Over time, key customer relationships, business models or primary markets go through transitions. What was once a great business engine can grow less viable years later because it has become outdated or ineffective due to market shifts or new developments in industry’s business environmental conditions. It is the course all businesses must run, facing the need to change along the way in order to survive. With the right analysis and understanding of the business foundations, strategy can be employed to transition the organization back to a viable model and profitable growth. This article explores the inflection point that occurs when profitability begins to decline and discusses strategies to leverage key customer segments as the vehicle to restore earnings and growth.
The Only Constant Is Change
As businesses grow, they become more diverse in capability. Over time, the number of product skews or service offerings increases in siz
e. With that growth, the number of customers the business counts on for revenue also expands. While the growth in customers is certainly desirable, it can also complicate things by helping obfuscate the “profit by product / service line” and / or “profit by customer” picture.
This is where slow changes can slip up on an organization and an inflection point in the business eventually occurs. Over time, once profitable segments might see margin deterioration as the market commoditizes, making them less desirable. In some cases, new product innovation has lagged behind competitors and now they have a superior offering that cannot be matched in value. In other situations, the business model has outlived the market for the product or service (think video rental stores or music CD stores prior to iTunes).
The signs of industry or customer segment trouble are there and can be proactively addressed, so long as trends are not ignored when they begin to show themselves. It may begin with missed sales or profit projections – a quarter here and there are come in unexpectedly lower, accompanied by a slowly shrinking pipeline and backlog. These may be signs of stalled growth or declining margins and the causes need to be determined so that appropriate actions may be taken.
If one or more core markets have truly reached an inflection point, the business will soon begin to note reduced profitability as orders fluctuate in predictability, overhead becomes too high and materials and labor costs are harder to manage. Once this cycle has taken hold, moral issues ensue and attrition begins to become a problem as the competition begins stealing top sales people away.
Do the Analysis
Looking at the profit picture is helped a great deal if earnings are analyzed by buyer. Analyzing profitability by customer paints a more accurate picture of what is really happening in the business. This analysis is doubly helpful if trends and points of commonality are explored in regard to order patterns, cost of sales, days outstanding, margin and other KPIs. The first goal in this examination is to begin segmenting customers into groups; those that produce healthy margins and those that do not.
Utilizing tools like the Organizational Value Quadrant (OVQ) to segment customer types is a useful in such an analysis. Each quadrant of the OVQ matrix represents a focus of a company or business unit and can be thought of as the strategy and business model generally being followed.
See the article “Concocting The Right Business Strategy: Organizational Value Quadrants” for more background and explanation on the OVQ matrix.
Analyze Profit By Customer Grouping
A second useful tool can be employed at this point. Once this grouping exercise has been completed, it is possible to generate a profit “heat map” against the value quadrants to clearly see which quadrants are performing best and where the business is not enjoying as much success. In the example below, four quarters of customer data were utilized, focused on net profit numbers.
Make Changes When Needed
Given the limitations on resources all business face, choices must be made on which revenue sources produce the highest profits and align closest with the organization’s mission and overall strategy. In the current example, the profit map shows the business is enjoying the highest profitability in two segments, “customer intimacy & synergy” and “operational & organizational excellence”. The company is not an overall leader in product innovation or service superiority across revenue-producing lines, but still has some degree of positioning there – most likely linked to one or two of their offerings that still lead in competitiveness. The company is also clearly lagging behind in the “product“customer enrichment & fulfillment” quadrant, so this outlier stands out as a problem area for the business to deal with as well.
Sometimes the analysis can lead to clear actions the business should take, and in other cases the results may not be definitive without more in depth exploration. In this example, consideration of actions to exit or deemphasize investment in the “product / service superiority & innovation” and / or “customer enrichment & fulfillment” customer segments are apparent.
With “product / service superiority & innovation” being the lowest performing quadrant, it serves as a good example to discuss further. The segment already suffers the lowest return on sales, which is producing drag on overall business profits. Additionally, this segment is a costly quadrant to dominate. Innovation is both expensive and risky to pursue, siphoning resources away from more profitable areas of the business for the company in this example. Based on current results, there is a higher likelihood that that strategy may not ultimately be successful for the business in the future.
The “customer intimacy & synergy” quadrant, focusing on the customization and tailoring of products / services, is the top profit producing segment in this example. The firm is doing relatively well at understanding their customer’s needs, “personalizing” the experience for them and delivering what buyers want. The close relationship with this group of customers has positioned the firm to convert on solution-based business at a higher margin. Given this outcome, more focus in this area might be warranted.
The second best producing segment in this example is the “operational & organizational excellence” quadrant, focusing on operational efficiencies, supply-chain optimization, maintaining low overhead and accomplishing more with lean structures. The firm has succeeded in creating predictability in delivering, quality, low price, no-hassle purchase experiences and ease of use for the customers in this segment. That capability might be leveraged in the customer intimacy quadrant as well.
With the combined performance in the two top-producing segments, resources might be wisely applied in growing key customer relationships through integration of the company’s operations with those of the buyer’s in a tailored and effective approach. When this type of quadrant synergy is followed, the investments can result in lowering key customer’s cost (“operational efficiency”) while increasing the profits of the supplier business and furthering the “intimacy and synergy” strategy that is already producing the top results of the four quadrants.
In this example, linking strategies for the two top-producing quadrants helps leverage the success of both segments. Tactically this might be accomplished through order management integration to streamline customer inventories and usage of business analytics of past purchase data to help smooth order patterns and better tune them to the customer’s needs. The key is to partner with key customers and shift the focus of supply chain efficiency initiatives from optimization solely within the organization’s supply-chain ecosystem to an optimization of the joint vendor-customer supply chain domain. This shift creates enormous new efficiencies for both organizations and helps increase the cost of switching vendors for the customer in the future.
Of course, shifts in strategy will likely have effects on many functions of the business as well as existing customer relationships from those lower-performing quadrants. As such, changes to strategy must be made responsibly and with much due diligence. Internal impacts would likely affect Sales, Operations, Marketing, Information Technology, Finance and even Human Resources. Strategy and planning for such shifts in positioning must occur with forethought into the organization’s real value proposition and core competencies.
Over time, key customer relationships, business models or primary markets go through transitions, potentially creating an inflection point in business profitability. Two analysis methods were discussed to use as tools for diagnosing problems and helping organize business data:
- Utilizing the Organizational Value Quadrant (OVQ) analysis to segment customer types
- Analyzing earnings by quadrant using profit “heat maps”
These analysis tools can be helpful in determining if business strategy changes are warranted to protect margins.
In some cases, choices must be made on which revenue sources produce the highest profits and align closest with the organization’s mission and overall strategy. Changes to strategy should be addressed when needed, but done so responsibly and with much due diligence.