As executives build their sales quotas and financial budgets for the year, many wonder which of their many assumptions and projections may come true. Unfortunately, with the continued market unpredictability in mind, it’s easy to believe that most business outcomes are outside of our control.
In this article, though, I’d like to explore the levers you can control to predictably make an impact on your business: sell-side price performance, purchase-price performance, sales performance, and cost-to-serve (CTS) management.
The profitability success formula is startlingly simple: Buy Low, Sell High, Sell More, and Manage Your Expenses:
Profit = Sum of ((Sell Price – Variable Cost) x Quantity Sold) – Fixed Costs) for all customer/product combinations
Since the Profit equation has only four variables, there are only four levers that matter and they are all rich in opportunity. To maximize profitability, you must strive to sell more, at the right price, at the right purchase cost, while managing expenses. Let’s consider how companies can maximize the impact of each lever.
#1: Sell Price (Sell High)
Sell price is the price your sales team captures from your customer, in each transaction you sell over the course of the year. Most companies have a variety of pricing layers and pricing methods that determine the actual, realized net sell price in each combination. They may have a list price, which sellers discount against to determine a customer’s net price; or a cost and applied margin. Or, if a company sells through channel partners, it may have a combination of list prices, standardized channel discounts/multipliers, and special discounts.
In all these pricing layers, there are two key culprits that lead to pricing underperformance: strategic defects and executional defects. When thinking about your pricing from a strategic perspective, you may find your pricing layers are:
- Based on cost-plus, not market pricing
- Overly generalized (“peanut butter pricing”), missing margin opportunities on specific, less-sensitive customer/product combinations
When thinking about how to execute pricing opportunities from an executional perspective, you may find:
- Every sales rep does their own thing, missing opportunities to extract margins on low-sensitivity items
- An overwhelming amount of unnecessary pricing overrides and customer-specific pricing line-items, particularly on low-sensitivity customer/product combinations.
Addressing leakage in strategic and/or executional dimensions by incorporating a data-driven pricing system and putting clear processes and controls in place can provide some of the easiest profit improvement available to your business. This is typically 200-400 basis points on revenue ($200-$400k per $10 million).
#2: Purchase Cost (Buy Low)
Today, there is an unprecedented increase in the frequency and magnitude of vendor cost increases. In certain markets, where buy-side cost variability is significant due to supplier rebates, special pricing, or cost supports, purchasing proficiency may be critical to maintaining profitability. Since many suppliers suffer from the same issues described in the sell price section, the suppliers’ weaknesses become the buyer’s opportunities.
If vendor costs and increases feel like an opportunity in your business, consider focusing on the following initiatives:
- Improve, tighten and automate your process for passing each vendor’s cost increases through your various pricing layers
- Identify patterns of vendor variances in project or customer cost supports and provide front-line employees with target purchase cost guidance
Tightening your buy-side purchasing performance can often yield significant gains in addition to sell price optimization by uncovering opportunities for additional cost support and/or cost recovery. This is typically 200-400 basis points on purchases ($200-$400k per $10 million).
#3: Sales Performance (Sell More)
Top-line revenue performance is the result of a daily tug-of-war in three key buckets of sales activity. To drive better performance, laser in on each bucket, perhaps assigning a sales leader to manage and measure against targets in a given bucket:
- New-Customer Acquisition: find net-new prospects that share the purchasing characteristics of your best-fit customers
- Existing Customer Growth: grow wallet share of existing products and consistently expand across net-new product lines, while measuring and managing account health.
- Lost-Customer Defections: quickly identify and remediate situations where customers’ buying trends indicate shrinkage or defection.
Supporting front-line sellers with disciplined sales processes, sales competencies, and prescriptive sales recommendations can often boost revenue by 10 to 20 percent, or more.
#4: Cost-to-Serve (Manage Your Expenses)
Net Income = Gross Margin Dollars – Cost-to-Serve Dollars
In the real world, customers (and sellers) often behave very differently regarding efficiency of service. Because controlling cost-to-serve is so critical to your bottom line, consider assigning a project lead to measure and manage the key cost-to-serve buckets where profit leakage is most pervasive:
- Small orders
- Inefficient vendors
- Through-stock vs. vendor drop-ship
- Returns and allowances
- Freight recovery
- Inventory misalignment
- Credit card fees
When front-line employees lack visibility, training, tools or guidance, cost-to-serve expenses quickly become a profit drain for most companies. Because gross margin is more visible and intuitive than net profitability, most companies cede control and accept a random assortment of profit-making and profit-destroying orders, customers, vendors, territories, branches, etc. For most companies, these inefficiencies may amount to 10 percent or more of their net profitability.
Manage Your Company’s Profitability for Years to Come
The distinguishing capability driving profitability in any given business climate is a data-driven, prescriptive approach to defining “good;” rigorously measuring defects; and then training and managing a closed-loop system to remediate defects. Without such a capability, the business becomes a roulette wheel of profitability — where chance dominates competency.
Circling back to the initial challenge, by focusing your energies on the four profit levers you really have some measure of control over, you will become the change agent of your business outcomes. While you may not be able to anticipate macro-level headwinds or tailwinds, you will shift the forces of change in favor of those within your control versus those outside of your control. And that is a defining choice for successful executives: how to identify and execute the changes that matter in the business.
