Margin improvement – this phrase usually conjures up images of budget cuts and lay-offs – and strikes fear in the hearts of the toughest managers. But it really does not have to involve any of these things – costs reductions though important should not be used as the only lever in any margin improvement strategy as you soon run out of cost reduction options. Gross Margin (as I wrote in my earlier post on key performance metrics) is the mother of all metrics and the quickest way to determine if your business in on track or not and acts as an early warning system to put in place margin improvement initiatives. So, a quick definition of gross margin:
Gross Margin (%) = (Net Sales – Cost Of Goods Sold)/Net Sales
The gross margin represents the percent of sales that the company keeps after incurring the direct costs associated with producing the goods and services sold by a company. The levels of gross margin may vary dramatically based on the nature of business (products or services, manufacturing or retail, etc.) but the principles and strategies behind improving margins boils down to two things – increasing your sales and increasing your operational efficiency to bring down the cost of goods sold.
Thinking through some such initiatives that I have been involved in and noting what worked and what didn’t, these are the five steps that I came up with that I believe are critical to the success of any margin improvement initiative:
Margin Improvement Step #1: Customer profiling or Knowing your best customers – It all starts with the right data that gives you the information that you need, in this case a profile of your customers (or customer segments) that gives you a view of where your profits are coming from. Pareto’s principle applies here too; around 80% of your profits would come from 20% of your customers (or segments). Now you have identified where to focus your energies on – sell more in high profits areas and less in the low profit ones. This will also help in reducing the cost of sales that arise from keeping alive or going after customers where you are consistently not making any margins.
Margin Improvement Step #2: Order to Cash process or Leaving no money on the table – Take a close look at all your internal business processes and systems that are in place to book orders, bill them and collect the cash. Where are the revenue leakages – do you have a method to track unbilled and deferred revenues and plug these? Are invoices being raised in time or are customers being essentially financed by you? Do you have policies to regulate and control warranties, refunds, credit notes, etc.? Little things add up to a big dent into your margins over a period of time.
Margin Improvement Step #3: Pricing Policies or Enabling your Sales force Effectiveness – The quickest way to increase the gross margin is to increase prices. Even a 2-3% increase in prices brings in a big jump in margins and the people who can do this are the sales team. So are the sales people in the company aware about the linkages in pricing and margins? Is there clear communication and transparencies in how pricing is done within the organization and how it translates into bottom line for the company? Are there tools that can help sales make better decisions by giving them access to real-time data on profitability? Making key stakeholders aware of the tools at their disposal and how their actions impact the outcomes is a big step forward in any improvement initiative.
Margin Improvement Step #4: Operational Excellence or Reducing inefficiencies – This is all about doing more with less and driving performance improvement through the smart use of metrics. Look at all areas of waste and inefficiencies – space that is not being used, people that are not being utilized, advertising that is not working, projects that are out of control, inventory that is gathering dust, supply chain expenses, travel costs, etc. Translate this into a plan with measurable outcomes and deadlines and assign clear ownerships.
Margin Improvement Step #5: Rewards and Celebrations Or Creating a Customer-focused Culture – Tie the incentives, awards and rewards that you give to your employees clearly with the margin goals. Tie Sales bonuses with the levels of margin that each sale brings in and not just the revenue. Celebrate early wins to reinforce the importance of the margin improvement initiative. Positive reinforcement works best here. Research shows that companies with a customer-focused culture that consistently deliver value beyond customer expectations grow at rates that exceed industry averages. Customer Focus is a profit strategy and the way to achieve long term profitability is to build and sustain the culture of customer focus within the organization
What steps have I missed ? What business operation metric do you use to measure margins? What has worked for you in improving margins? I would love to learn from you.
