For the “Haves” and “Have-Nots” of Cost and Profitability Solution

For a long time we have been talking about the benefits of having Cost and Profitability solution. We have been doing this during the presentations to the prospects, workshops, seminars, webinars etc. The Activity Based Costing/Management concept had been there for more than 20 years now. Still there is a majority of organizations across the globe that ‘have not’ embraced it. Some of the organizations have had it and later stopped using it. The concept itself had its ups-and-downs during those 20 years. On this background we see that most of the times people talk on this subject for those who are ‘Have-Nots’ of the concept. Today I am going to write primarily for those organizations which have already implemented Cost and Profitability solution. It’s just that I cannot resist myself writing about the benefits of this solution for those who do not have it, before I proceed for the ‘Haves’.

Benefits of Activity Based Management (ABM) for “Have-Nots”

a) Information for effective decision-making – ABM provides more accurate information about the profitability of the products, customers, channels etc. This helps the organization to understand the ‘cross subsidization’ among the products/services. It also tells about the profitability of the customers and more importantly the possible causes. This helps the organization to put the resources for the right set of customers to maximize the profitability.

b) Information to continuously improve processes and reduce costs – ABM provides the important information about the cost of various processes. Process is nothing but a set of activities performed in a sequence by one or more functions. With ABM we can understand the cost of those processes, benchmark them against internal or external targets and improve upon them.

c) A relationship between organizational cost and organizational value – ABM provides objective information about the cost of the various activities or processes. We can add other subjective or qualitative attributes like ‘value add’ to these processes. This added value can be seen for customer, organization etc. By comparing the cost of the process or product or customer against the value that is added by it, we can focus and create appropriate action plan.

d) A focus on significant costs – There are various programs running in any organization for the improvement of productivity, reduction of waste, managing processes etc. The unique ability of the ABM initiative is it helps to focus on ‘significant costs’. Otherwise people take various improvement programs, which may or may add significant cost improvement. ABM helps to prioritize the improvement program by combining the objective of the initiative like importance to strategic value, importance to customer value, potential to change etc. together with the cost of the process. By creating a 2x2 diagram organization can choose the processes with high customer value and high cost processes first for improvement.

e) Methods to measure performance with accountability – Performance of a process or activity can be measured at least by three ways. 1) Productivity 2) Cycle time 3) Quality. For example let us take an activity ‘Assemble a product’.

1) Productivity – Cost per assembly, # of assemblies per person
2) Cycle time – time to assemble a product
3) Quality - # of product assemble correctly in first attempt

With this kind of measure we can monitor the performance of various activities. Now the activities are performed by one or more persons. With this we can manage the performance of the activities and people together with the accountability of the same.

Now we talk about the benefits to the “Haves” of Cost and profitability solution. This is not talked about so often, but it is equally important as the use of the data that is calculated is also important for the organization. This helps them in taking business decisions. In the earlier days of ABM, the projects used to be for solving certain business issue. After the model was created and analyzed, people seldom updated the ABM model. The current situation is different, as the results of the cost and Profitability solution can be and is used in other business solutions like Planning and Budgeting, Scorecarding, Customer Intelligence etc. Also the improvement programs in the organization are looked upon as a ongoing exercise rather than one time project. For this actually American Productivity & Quality Center (APQC) had done an exercise and I will be elaborating on the findings.

Best practices for profitability calculations

a) At best-practice organizations, customer profitability is owned by marketing, with finance as a key stakeholder – Though the responsibility of calculating the profitability lies across the organization. The use of the information of profitability and related improvement lies with the marketing department. The Finance department is the custodian of the information.

b) Best practice organization create a organization wide view of the customer – With the help of initial understanding of the customer profitability, organizations use the same information for overall customer intelligence. This leads the organizations to create the ‘one view’ of the customer across the organizations. For example for Retail Banking the profitability of the customer is calculated across the products held like savings account, cash-credit account, fixed deposit account, housing loan account, car loan account, Demat account etc. With this single view the overall profitability can be seen and cross-subsidization in various service fees can be seen.

c) Best-practice partners have clearly defined customer segments and sub-segments – Organizations generally start the segmentation of the customers with the help of demographic information like age, education, life-stage, geography etc. Profitability information helps the organization to segment the customers according to the profitability. The organizations at least segment the customers with profitability deciles (creating 10 groups of customers). Once this is done analyze the behavior of the customer in each of the deciles to understand why the customer is in that category. This helps the organization to create the segmentation by behavior (psychographic). The profitability of the customer largely depends on the behavior and this information helps the organization to improve the profitability by managing the behavior of the customer.

d) Best-practice organizations capture revenues and costs at the transaction level for each specific customer account – This is possible only with the Cost and profitability solutions. With this information at their hands organizations can compare the cost of transactions across the products, channels, regions. The use of channels for various transactions can be seen and the customers can be properly channelized to use the low cost channels.

e) Best-practice organizations take a holistic view of customer profitability and include lifetime value and customer valuation metrics in the calculation – As we discussed earlier the customer profitability information is used for segmentation, marketing campaigns, retention etc. With the available information of past profitability together with the analytical values of propensity to buy and churn, the organization can calculate the ‘customer lifetime value (CLTV)’ and use this information to retain the customers with highest CLTV. Also analyze the behavior of those customers to align other customers.

f) Best-practice organizations include the majority, but not all, of their costs in the customer profitability calculation. Best-practice organizations use appropriate methods for cost assignment – With the help of ‘time driven activity based costing’, we take the cost that are relevant to the various processes. The installed capacity cost if not utilized completely is not taken to the product or customer. This is shown in the ABM model as ‘Cost Available to Use’. Also the cost of various departments that are not related to the customer or product are separated and shown as ‘Cost to sustain business’. This helps the marketing department to use relevant information for taking business decisions.

g) Best-practice partners all work closely with IT. Enabling technologies for calculating customer profitability include data warehousing, CRM systems, data mining, external databases, and predictive analytics – The work with the IT starts with the building of the ABM model. Here most of the data available in the transactional systems is brought into the ABM model with the help of the ETL tools. The no-system-data is also brought with the help of the web-based solutions. Once the results are calculated in the ABM model, it integrated with the other solutions using the warehousing solutions. The historical data is used for predicting the future behavior and the related profitability of the customer.

h) Best-practice organizations emphasize intelligence (e.g., decision support), not routine reporting, in customer profitability information dissemination - The organizations do not create large number of reports for everybody. In fact the information is provided to those who are decision makers and also as and when required. In this the OLAP tools help the organizations to create the ad-hoc reports and the slice-and-dice required across various dimensions of the report. The dissemination also happens now with the dashboards and intranet facilities.

i) Best-practice organizations secure buy-in from the users and upper-level support for customer profitability initiatives – This is the most important factor in the initiative. The buy-in helps the authenticity of the input data as well as the results. This helps the decisions makes to use the output freely for the improvement initiatives and business decisions.

j) Best-practice organizations hold employees accountable for customer profitability – Most of the times the compensation or incentives the sales force is on the basis of the revenue that is booked (may or may not be realized). Typically the sale people sell those products that are comparatively easy to sell and bring more incentive. This may not always tie-up with the overall strategy or profitability targets of the organization. By understanding the profitability of the customers and holding the employees accountable for the profitability, organizations can align the sales force to the overall performance and strategic initiatives of the organization.

k) Best-practice organizations use customer profitability and segmentation to appropriately align sales and marketing resources – With the Cost and profitability solution, organization understands the current profitability of the customers and more importantly the reasons for their current profitability. With this information and the future targets, organizations can plan and employ the resources to maximize the profitability. The Marketing campaigns can be also targeted for ‘right’ customers. This helps in optimizing costs for the campaigns as well as the success rate of the campaigns increases.

l) Best-practice organizations have specific programs/sales efforts geared to their more valuable customers – The cost and profitability solution provides the accurate and detailed customer profitability information. Based on this the organizations can focus on acquisition, retention, cross sell, up sell programs.

m) Best-practice organizations successfully convert unprofitable customers to profitable customers - The organizations can also put their efforts to move the customers from lower profitability to higher profitability zone either by providing alternate products, removing activities that are not required, menu-based pricing etc.

Finally it has been observed and accepted by various organizations that the insufficient profitability insight is hurting the performance of the organization. The most accurate and detailed profitability information is provided by the Cost and profitability solutions. The results of the same can be used for better strategy formulation & execution, better marketing efforts and better matching of the resources to potential.