How does your business compare to the competition? Are you more or less efficient? Do you have higher costs?
These are important questions because they are directly linked to how profitable your company is and how healthy it will be over the long term. But surprisingly few entrepreneurs have the answers.
The solution is to measure your performance in key areas and benchmark it against other companies in your industry. Benchmarking is a simple and effective way to get a snapshot of how you’re doing in terms of productivity, cost control and other areas. Once you know where your business stands, you can start improving and reaping the benefits on the bottom line.
Benchmarking involves choosing performance measures you can use to compare yourself against other companies. Some will be specific to your industry. For example, a restaurant might track revenues per table. A warehousing business could follow costs per square foot.
Other measures are more general, such as sales per employee or productivity per hour worked.
Benchmarking is a starting point
Benchmarking also has other benefits. It may help to show potential gains if the entrepreneurs were to invest in operational improvements. Benchmarking isn’t an end in itself: It’s a starting point to target processes or activities that don’t add value for your company.
The entrepreneurs are advised to use benchmarking data to carefully assess their operations and identify wasted efforts. Examples can include idle machines, overproduction, unnecessary operations or work, excess inventory, inefficient workspace layout and inadequate employee training.
Not a one-shot exercise
The general pattern is that you get used to doing things in a certain way and it’s not easy to see activities that don’t add value. That’s why benchmarking is so important. It’s also not just a one-shot exercise. Businesses should regularly review their performance data and adopt a continuous improvement culture.
The relevant tools help keep you on track. What you need to do is to regularly look at the indicators and think about how you can improve. If you do it with a sense of commitment. It will lead to a cultural change in our company.
Earn profits
The main aim of a business is to earn profits. Thus, a company has to attract and retain those customers who are profitable. This is known as profitability analysis or customer profitability analysis (CPA). In simple terms – An analysis of cost and revenue of the firm which determines whether or not the firm is profiting is known as profitability analysis.
The age-old 20-80 marketing principle (or the Pareto principle) says that 80% of the profits arrive from 20% of customers. This principle recently received a modification. According to modification the principle can be modified as 20-80-30, wherein 80% of the profits come from 20% of the customers and 30% of this profit is spent in managing the unprofitable customers!
It is not necessary that the top 20% will contribute 80% profits because they too have a cost consideration. A lot of the profits are spent in giving service to the top 20%. Furthermore, the top 20% also receive the most discounts.
The smaller customers on the other hand do not require too much service, they do not get much discounts and they pay in full.
Thus, we find out that both the repeat customers and one-time customers are equally important for a company. That is why saturated industries generally go after new customer acquisition rather than just concentrating on existing customers.
That is also the reason why industrial product manufacturers generally stick with their small customer group rather than going all out for new customer acquisition.
Now the question crops up - what makes a profitable customer? A profitable customer is a person, or company that over time yields a revenue stream that exceeds by an acceptable amount the company’s cost stream of attracting, selling, and servicing that customer.
Profitability analysis
Profitability analysis mainly has a focus on four criteria:
* Customer profitability analysis (CPA) – Which calculates revenue coming from customers less all costs
* Customer product profitability analysis – This equation helps calculate the profitability per product and per customer.
* Increasing company profitability (ICP) – which increases the competitive advantage of a company
* Implementing Total Quality Management (TQM)– which increases the total quality
Let us analyse these criteria in detail
Customer Profitability analysis (CPA)
CPA is based on activity-based-costing and helps in calculating the revenue coming from customers while at the same time removing all costs from it thereby calculating the actual profitability per customer. The CPA is a very important tool for profitability analysis and is frequently used.
Customer product profitability analysis (CPPA)
Some companies have a wide variety of product portfolio. So what would be their benefit per customer per product? To calculate this, the CPPA can be used. This profitability analysis method can be used to find out both – profitable customer as well as profitable products.
Increasing company profitability(ICP)
Companies don’t need to produce products with high value itself, but also products which are competitive in the market because of their pricing. Cost leadership is one of the leading sustainable competitive advantages a company can have. Thus a company has to take care of its cost which will subsequently bring its profitability. Furthermore, any advantage the firm has, should be seen as a customer advantage. Developing on customer advantages will result in increasing the overall company profitability.
Total Quality Management (TQM)
Profitability of the firm also depends on its ability to continuously improve its products and processes. TQM involves everyone and the concept believes that with involvement of the top management, the workforce, suppliers and even customers, the overall output of the firm can be increased and thus the firm will always meet customers’ expectations thereby thoroughly satisfying them and therefore increasing the overall profitability of the firm.
Thus, profitability analysis leads to the company discovering the areas where it is profitable and where it is not. It can help the company decide where it can lower the cost and where it can increase value. As we said in the beginning, the motive of a business is to earn profits and profitability analysis helps the firm achieve the same aim
Efficiency control
If the profitability analysis reveals that the company is earning poor profits in connection with certain products, territories or markets, the question is whether there are more efficient ways to manage the sales force, advertising, sales promotion and distribution in connection with these poor performing entities.
Most important out of those four factors, is the Sales force efficiency. A good sales force structure is adaptive, efficient, and effective. If the sales force structure is adaptive, the company can react quickly to product and market changes without a major structural over haul. A structure is viewed as adaptive if a selling process change resulting from product or market fluctuations can be accommodated within the existing sales force structure.
The money a company invests in its sales force is used to employ sales people and managers who generate calls and interact face to face with customers and prospects. The sales calls are directed at a marketplace, and the marketplace responds to the calls by buying the products and services of the firm. Efficiency reflects the rate at which the sales force converts its money investment into calls.
A highly efficient sales force has a high level of call activity for its investment. Effectiveness represents the buyer’s response to the calling level of the selling organization. A highly effective sales force has high impact per call; it generates high levels of sales for the call investment.
A sales force structure could be geographic or specialized.
Companies using the geographic structure assign their salespeople to sales territories made up of a list of accounts or a group of contiguous geographic units. Each salesperson sells the company’s entire product line to all of the accounts and prospects in his or her territory. The salesperson is responsible for all selling activity in his territory.
Specialized structures
The geographic structure may not be suitable for certain companies. Market, product, and activity heterogeneity and complexity provide an answer
Some company’s market typically has many participants. Some are customers; others are prospects. Some are large; others are small. It is unrealistic to expect them all to be similar. In fact, most markets are heterogeneous; the participants have different needs and requirements. Some customers are price-sensitive, while others desire customization. Some need immediate delivery; others need ninety-day dating. Some need vast amounts of information, while others just want expeditious order processing using the Internet.
Some provide high sales and profit opportunity, while others provide marginal opportunity, perhaps not even enough to pay for the sales force effort. The non-uniformity of customer needs requires a sales force structure designed to accommodate heterogeneity.
In addition to being heterogeneous, some markets are very complicated. They may have many buyers with different needs. For example, when Boeing Company talks to a probable customer for selling a modern aircraft, they have to deal with several influencers.
The financial people need low-cost financing; the operations people need easy maintenance, high reliability, and interchangeable parts; the marketing people want comfortable seating. Airline needs are also highly technical, requiring state of the art engineering. Like Boeing, many products can be highly complex as well.
Salespeople in some industries, such as medical imaging and specialty chemicals, require six- to eighteen-month training programs before they can represent their products effectively.
(Lionel Wijesiri is a retired company director with over 30 years’ experience in senior business management. Presently he is a freelance newspaper writer.)
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