small, was accompanied by a new sales objective that became part of the sales rep’s bonus calculation. The reps actually had 15-20 different objectives!
I knew that a sales rep couldn’t simultaneously maximize 15 objectives, and the customers would balk at responding to all these changes. So what did the reps do?
Each rep picked the two or three objectives that he or she thought would make the most difference, and ignored the rest—and most often these varied from rep to rep. This was the underlying cause of the huge problems in the brewery’s operations. How did this crazy, costly situation arise?
I remember talking to the sales reps and customers, and thinking about the widening proliferation of product innovations. I had an image of dueling product managers at headquarters, each producing a stream of product (or packaging) changes because each had to show “progress.” Each was vying for slightly enhanced revenues.
And each product manager was seemingly oblivious to the big picture, including the huge second-order consequences that were degrading the performance of both operations and sales.
In the MIT meeting, I related my experience with the sales reps. I suggested that if I had a room full of their sales reps, the sales reps would have expressed the same frustration with the company’s product management situation. The operations managers were amazed.
In this company, it appeared that product management was “driving the boat.” Each product manager was focusing on only one rather narrow primary measure: his or her product revenue or gross margin—without regard to the overall effect, or to the important (but hard to measure) second-order effects on both sales and operations, and on the customers. The operations and sales groups were stuck essentially “waterskiing behind the business.” And situations like these are happening in company after company today.
Why is this occurring? The answer stems from the transition we have been going through from one business era to another.
Changing business eras
In the prior Age of Mass Markets, which occurred throughout most of the 20th century, revenue maximization was the win strategy. Companies had relatively uniform pricing, cost to serve was relatively uniform as the products were just dropped at the customer’s receiving dock, and economies of scale meant that large production volumes led to diminishing unit costs. And diminishing unit costs meant more profits.
In this situation, product management was indeed driving the boat. Their job was to maximize revenues. Most consumer product companies were characterized by a relatively small number of high-volume brands. In this situation, the cost of the small “tweaks” in products and packaging were small compared to the huge gains in scale.
Over the past 30 years, however, our business system has changed enormously. We have entered what I call the Age of Diverse Markets. In this new era, companies have instituted complex pricing varying from customer to customer, and even product to product. Cost to serve varies again by customer, and even by product within a customer. Products have proliferated into all ecological niches, and flexible manufacturing and outsourcing have enabled many niche products to achieve minimum efficient scale.
Today, profit maximization requires a deep understanding of the interaction between pricing and cost to serve on a very granular basis (individual products within individual accounts). It also requires the tight integration of product management, sales and operations with their counterparts responsible for the second-order costs they so often produce. Chief among these are the critical costs of sales inefficiency and operations complexity—just what the beverage company’s top operations managers and sales reps were so concerned about.
Where you are making money—and why
Virtually every company has huge hidden costs—and huge latent benefits from aligning their departments, but this requires new profit metrics that show the full, true net profits of every company activity. Simply looking at broad average metrics like revenues, costs and gross margin tell you whether the company is making money, but not where and why it is making—and losing—money.
Enterprise Profit Management (EPM) provides this vital information. Over years of experience with EPM—a transaction-level SaaS profit improvement system that creates a full P&L on every invoice line—we have found that virtually all companies have a characteristic pattern of profit segmentation:
• Profit Peak customers—typically about 20% of the customers generate 150% of a company’s profits;
• Profit Drain customers—typically about 30% of the customers erode about 50% of these profits; and
• Profit Desert customers—typically the remainder of the customers produce minimal profit but consume about 50% of a company’s resources.
The same profit pattern characterizes every dimension of a company—suppliers, stores, sales reps, order lines and—importantly—products.
Because EPM shows the all-in P&L details of literally every customer and product, it is easy to see where the company is making money, where it is losing money and why. This is the key to identifying the misalignments (like the brewer’s excessive product proliferation) that are causing huge hidden costs—and the opportunities to rapidly raise profits, at no cost, by remedying these pervasive inefficiencies.
A natural alliance
In today’s business era, sales, operations and product management have surprisingly aligned interests. They are poised to form a natural alliance to maximize profitability, often without realizing it.
This vital transition is shown clearly in the traditional way to sell to important accounts—sales rep ramping up sales volume, then bringing the operations manager in at the end for a courtesy call, or “sales first, supply chain last.” This obsolete and counterproductive approach to account development stems from the past Age of Mass Markets.
In today’s Age of Diverse Markets, all this has changed. Leading companies have found that the most effective way to develop and accelerate sales in their Profit Peak customers is to introduce their operations and supply chain managers to their customer counterparts in their key customers early in the account development process. The operations managers naturally bond with their counterparts, and together they quickly develop innovative ways to work together to create new efficiencies.
This process has two very important results: (1) the customer, itself, will become much more profitable on handling and selling your products, and this will create huge, rapid sales increases for your company—often 30% or more, even in highly penetrated accounts; and (2) in the process, you will lower your own cost to serve. In this way, your operations team becomes an unlikely sales hero—creating huge new revenue increases coupled with lower cost to serve. The best of all worlds.
Surprising operations heroes
In my MIT graduate class and executive courses, I often ask whether in a company all revenues are equally profitable to serve. The answer is “of course not.” It is clear to everyone that some revenues fit the supply chain and operations, while others do not.
This leads to a very important conclusion. The most important way to achieve quantum increases in operations productivity is for the sales force to bring in revenues that fit the company’s supply chain and operations. This means that in a well-run company, the sales reps are primary determiners of operations productivity—the unlikely operations heroes—while the operations managers are a key generator of new revenues, especially in the Profit Peak customers—the unlikely sales heroes.
How to achieve alignment
Does this mean that you must turn away important new sources of revenue because they don’t fit your current operation? Of course not.
It does mean, however, that both sales and operations—and especially product management—have to develop a deep understanding of Enterprise Profit Management, which identifies the complex interaction between revenues and costs on a very granular basis (individual products in individual customers), and they must have highly efficient processes to coordinate and align their sales, product management and operations activities.
When your sales, product management, and operations are fully aligned, your revenues will be maximized and operations costs will be minimized. Today, your supply chain managers should be your most important sales heroes, your sales reps should be your most important operations heroes, and your product managers should be the heroes of both groups.
Four steps to high profits
How can a top manager achieve this high-profit internal alignment? By making supply chain managers essential partners with sales and product management at every stage of the account development cycle—and even before the sales cycle begins.
The key success factor is to get sales, product management and supply chain management on the same page in four key business processes:
1. Relationship structure. If your sales reps are free to agree to a wide variety of customer requests and demands, it places a huge cost burden on your supply chain. The answer is for sales, product management and supply chain management to agree on a set of perhaps four or five standard customer relationships—ranging from arm’s length to highly integrated. Each relationship should have measurable value for both supplier and customer, and a clear to-do list for each party. Then your supply chain managers can create a streamlined process to support each relationship.
2. Market mapping. This is the process of matching customers to relationships based on an assessment of where each customer should wind up. This assessment involves both sales and supply chain factors, like buyer behavior, operating fit and capability to partner. This is very different from simply asking the customers what they want. Your sales process should be focused on moving customers to the right relationships.
3. Account management. In major account relationships, the account development process must involve both sales reps and supply chain managers from the start. In a well-integrated relationship, your supply chain managers can dramatically lower both your customer’s costs—and your own costs—by influencing your customers’ inventory levels, order patterns and other key (mostly supply chain) factors. When you increase your customer’s profitability, it almost always drives sales increases of 35% or more, even in highly penetrated accounts. A top executive of P&G once noted at MIT, “Our customer is Wal-Mart’s CFO.”
4. Product management. For product managers, Enterprise Profit Management provides the key to becoming profit heroes. The critical insights are that the vast majority of a company’s profits come from its Profit Peak customers, and EPM identifies which products they purchase. Certainly, it is vital to protect and build the portfolio of Profit Peak products that these key customers buy. However, it is also very important to protect the less profitable products that are important to these customers, enabling you to grow your positioning as their primary supplier.
In contrast, proliferating the product set primarily bought by Profit Drain and Profit Desert customers is counterproductive, and erodes the resources that you should be devoting to building your relationship with your best customers.
Rapid, sustained profit growth
Maximizing profits is a team effort—a team comprised of sales, product and supply chain managers using EPM to coordinate with each other. Together, they will become your unlikely profit heroes, charting a course and driving your company to rapid, sustained profitable growth.