Today’s headlines feature the widespread effects of supply chain disruptions. Most companies focus on how to increase the robustness of their inbound supply chains, but the most important and urgent CFO task is securing and maximizing your company’s long-term profitability by managing the effect on your customers.
Some causes of supply chain disruptions are transitory, like Asian factories temporarily closing due to Covid outbreaks. The most important disruption causes, however, are long-lasting difficulties with intractable infrastructure and political problems. Most U.S. ports are severely constrained by environmental regulations and space limits, along with stubborn institutional problems with intermodal coordination. Global warming promises to exacerbate these structural issues.
This lasting problem requires long-term changes in companies’ plans and priorities, and not just temporary stopgap fixes. Managing this process is one of the most important CFO challenges. Astute CFOs have an historic opportunity to make a massive impact on their companies’ profitability for years. However, first-mover advantages are critical, and the time to act is now, when your customers and suppliers urgently need lasting solutions.
Align Your Product Allocation With Customer Profitability
Chronic supply chain disruptions raise several critical CFO questions:
- Which are my most profitable customers?
- Which products are most important to these customers?
- How can I ensure that my most profitable customers get full allocations of scarce products?
- How can I manage my customer product allocations to convert many of my money-losing customers to high-profit?
Enterprise Profit Management (EPM) is the key to answering these questions, and maximizing your long-term profitability. EPM calculates the full all-in profitability of every transaction of every customer. In our experience using EPM to analyze and improve the profitability of over $100 billion in client revenues over a wide range of industries, the old paradigm of using gross margin to estimate profits is misleading, as it rarely predicts actual net profits.
SaaS Enterprise Profit Management software is available that creates an accurate view of the true profitability of literally every nook and cranny of your business in a few weeks. This view of granular profitability by customer and product is critical to managing supply chain disruptions and maximizing your long-term profitable growth.
Most CFOs intuitively understand that some of their customers produce high profits, while others drain profitability, and many other customers have little profit effect. EPM enables you to identify the exact profitability of each of your customers and products. In our experience, this profit pattern almost always emerges:
- Profit Peak customers—your large, high-profit customers—comprise about 10-15% of your customers, and produce about 150-200% of your reported profits
- Profit Drain customers—your large, money-losing customers—comprise about 10-15% of your customers, and erode about 33-50% of this amount
- Profit Desert customers—your remaining small customers—comprise about 70-80% of your customers and produce minimal profits while consuming half or more of your company’s resources
This is the essential starting point of your supply chain disruption management process.
Your Profit Peak customers are relatively few and very important. You should be in constant touch with them (perhaps weekly) to monitor their needs and provide support. These customers warrant the highest allocation of scarce products. This is a time when extra care and “hand-holding” will enable you to build closer cooperative bonds with your key customers, providing a natural pathway to greater share of wallet. Building a direct supplier CFO to customer CFO link as part of a multi-functional engagement team, with periodic personal calls, is a critical part of this process.
Your Profit Drain customers also are relatively few, and they are important because they drain profits. In our experience, the problem with these Profit Drain customers usually is not below-market pricing, but rather unmanaged operating problems (e.g., overly frequent ordering, problematic product mix) that can be relatively easy to fix, and benefit both companies. These customers warrant a lesser, but significant allocation of scarce products.
However, you have a very important opportunity to engage your Profit Drain customers in a process to fix the operating problems, elevating some to Profit Peaks. You can offer an incentive of a higher allocation to induce Profit Drain customers to engage with you in this process. Again, establishing a direct supplier CFO to customer CFO link for those Profit Drain customers that are working with you to become Profit Peaks is very important.
Your Profit Desert customers are numerous and generate minimal profit. A few of these customers may be appropriate for a development program (e.g. a large customer where you have a low share of wallet, or a new, high-potential account). Generally, however, the Profit Desert customers should get a much lower allocation of scarce products, except your development program accounts should get a higher allocation as an incentive to become Profit Peak customers.
Manage Your Changing Product Mix
Once you have identified your customers’ respective profit segments, the next step is to manage each important customer’s product mix in light of your supply disruption. Because EPM tracks activity and profitability at the transaction level, you can easily identify and prioritize the specific customers of the relevant products, profile their order frequency and infer their willingness to accept substitute products.
This information is critical for sales managers. They can create a specific roadmap of customer importance, product importance to each specific customer, and profit exposure—customer by customer—and create and prioritize a set of strategies to minimize the harmful effects both to the customer and to their own company. As conditions evolve, they can easily renew this information and revise their customer management strategies to reflect the changing environment.
Product managers also have a vital interest in this granular customer product mix information. For example, they might find that a number of important Profit Peak customers favor a particular relatively small supplier, while the company’s small, less-profitable customers were primarily purchasing from a larger supplier. This would alert them to shift their priorities to focus on the smaller supplier that was important to their critical customers.
This granular customer product mix information and prioritization is critical for supply chain managers as well. They need to coordinate with their counterpart managers to channel the disrupted product flow to the higher-priority customers. This may well require a manual systems intervention, as most supply chain order management systems are designed to respond to customer demand, rather than to ration product to high-priority customers.
The most important imperative for CFOs facing disruptive supply chains is to be proactive both by creating the essential granular EPM information, and by partnering with their counterpart sales, product and supply chain managers to create effective action plans to grow their company’s profits and to strengthen their essential customer relationships.
The common reactive alternative inevitably creates short-term profit crises and longer-term customer alienation. Here is the typical progression.
When supply disruptions start to cause shortages, the company’s sales reps act in good faith to advocate their customers’ need for the scarce product. As supply availability tightens, they redouble their efforts to help their customers. This quickly leads to an untenable situation in which they are frustrated and angry at their inability to keep their promises to their customers, and their customers begin to lose their sales reps’ hard-earned trust.
The distribution center, in turn, is deluged with urgent requests (often calling in old favors), but is unable to respond. Some supply chain managers simply agree to favor large customers, which is counterproductive because in most companies many large customers are Profit Drains. Others revert to a “first-come, first-served” policy, which is no policy at all.
The CFO is the key determinant of whether the company is proactive or reactive. Effective CFOs create the right information and develop the right partnering process to translate the company’s priorities into results. This ensures the company maintains its profits, grows its essential customer relationships, and builds customer and market trust for years to come.