Profitability and Cost Management
Profitability and Cost Management is the practice of providing decision makers with directionally correct and relevant economic information that helps them make decisions to achieve their profitability and cost objectives.s
Much of the economic information decision makers need relates to Product/Service and Customer costs and Profitability. That means economic cost models need to be broader than traditional cost accounting, which focuses on measuring and reporting costs for external financial reporting. Effective Costing and Profitability Models should include all costs consumed in creating, selling, and providing the company’s products and services to its customers through the markets and service channels it serves. These Profitability and Cost Models need to reflect the economic realities of the organization and not be constrained by traditional cost accounting methods and systems. The broader perspective of costs and profitability applies to all the product/service, customer and channel dimensions of profitability.
Cause and Effect Relationships
An effective cost modeling system will account for how the products and services the organization provides to its customers consume activities and resources of the organization through “Cause and Effect” relationships versus easier arbitrary allocations often found in traditional accounting. These cause and effect relationships model how customer behavior in their various markets and channels of service uniquely consume the activities and resources of the organization, from sales and marketing and product/service development to operations and product/service delivery and support.
Companies often have better information on the revenue side of the profitability equation, but not always a complete one that intelligently includes complex discounts and credits programs, etc. An effective Profitability and Costing Modeling system will include causal logic in both sides of the profitability modeling system at a level of detail with directional accuracy appropriate for assisting decision makers at multiple levels of the organization to achieve their cost and profitability objectives.
Armed with a complete picture of Costs and Profitability by Product/Service, by Customer, by Channel, etc. decision makers can gain insights needed to make decisions that have significant impact on the organization’s profitability.
Customer Profitability - Whale Curve
With well designed and implemented profitability systems, customer profitability is often reported on a “Whale Curve” where customer profitability is ordered highest to lowest on the X-axis and accumulated across the Y-axis. Although the numbers and shape of the curve vary by company, it is not uncommon to see 20-25% of customers generating the potential profits; 50-60% breaking even, and the remaining 20-25% unprofitable, reducing potential company profit to its actual 100% level.
However, just knowing which customers are profitable is not enough. The system must provide management deeper understanding why, where opportunities for improvement exist, and help quantify the impact of improvement decision alternatives. Armed with a complete picture of “Cause and Effect” Activity Costs and Profitability by Product/Service, by Customer, by Channel, etc. decision makers can gain the holistic insights needed to make decisions that will have the most significant impact on the organization’s profitability.
High Volume Data and Granularity
With today’s technology it is now practical to develop profitability models with very high volumes of transaction data to model costs and revenue at low levels of granularity. Companies can now have visibility into their Costs and Profitability at much finer grain of detail.
Client Profitability Granularity Examples
Today’s Business Intelligence and analytical tools provide the means to analyze and costs and profitability across any attribute available in the data. For example, by customer market, size, or location; by product group or complexity characteristic; by service channel; etc.
Art of Good Design - Appropriate Level of Detail
Information Technology advances have significantly increased the size of modeling capabilities. For some software solutions more than others. While it has always been the case, now more than ever, the art of good Profitability and Cost System design is to determine the most appropriate level of detail to support the various stakeholders’ needs while delivering a solution with practical effort and cost to sustain it over time. Technology is making it faster, cheaper, and easier to do more. But what level of detail and volume is most appropriate? We help our clients answer that question and many more.
PCS Consulting specializes in the design and implementation of Profitability and Cost Management systems using off-the shelf application software, data integration and business intelligence technology. With these tools and experience to effectively use them, we assist our clients to provide their decision makers with valid economic decision support systems at the right level of detail.
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