Cost reduction only or Profit optimization too?

Now days wherever we are, with friends or colleagues or customers or conferences we are sure to hear about the downturn and the various ways people are trying to sustain in this kind of scenario. People are talking about the postponement of projects, reduction in people, reduction in expenses like from travel, communication up to printing stationery. Quite a few organizations are also looking for the programs to improve the costs in the organization using productivity improvements, process management and waste removal in processes. Some organizations are asking their vendors to reduce the prices, accept longer payment schedules. At some places there is only a directive from the top management to reduce ‘x’ percentage from the operational expenses and then the department heads are chopping expenses like anything.

All these steps are being taken to maintain or maximize the retained money with the organization when there is a reduction in the revenue. This retained money is nothing but the net profitability of the organization. This is even more important for the publicly listed companies where the ‘quarterly results’ pressures are even bigger.

On this background when I go for making people understand the benefits of Activity Based Management (ABM) to their organization, they are still in the same mind set. I mean they are thinking of the same ways of reduction of cost and then try to see how your concept or solution is going to help them. The solution providers are also in the race to show them the ‘cost benefit analyses’ of their solutions. I am not saying this is a wrong way to look at the situation or even handle the situation, but there is another angle to this also and people are less attentive to.
My position is that understanding profitability is always important for any organization and it is even more important in the current economic scenario. This profitability is about product profitability as well as customer profitability of the organizations. It not true that, the organizations do not know their product or customer profitability, but is not the ‘true profitability’. This is because the way in which the traditional costing calculates the profitability of the products and it calculates the cost of product by taking all the expenses to the product.

When we calculate the customer profitability using ABM we are segregating products costs from cost of selling those products to various customers and hence it gives accurate customer profitability. In the diagram where customer profitability is plotted we can see that the first 10-12 % of the customer bring the 100% profit that you are getting. So if we speak theoretically, we can say, we will deal with only these customers and still get the same profit for the organization. But is that the potential of the organization? I would say no. A big ‘NO’. Because there are next 30-40% of the customer that take you to the 300-400% of current profit levels. The next 30% of the customer that are almost ‘no profit-no loss’ type of customers and the last 20% of the customer bring you to the current level of profitability.

Organizations should understand this potential in their organization and get the visibility of the real ‘culprits’ for the situation. By understanding who those customers are, that are eating the profits earned from the organization and also finding the behavior pattern would help the organization retain profit at a higher level than today.

Using Activity Based Management can help organization to find out the true profitability of the products and customers and build a graph like this. The efforts that the organizations are putting in the improvement of costs with various methods will definitely help them in the current situation, but unearthing this huge ‘profit potential’ in the organization and acting on that will make the organization to remain healthy in the current economic scenario.