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Perform Key Measures and Increase Margins

An Interview with Bruce Merrifield, Jr.

PFW Password - Spring 2005 D. Bruce Merrifield, Jr. has run his strategic consulting and business speaking practice -- Merrifield Consulting Group -- since 1980. Merrifield specializes in how to maximize the effectiveness of independent distribution channels, high-performance service management and the impact of electronic commerce on distribution channels.

In light of this PFW Password's focus on customer profitability, we thought it would be valuable to receive a specialist's view. We spoke with Merrifield in search of answers as to how dealerships can obtain key numbers and initiate processes designed to improve margins.

What kinds of information measures -- metrics is the technical term -- does a dealership need to retrieve from its database, and in what forms should this data be expressed?

You need to find an appropriately complex formula for computing and ranking customer profitability (See "The Formula for Customer Profitability" below). I prefer a crude method -- like peeling away the layers of an onion. Do a quick-and-dirty first cut, then, with more insight, do another layer of analysis. If you format results in an exception ranking report, you can address the extreme, high-leverage opportunities. Note: Exception ranking reports for slow-pay accounts are another extra-cost dimension way to look for those accounts that are losing money for the dealership

A good, experienced credit manager can tell you off the top of their head which accounts are the chronic, abusive players to further investigate. A more exact and automated approach would be for the computer to calculate the month-end total receivables and days outstanding for each account and store this information in the customer master file for twelve months or more. Then every six months you can run a ranking report for the accounts with the longest outstanding-days average to the fewest, investigate further, and take appropriate action. Don't pretend that the deadbeats are paying all of their late charges. Most firms write most of these off.

We need to rank customers, where the variables will be number of transactions versus margin. If you have a customer profitability ranking, then you can determine a niche market. Of course, there is overlap for these customers. There is only one way to be at the bottom of such a report: little margin activity and lots of transactional expense, which always causes a loss. Run this profit ranking report for each profit center, each service division, and each sales territory. Identify who is the most profitable by subgroup, and by kind of business, and delineate them into small (cash and carry), medium, and large. Who are they and what are their complaints? The answers to these questions should help to determine what their niche is. In general, we are too busy reacting -- we need to be more proactive.

Additionally, Merrifield points to the following as key considerations:

• The gross margin dollars, per employee, on an annual basis -- the value added per employee is what supports premium compensation for jobs done.
• We should determine if outside sales is making too many sales calls relative to the cost.
• The markup on the product you are pushing. Because out of sight is often out of mind, channel partners will often take these shock absorption services for granted and free, if distributors don't measure true, extra costs and values and market them to earn special fees to ensure making a profit. Distributors assume they will cover these costs and then some with their markup on their regular product sales to the customers, but according to a customer analysis they usually don't. Eighty percent of the typical distributor's customers are currently at break-even or less than break-even.
• Complex models result each time you factor in an activity-based costing (Bill of Material plus a Bill of Activity -- labor plus overhead). Prepare a monthly "5-5-5 report" -- an activity-based-costed profit and loss analysis of the top five most profitable, the top five least-profitable and the top five most promising customers -- coupled with a list of questions, for example, What should be done to make sure we don't lose this customer? Most [distributors] would do well to segment customers and look at them through the profitability lens. Absorb costs for the few customers who are outrageously profitable and, with the others, use it to negotiate.
• In order to achieve service process excellence, you'll need a manager to track the raw occurrences -- which can then be translated into graphs and spreadsheets "on the wall". For example, Dell Computers has reduced their labor to eight minutes per PC, uses the "just-in-time" production model, and receives quick payments by credit card. The number one measure which shows that you need to employ great people for long periods of time is Gross Margin Dollars per Employee. Without a high number here, you can't absorb labor costs. Note: Gross Margin Dollars per Employee is calculated by taking the net sales-cost of goods sold, divided by number of employees.
• "Tax Reinvested in Employee" is the profit-after-tax per employee reinvested to grow the company -- and the employees' -- future.
• Know or share basic service metrics that are tuned to target customer niches so that employees can know how well they are taking care of the customers that in turn take care of them by staying loyal and buying more. Tell the employees who the top five most profitable customers are, along with the top five most important target accounts, so that anyone can step up to give an extra service effort for these customers if given the chance.

So, now that we have the information, how do we apply the results? We want to know what "hard decisions" may need to be made, in light of our statistical analysis…

Once the customer profitability ranking is determined, then you can see that some accounts -- maybe 50% or more -- are killing the margin, so you should then visit the customer -- despite the fact that no one likes confrontation -- and discuss the fact that the relationship is not good for both parties. The bottom 20%, starting with the last-place accounts, need to be individually analyzed and most likely acted upon in some corrective way. Suggest that each area investigate and shape-up, ship-out, or fully explain their worst accounts. If as a result, these accounts will need to order twice as much, half as often, pay up-charges for their small orders, or leave to paralyze your competition with their losing mix of business, resources are freed. You will be able to take on new, presumably profitable business without adding extra people.

In order to solve the problem, the process may need to be re-engineered in order to limit transactional costs and keep price increases to a minimum, and if certain limits are applied, customers -- and salespeople -- may leave. Salespeople like their own personal magic acts, but if team selling is implemented, the account relationship changes, and management needs to become involved. Essentially, metrics need to measure the right things, like finding those who aren't carrying the load, so the upsizing -- or downsizing -- of people has to be done. Some won't want to change, so they won't be part of the solution. You've got to know when to hold them, and when to fold them.

Can we use this type of analysis in a "preventative" context? In other words, can we predict inefficiencies, and head them off before they happen?

Customer retention is dependent on basic service brilliance -- dealerships need to be 2-8% better than their competitors on all of the most important metrics -- so, from a preventative perspective, the occasional snafu will be forgiven by the customer. If we ask customers why they switched significant volume to some other supplier months after the fact, then we are being reactive again.

Being significantly and consistently better than the competition on service excellence isn't too hard if all of our employees know how and why to super-focus on the 5% of the most profitable customers and the 5% or less of the potential customers that have significant long-term profit growth potential. The questions then become: How do we identify the 10% or less of all customers in our market to super-focus on? How do we re-think our service systems and service training to be consistently brilliant and proactively flexible for those accounts? And, how do we identify all of the losing and "growing nowhere" accounts for whom we must free up activity costs that aren't covered by the incoming or future potential margin dollars?

What common mistakes do distributors make, with respect to underachieving on margins?

Many distributorships have reactive service technicians only, where preventative and proactive service-quality efforts are not made, so the question becomes how do we sell through them to increase the bottom line? So, the daily service business needs to reflect brilliantly in one or two metrics. We need to have strategic insight in order to unweave, and reweave, the business.

How significant is it that distributors create a perception of service value for their customers?

The "little deals" have to be made. Like the old Marriott hotels, where the fine, colored sand in the cigarette holders, monogrammed towels, crested soap, and mints on the pillows convinced people that the hotel's prices are worth it. You have to "live the promise" with customer service, through things like automated reminders. One call, when there are no hassles or break-downs, may produce a big payoff.