Information has a cost; good data doesn’t come for free. Bad business decisions have a cost too. Consider product cost and customer profitability. If you are using standard accounting approaches (developed a century ago to meet the needs of manufacturing), then you are most likely in that camp of bad data leading to bad decisions.

Jonathan Hornby discussed this in his post recently, Top 3 Issues for the CFO, and for good reason. It’s not surprising to find that approximately 30% of your customers and / or products generate 500% of your reported net income, but the worst 20% destroy 400% of that value.

But which 20% is your latest marketing campaign attracting?

Cost and profitability analysis can answer that question – before you implement the campaign. It's as simple as 1, 2 3.

STEP 1 – Get good data

Effective cost and profitability analysis starts with identifying activities and behaviors that drive outcomes and thus cost. Without such an approach in place you are flying blind.

Why? While accurate revenue measurement at the customer and/or product level sometimes has its challenges (are “Acme”, “Acme Corp”, and “Acme Corp, Inc.” all the same company?) it’s the Indirect Costs that create the headache. Those legacy standard cost approaches allocate indirect costs based on some broad-based metric such as revenue, volume, direct material and/or direct labor that has little to do with how those indirect resources were actually consumed.

If you are in the Telecom, Healthcare or Financial Services industries, where is your direct material, and what would be your direct labor? You end up instead with another useless revenue-proxy rather than meaningful, accurate cost and profitability information.

With a good cost and profitability solution, bad data turns good before it’s analyzed.

STEP 2 – Analyze the data

Stack up your customers, offers and channels in terms of how they cumulatively contribute to profit. This can be shown as a graph called the “profit cliff” (the profit falls off a cliff, literally).

Focus on 3 segments, those that: contribute to profit; break even; destroy profit. Perform a cluster analysis for each segment to identify common activities or behaviors.

For those destroying profit use an activity based management solution to create various scenarios that move them to different (lower cost) channels. Work with marketing to calculate their propensity to buy other (profitable) offers that could mitigate the loss. Drill in to actual processes and consider how you could simultaneously improve the process and lower cost for the activities/ behaviors demonstrated by this segment.

For those that contribute to profit, categorize product mix, channel usage, demographics and other descriptive information. Use this to improve your customer segmentation profiles and recalibrate who should be considered your “best customers” – it’s not always those that spend the most.

For those that are break even, focus on life time value and assess which paths they are likely to follow in the future.

STEP 3 – Use the insight, make good decisions

Share the knowledge – embed it in operational systems and help employees understand why and which characteristics are good.

Armed with trustworthy information and on-target analysis, Sales can re-price, cross-sell or migrate customers to more profitable channels and product mixes.

Operations can re-engineer to improve efficiency and value (e.g. shared services). Idle resources and excess capacity will jump out and beg for attention and action rather than being buried and obscured in some standard allocation.

Your Planning function will be able to model the impact of increased energy costs or decreased labor rates on your products and profitability BEFORE you commit to binding business decisions.

Marketing will be able to focus laser-like on retaining and growing your most profitable, high-lifetime-value customers, and sales incentives can be based on the actual margins and profits generated, not just volume at any cost.

Parting thought …

Having an accurate understanding of your true costs and profitability is as big of a strategic competitive advantage as any intellectual property or business model. In fact, it’s the basis for effective and profitable execution of any competitive differentiator.

It’s not the strategies themselves that fail, it’s generally their execution that fails, and having good cost and profitability analysis as the basis for good customer, product and operational decisions is the first key step on the road to successful execution.