Summary: With the uncertainty of an economic downturn, companies in 2019 will look to cut costs in an attempt to meet shareholders’ earnings expectations. Typically, cost reduction programs are established by functional areas of the business (sourcing, supply chain, inventory, etc.) and may be tailored to certain groups of customers based on top line revenue contributions. Why is this a problem? Simply stated, not all customers are the same as it relates to their true profit contributions. In fact, for most companies, a small minority of customers actually provide the vast majority of profits that subsidize marginal and unprofitable accounts.
Cost cutting decisions made across a customer base can have serious, unwanted consequences. Reduction in service levels or inventory availability for highly profitable customers can cause them to become dissatisfied and to look to your competition for alternative choices. The end result, your cost cutting measures may actually have the unwanted effect of significant decreasing the profitable performance of your company.
Case In Point: Prior to looking for ways to reduce operating costs, a profitable 5 Billion dollar company in Chicago decided to accurately measure the profit contribution of each customer and customer delivery location. Their customer base comprised of 110,000 delivery locations across the United States. Want to venture how many locations provided the vast majority of their profits? Most people would say use the 80 / 20 rule and therefore over 20,000 customer locations. The actual answer was less than 3%. Without knowing this and relying on higher level revenue or gross margin information, typical cost cutting measures could have had catastrophic results.
Action: The approach that this company used for this analysis ensured that the entire organization had confidence in the profit performance information. As a result, the information was very actionable. Cost reductions were implemented for the unprofitable and very marginal customers while protecting the service and support of the high yield customer group.
Takeaway: Wholesale cost reduction programs can be dangerous. It is imperative to identify customers that provide significant profit contributions to your bottom line and protect that business relationship. However, determining the root cause for poor performance is equally important. With that information in hand, cost cutting programs can be tailored to customers or customer segments to not only reduce operating expenses but also improve these customer’s margin contributions.
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