As business grows, declines, or remains steady, a clear understanding of profitability by segment is paramount. Increasing revenue is great so long as your costs are not increasing disproportionately. Decreasing costs is also wonderful assuming it does not harm your brand or constrain future revenue. Revenue and costs are fundamental for driving profitability, but the focus must be on their combination rather than either as a sole input.
Profitability varies by product, channel, customer, plant, etc. Understanding how these variables impact your profitability enables you to make better decisions. However, truly understanding what drives your profitability up or down is hard. Often businesses do not have the information readily available. Revenue is typically understood at the customer and product level, while costs are not, and it is often hard to allocate costs to this level. A profitability study can provide this level of visibility and help you better understand the business variables that most impact profitability.
Case Study Organization
Recently, I helped a professional service organization do a study to understand profitability across their products and customers. The organization was experiencing revenue growth but also a significant decline in net profit. There was a gut feel across most of the organization that some of their largest customers were not profitable. Internal misalignment created roadblocks for making changes without a clear view of profitability at a granular level.
A profitability study enables businesses to pull together revenue and costs at a granular level to enable a clear understanding of profitability across any segment or sub-segment of the business.
Often the data to build a comprehensive profitability study is not readily available. Costs are sometimes unclear and hard to allocate to the product and customer level. In manufacturing it can be relatively easy to allocate raw materials to a finished goods, but the conversion cost including machining time and labor costs are harder to allocate.
For example, our client did not have a clear understanding of the time required by the staff to serve different customers or “produce” different products. As a professional service business, the largest cost they have is the cost of their employees’ time. To calculate labor costs, we had to understand how employee-time should be allocated to the customer and product level.
Time studies are valuable in determining how to allocate resource costs. Time studies allow you to move from gut feel to using actual data to understand how resources are being used and ultimately should be allocated.
We were able to break down costs and allocate them to the customer and product levels using the following methods:
Product Complexity Classification
Customer customization of products significantly impacted the time required to “produce” different products. Complexity classification allowed for product groupings with similar time standards.
Employee Time Studies
Used to determine the standard time required to produce a specific product.
Documentation of Account Management Time
Our client’s customers had drastically different account management time requirements. Often account management time is left out of profitability studies, but the resource drain from some of the customers was so great, we decided to incorporate this cost.
Figure 1: Profitability Model Inputs and Outputs
The organization had four key products (or product families). During initial discussions, it was clear that each product family had different complexity levels (or levels of customization) depending on the customers’ needs. We needed to create standard costs based on a standard amount of time required to deliver the product. Standard costs could not be done at the customer level. We determined there were three different levels of complexity (standard, custom, and custom plus) across all product groupings.
Next, we had to classify each customer product type to the correct complexity level. The complexity level combined with time study results and standard resource costs, allowed us to calculate standard costs for each product family / complexity combination. With four product types and three complexity levels we needed twelve standard costs.
Many organizations have a significantly larger portfolio of products, but the same methodology can be utilized. In many businesses, the standards are more clearly defined because SKU XYZ is the same as any SKU XYZ, where in professional services (and especially for our client) each product is a little different.
Over several weeks all team members tracked their time by product and complexity. This was a time consuming and slightly painful process, but once aggregated we could create standard time by resource type for each product.
We did this using excel spreadsheets completed daily by each employee. The information collected included:
Account Management Time
Often in profitability models all Sales and General Accounting (SG&A) activities are excluded. The focus is typically purely on gross margin.
With this client, we saw an extremely large variation in the amount of SG&A time required by each customer. Some customers just needed initial set up, then all the business flowed without significant hands-on client management. Other clients required routine travel visits, monthly or quarterly comprehensive customized reporting, and additional value-add services that were not being monetized.
An output from the profitability study would be recommendations to monetize these additional value-added services. Due to the internal struggles to understand the situation and drive change, we decided it was important to incorporate these customer specific additional value-added account management services into the profitability model.
To gather and quantify this information, we spoke to each account manager and documented each customers’ specific needs. We then quantified the travel and resource cost required to support these needs. These account management costs were then allocated to historical sales based on the quantity of products purchased by each customer.
Once we gathered all the relevant data, we consolidated it into a profitability model which provided the capability to view profitability at any level of the organization. To build the profitability model we took historical sales combined with the newly created standard cost from the time studies and the allocated customer specific account management cost. This resulted in calculated profitability at a granular level. This enabled the business to look back and understand profitability for each sale they had made in the previous twelve months
By building the profitability model at the line level, we created the ability to aggregate or pivot the data to view profitability from any viewpoint. We could look at profitability by Customer, by Product Type, by Complexity Level, by Sales Rep, by Region or any combination of these variables.
Results – Call to Action
The ultimate reason for performing a profitability study is to determine what actions a business can take to improve profitability. The profitability study and model create visibility into opportunities, but that visibility has no value for the organization until they can take action based on the learnings.
Key Learning & Recommended Actions
Select customers are highly unprofitable driven by low pricing combined with highly customized products and unmonetized value added services
Charge for value added services
Raise price and / or
Move customers towards more standardized product
Profitability varies significantly by product type – premium level product types have significantly higher profit margins and cause lower strain on the business
Limit sales of lower level product – possibly eliminate lowest-price product offering, automate offering or significantly raise price
Expand offering of premium products
Ensure pricing structure does not allow for degradation of premium product sales and migration of customers to lower level products (clearly differentiate value versus price)
Low volume customers, even when priced at a slight premium, typically have lower profitability
Consider raising prices to the point of acceptable profitability or ending business with smaller customers and / or
Only provide premium product types to smaller customers
A theme I see when working with clients is that having improved visibility into your business through collaboration or improved understanding of your data, consistently delivers by uncovering opportunity. That opportunity might come in a form you are expecting, and the visibility created just clarifies confirming gut feel. Or the opportunity might be in totally unexpected.
Ultimately, understanding and having more visibility into your business and the factors that drive profitability is important. But the opportunities will only materialize into improved profit for the business when actions are taken to capture the opportunity.
If you would like to speak to me more about profitability, please e-mail me at firstname.lastname@example.org
“We used Supply Velocity to rethink our sales process. By analyzing the entire process we found wasted time in our Sales, Admin and Operations departments. Streamlining this process created extra time for each Sales Rep, allowing them to spend more time with Customers and increase the value we add. Gross profit margins are up 40%!
We are now using Supply Velocity to help us rethink our entire Strategic Plan.”
Jeff Reitz, Vice President, Central States Bus
“We are using Supply Velocity’s Lean Six Sigma methods to analyze a variety of processes including rationalizing SKUs (stock-keeping-units). By using math to evaluate SKUs we took some of the emotion out of our decisions. We expect significant increases in sales and productivity from reducing poor performing SKUs.”
Mark Kelso, Director of Process Improvement, Save-A-Lot
“Your process encourages this group to work together, better communicate and have fun doing it.”
George Edinger, President, C&R Mechanical
“We used Supply Velocity on our Warehouse optimization project. One of the key characteristics of Supply Velocity is that they listened to our requirements and provided a clear path for our Warehouse processes using lean tools and our future sales growth as objectives.”
Haris Tokalic, President, Grand Rock, Inc.
“Supply Velocity gave us the tools to analyze our business and processes based on the facts and numbers versus our perceptions. Our common quote was “Let the numbers lead us”. The key for our organization was how quickly we moved from classroom to actual project initiation. We were able to jump in, start using the tools and see a difference right away.
The get-into-action approach was good for our culture.”
Ned Lane, President, CeeKay Supply
“Myerson engaged Supply Velocity, specifically Ray Davis to visit our plant in Trinidad to conduct a two day assessment of our production procedures and provide us feedback on areas for improvement and where applicable, areas for future analysis.
Put simply, we got everything we paid for and in addition to more in depth analysis, we got specific tasks that were immediately actionable. Our local management team found Ray to be engaging, highly credible and insightful based on his wide experience. In other words the cultural differences and lack of specific industry knowledge weren’t impediments to things we could implement immediately and on our own. In a nutshell it was money well spent and will pay itself back many times over.”
Lee Hartwell CPA, Plant Manager, Myerson Tooth
“Supply Velocity created visibility within our Assurance Services Group… visibility of performance, Client-service, employee satisfaction and processing time. Using the Supply Velocity System, Audit Report Cycle time is down over 50%. We are using his strategies to create greater Client loyalty.”
Fred Kostecki, Partner-In-Charge, Assurance Services, Rubin Brown
“Many thanks to all three Supply Velocity presenters. I think you guys took a very difficult time for learning and capitalized on everyone’s time and training needs. I truly hope this helps your business as this was a considerable undertaking on the part of Supply Velocity. Outstanding!!”
Mark Holdinghausen, VP of Operations, DEMA Engineering
“For several years we have worked with Supply Velocity to support us with their expertise on Lean Operations and Supply Chain Management. Supply Velocity has helped us implement Lean, improve our inventory systems, and educate our people. They are professionals who are always available to help us as needed.”
Lorenza Pasetti, CEO, Volpi Foods
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Tom Kuthe, V.P. Construction Operations, C&R Mechanical
“In a time of volatile supply chain disruption, Supply Velocity is helping us develop Demand and Supply Planning processes to proactively tackle these new challenges. They are genuine partners, working with our team, facilitating and teaching.”
Jane Thrasher, Vice President of Supply Chain, Horizon Hobby
“We are pleased that Essex selected Supply Velocity, Inc. as our Lean Implementation Partner. At one facility, we have saved over $350,000 in work-in-process inventory, reduced throughput time from 2 weeks to minutes and increased inventory turns 3 to 8 times per year. All these results are in just 6 months. Our return of investment is very high.”
Terry Etter, Vice President of Operations , Essex Medical Systems
“Closure Medical recently completed a major reorganization in order to enhance our ability to rapidly create innovative medical devices. We hired Supply Velocity to help us map out the process and service flows of the new organization that would maximize our product development process (PDP). In four weeks, Supply Velocity helped us envision a new PDP structure, develop measures and accountability for each step, and gain consensus within the organization. Supply Velocity’s focus on speed and accountability helped us complete a critical project in a timely fashion.”
Gabe Szabo, Vice President, Product Development, Closure Medical – A Division of Johnson & Johnson
“Supply Velocity has helped Clean succeed in a number of ways. First, they provided the education that kicked off our Lean Process Improvement journey. They also facilitated a number of large supply chain and process improvement projects including: 1) building quality into our direct-labor productivity incentive program, 2) designing the layout of our garment warehouse, and 3) streamlining our route service process.
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Jeff Lazaroff, Senior Vice President, Clean Uniform
“Our experience with Supply Velocity was one of the best values we have ever had from a consulting project. Cyril Narishkin brought a structured lean methodology, invaluable experience and engaging facilitation skills to help us streamline a very complex and disjointed sales order process. Just as importantly, our team now has the knowledge and process competencies to address other business improvement opportunities going forward.”
Mike Howard, CEO, Aspeq
“Supply Velocity is driving instrumental change in our inventory management processes. This is critical for us to be competitive in a supply chain environment with numerous disruptions. They are making change happen, which can be challenging in a 182 year old organization.”
Jim Carroll, Executive Vice President Operations, Schaeffer Manufacturing
“Anheuser-Busch Precision Printing had been implementing Lean Operations on our own for the past two years. We needed to move faster and partnered with Supply Velocity, Inc. Through Supply Velocity, Inc.’s mathematical workflow balancing and visual management tools, dramatic improvements were achieved. The entire converting operation was rearranged based on Lean principles. The result is a 20.6% productivity improvement, enabling us to operate with 23 fewer people in production.”
Rich Lavosky, General Manager, Anheuser-Busch Precision Printing
“Supply Velocity’s Lean Six Sigma System has given us new tools to help improve our sales performance. We have learned new ways to analyze our business which makes problem solving more accurate and has made us better leaders.”
Rachel Andreasson, Executive Vice President – Marketing, Wallis Companies
“In thirty years of hiring consultants, Supply Velocity, Inc. was the first to tell me what they were going to do, set a price they stuck to and substantially exceed my expectations. I have recommended them to friends and acquaintances. They were true partners in assisting with the turnaround of an acquisition we had been struggling with for two years.
Their math-based technology, solid down-to-earth facilitation skills, and positive, patient and enthusiastic attitude combined to make our implementation of Lean a very rewarding experience.
We increased our production by 50% in the first month of implementation and continue to see improvements. Improvements have not only been realized in productivity, but also in quality and morale. We have increased profitability by $2M on flat sales of $10M.
Based on Supply Velocity, Inc.’s integrity and our results, I will continue to refer them to others and utilize them in the future as we expand our company through acquisitions.”
Bill Gilbert, President, Fusion Coatings
“We engaged with Supply Velocity to help us embed process improvement at all levels of the business. Our team learned from Mitch to let the data drive decisions, to use Lean tools to help us see our processes critically and objectively, and to create a control plan to manage all of the tasks that were the outcome of the data study.
The project turned out to be very significant to the company and most importantly, our customers. We reduced our customer wait times by 40%, and cut in half the labor cost to fulfill customer orders.
Some results are not able to be measured. However, as a result of this project, we have started to build a Lean mindset and culture, which is part of our strategic mission to save our customers money. Supply Velocity has been a valued partner in this mission.”
Dionne Dumitru, COO, Weekends Only
“Isolating a problem, finding short, and long term solutions with measurable results is what was promised and results is what was delivered by Supply Velocity. Upon launch of the Lean Six Sigma Selling System, we knew more about our customers, our products, and were able to create a solid plan to increase sales of our most profitable products. Within months of implementation, our booked sales jumped 60% and our most valued customers were getting direct, active, and calculable attention.”
Mark A. Presker, General Manager, Architectural Millwork of St. Louis
“The role of the Erie Insurance Marketing Department has been evolving over the past several years – from a support role to a more critical role of driving growth in our organization. Because of our increased workload and desire to prioritize the most critical projects, we hired Supply Velocity to teach us the skills of Lean Six Sigma.
Participants included the Promotions, Market Research and Agency Licensing sections of the Marketing Department.
We learned valuable tools to help us to prioritize based on the voice of the customer.
I firmly believe these skills made a difference in how we work every day. We are moving new projects forward, eliminating or changing ineffective processes, and we are a much stronger department. We continue to use the tools to help us with our highly-complex and time-consuming projects. Supply Velocity helped us to accomplish our goals.”
Karen Rugare, Director of Marketing, Erie Insurance
“In 2015 we began working with Dr. Mitch Millstein to optimize our inventory locations supporting e-commerce and in-store inventory needs. From this work we developed a new omni-channel warehousing and inventory plan that entirely redefined our approach to warehousing, inventory management, store distribution and fulfillment. As a result of the analyses by Dr. Millstein we have begun the move to an improved omni-channel design by reassigning MSAs to new warehouses, greater leveraging of in-store inventories to satisfy e-commerce demands, and exploring acquisitions of new warehousing space in strategic locations. We have already seen an improvement of $300,000 from both more efficient shipping strategies due to better inventory management.”
Rob Bowers, Vice President of Strategy, Total Hockey
“Supply Velocity has provided the technical expertise and political capital to move our project forward. They have just the right amount of push and the right amount of support. Supply Velocity has helped us make real changes to improve efficiencies in logistics without jeopardizing our performance. We’re happy and our customers are happy.”
David Walters, President, Hy-C
“Mitch Millstein and his team helped guide our shop fabrication division in the re-layout of our custom pipe and steel fabrication facility when we moved into a new building. It is not only the results but how he helped. We were involved in every step. I personally did time studies and was able to see the non-value added steps required to manufacture in our old layout. When we created our new layout, everyone was involved, from the executive team to our direct labor force. With Mitch’s help we increased our throughput by a 3x multiple, while providing more competitive prices to our clients as a result of the efficiency improvements.
This has enabled us to not only make more money but also to expand our commercial reach and serve more, and larger customers. I would recommend Supply Velocity to any company that wants to make improvement in supply chain and operations.”
Geoff Gross, President, Gross Mechanical
“I am thrilled to provide this testimonial for Supply Velocity and their outstanding work in implementing Lean Warehouses and processes at Crescent Parts & Equipment through the COVID pandemic. With their data-first focus and Mitch’s exceptional coaching and experience, they transformed our business into a more supply chain-oriented organization, enabling us to grow while prioritizing employee safety and creating a better work environment. Supply Velocity’s expertise in Lean methodologies and their comprehensive evaluation of our customers have been instrumental in optimizing our operations and increasing customer satisfaction. We highly recommend Supply Velocity to any company seeking to implement Lean processes and enhance their supply chain efficiency.”
Josh Cole, Director of Supply Chain, Crescent Parts & Equipment
“In the spring of 2003, the St. Louis Area Chapter of the American Red Cross engaged Supply Velocity, Inc. to perform a study and make recommendations to streamline office processes, maximize cash flow in purchasing and warehousing and restructure and enhance our maintenance department. Supply Velocity, Inc.’s process was methodical, flexible, staff-oriented, inclusive and, above all, trackable.
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Joe White, CEO, American Red Cross – Saint Louis Chapter