At a time when business executives and stakeholders are examining profit margins with microscopes, companies simply must have complete visibility into their profitability. And as any good businessperson knows, net profitability is more than just revenue minus the direct costs of the goods or services provided (see equation below); indirect costs — such as overhead expenses incurred from acq
uiring, supplying, and maintaining customers (also called “cost-to-serve” expenses) — are also key profitability determinants.
These indirect costs are abundant, especially in today’s complex, multichannel environments. Accordingly, to develop a more complete understanding of their net profitability, companies should manage performance not by looking at gross margin, but by fully analyzing cost-to-serve.
Cost-to-serve analysis provides visibility into costs throughout the business and helps managers identify where decisions that appear benign to one department could increase cost-to-serve in another. For instance, a sales manager may be under pressure to go the extra mile for accounts that generate a lot of revenue without knowing whether those customers generate a profit. With cost-to-serve analysis, poor-performing customers can be rapidly identified and remedial action quickly taken; profitable customers can be investigated so best practices can be propagated.
According to Gartner, 51.9% of financial managers view measuring product and customer profitability as a key constraint.1
Where Profitability Metrics Often Falter
A lack of profitability accuracy frequently stems from evenly apportioning indirect costs to all customers and products. Such a broad-brush approach fails to provide the insight that business users need and undercosts more complicated and demanding customers, resulting in inaccurate information that may lead to poor decisions.
To avoid this, a company should allocate expenses to customers and products using cause-and-effect assignments that reflect the work that those customers and products create for the business, as well as the resources needed to do that work. More accurate expense assignments are often achieved through activity-based costing, a model that assigns the cost of a business activity to a product or service according to its actual consumption of that activity. With activity-based costing, business managers can gain insight into the underlying drivers that make a customer unprofitable, and then act appropriately.
To analyze cost-to-serve and identify profitability drivers, companies are turning to solutions such as SAP BusinessObjects Profitability and Cost Management, an application that allows costs to be assigned to customers and products using cause-and-effect relationships.
Ensuring Comprehensive Reporting
Many organizations that run SAP ERP and deploy the SAP ERP Financials controlling modules for cost and profitability reporting are also using SAP BusinessObjects Profitability and Cost Management (see sidebar). This application enables users to model cause-and-effect assignments to produce accurate cost-to-serve reporting.
The data needed for profitability modeling may reside in a company’s SAP systems, like SAP NetWeaver Business Warehouse (SAP NetWeaver BW), or in third-party systems; calculating cost-to-serve doesn’t mean ignoring data about direct costs from elsewhere in the organization. As long as the data is accurate, it can be directly loaded into SAP BusinessObjects Profitability and Cost Management and supplemented with other costs that need to be calculated using activity-based costing to provide accurate profitability reporting.
SAP BusinessObjects Profitability and Cost Management includes functionality that enables finance users to load data themselves, but the application is also shipped with SAP BusinessObjects Financial Information Management, an extract, transform, and load tool. An organization may wish to move calculated results back into SAP NetWeaver BW so a user can analyze the results with other customer data that was not needed for cost modeling. Companies can also load data from third-party sources with the SAP NetWeaver BW DataBase Connect tool.
Analyzing the Results
There is considerable flexibility in the choice of tools used to report and analyze the results that SAP BusinessObjects Profitability and Cost Management calculates. If the results remain in the application’s database, a user can analyze and query them using the application’s web books, or the data can be consumed by SAP BusinessObjects business intelligence (BI) solutions or an OLE-DB compliant third-party tool. If the results are moved into SAP NetWeaver BW or any other database, a user can analyze them with SAP Business Explorer (SAP BEx) tools, for example.
To enhance and accelerate reporting, SAP is developing industry-specific reporting packages under the name “Customer Value Analysis” for SAP BusinessObjects Profitability and Cost Management and SAP BusinessObjects BI suite customers. These packages provide out-of-the-box analysis and reporting (see Figure 1), allowing business users to drill into and visualize data in various ways, identify outliers that require attention, and gain insight into reasons for poor profitability by using discriminator analysis to see how the purchasing behavior or discounts of one customer differs from that of its peers. That way, users can quickly develop both enterprise-wide and customer-specific strategies to remedy problems.
||A typical whale curve ranking customers (left to right) according to cumulative profitability; the results were calculated with SAP BusinessObjects Profitability and Cost Management
The Bottom Line
By implementing cost-to-serve reporting and analyzing operational processes, an organization can identify non-value-add activities that can be eradicated, resulting in immediate cost savings. And by focusing more on profitable customers and products, a company can increase its net margins.
Richard Barrett (email@example.com) is Director of Solution Marketing at SAP, responsible for SAP BusinessObjects enterprise performance management (EPM) solutions. He has worked in consultancy and national and international positions in consumer marketing, insurance, and business-to-business marketing, where cost and profitability reporting have been part of his responsibility.
1 “FEI Study Shows Financial Executive View of IT and Opportunities to Improve Collaboration” (July 21, 2009). [back]