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Hi. Alan Stratton here from Cost Matters dot Com
In this series of posts, I have discussed powerful questions to find cost reduction
or cost optimization opportunities at an activity and business process level. Then I went on
to explore cost reduction opportunities in product overhead. But I have saved the best
for last. In the past, business was about making or
delivering a product. In the past, products were tangible, physical objects with apparent
intrinsic value. Products took time to assemble or manufacture, to move them through a distribution
network, and to deliver them to customers. End of story. With the amount of money tied
up in products, coupled with their intrinsic value, business management, inventory valuation,
taxation, and financial reporting all evolved to support this model.
However, in more and more modern businesses, there is much more than just physical products.
Customer relationships are must more prominent. A larger share of revenue depends on products
and services that are not physical objects. Due to this shift, an ever increasing share
of corporate overhead has very little to do with what has traditionally been included
in product cost. Further, business management, inventory valuation, taxation, and financial
reporting have not yet evolved to support this new business environment.
Fortunately, Activity-Based Cost (ABC) analysis can fill this void. An ABC analysis applies
to any sort of activity. For customer value analysis, we select activities that support
customer relationships. Activities related to products are driven to products; Activities
related to customers are driven to customers. Now, in the second stage analysis, instead
of driving cost to a product, drive it to customers. For now don’t worry about product
costs, these will come to customers via the products they purchase.
When properly done, we now have the convergence of revenue, cost of products and services,
and cost to serve customers. We now can see if what a customer purchases supports the
cost we incur to serve them. When we see a relationship out of balance, we have the tools
to do something about it. Remember cost drivers from the first part of this series? Possibly
the customer always orders in very small quantities, requires a lot of special services, always
pays late, or anything else. In addition, they may only purchase low margin products.
Remember that we have a more accurate product cost also.
In contrast, without ABC, most companies used customer revenue as a measure of profitability.
But, revenue does not reveal all the “specials”. Many ABC analyses have revealed that companies
make many times their ultimate net profit with a small percentage, about 20% or less,
of their customers. About 60% of customers break even. The remaining 20% of customers
cost them a lot of money, many times the company’s ultimate net profit.
Customer value depends on customer profitability. Without an accurate cost to serve, who can
know profitability and customer value? With this information, we can focus on better serving
profitable customers and fixing what we need to fix with unprofitable customers. Where
can we fix it? We fix cost drivers from activities, discussed in part 1. We fix processes, discussed
in part 2. We fix how products consume activities, discussed in part 3. And now, we fix how customers
consume activities, discussed in this post. We have the tools to distinguish a profitable
relationship from an unprofitable relationship. Once we can distinguish one from another,
we can prioritize and fix those that are broken. We know where to go to improve our bottom
line.
What are your experiences finding hidden money? Please share below this post at Cost Matters
dot com.
When cost matters, profits soar. This is Alan Stratton from Cost Matters dot Com THANK YOU