Pitfall 3: Customer Net Margin Isn’t Measured (Lesson 4)
What do B2B suppliers use as their key performance measurements? Beyond year-end financial reporting obligations, if you were asked to nominate the essential one or two metrics that best articulate business performance, what would you select?
There would be many and varied answers to these questions, but I offer that systematic and ongoing measurement of customer net margin must find its way into every supplier’s monthly reporting pack. It’s the metric that regularly fails to make it onto the scoreboard, and this needs to change.
Let’s look at the cause and effect of not tracking customer net margin in your business.
If You Can’t Measure It, You Can’t Manage It
Gross margin is more commonly used when measuring individual customer profitability, as it uses the already measured costs of goods sold (COGS) to the customer.
Net margin is more complex. It’s not a linear or automated calculation that can be readily extracted from an Enterprise Resource Planning (ERP) system like SAP. It requires individual business functions to record and apportion costs and time directly to identified customers.
Traditionally, such measurements are reported on an overall functional basis. Measuring and reporting net margin by customer requires effort.
So, traditionally, finance reports company net margin and overall profitability while sales talk a lot about customer revenue and volume, and operations share information on total yield and unit costs. All the other functions in your business report on their unified targets. Cross-functional supplier KPIs are rarely tied to the well-being and commercial health of its individual customers.
The effect of this must be obvious. The real “score” of a customer’s worth to a supplier gets obscured behind a cloud of consolidated numbers. The discretionary resources applied to servicing specific customers do not get recorded and, as a result, are not managed.
This is the prime reason why the supplier’s net margin succumbs to “silent erosion.”
You can ignore it on the basis that your consolidated performance is doing just fine. Many do, but ultimately a supplier’s business depends on the individual performance of many customers, particularly the large ones.
If the customer base changes, so will the consolidated numbers. It’s preferable to know how they’re likely to change before they do.
Few businesses measure customer net-margin. Do you?
During the preparation phase of a recent margin review engagement, I was proudly advised by the client’s finance director that they were achieving an estimated 37% net margin from sales (supply) to their largest customer.
With this in mind I wondered why I had been engaged in the first place, but the answer soon became clear. Over the ensuing weeks of cross-functional workshops and interviews, it became obvious that this largest customer was causing a mountain of cost and disruption throughout the supplier’s business.
95% of their total overtime expense was attributable to the demands of this customer.
Extra customer service staff had been employed because orders were routinely submitted incorrectly and required reworking. Minimum order quantities were simply not enforced, so supplier-born delivery charges were excessive. Worst of all, the manufacturing line managers frustratingly acknowledged that at least 25% of their forward production plans were routinely changed with less than 48 hours’ notice.
The resulting net margin calculation produced a figure closer to 11%. The negative impact on staff engagement was extreme.
Whilst the client did not have the systems to automatically produce a monthly net margin calculation for this customer, upon completion of my review it did have a team of people who were now eager to meet routinely and put together a report with the finance director that more accurately measured what it was costing to serve this customer.
From there a margin recovery plan was constructed and implemented.