The Margin Rescue

Originally Published: Management.co.nz, 17 January 2019

If there is no choice but to match a competitor’s lower prices, then the “cost to serve” must also be reduced, to maintain acceptable margins, says Paul Allen who sees business lessons to learn from the movie Apollo 13.

In the Tom Hanks’ movie Apollo 13, three astronauts make it safely back to earth, despite a mid-mission oxygen tank explosion that all but cripples their space craft. The story goes that the primary energy source fails, forcing engineers on the ground to completely redesign how to power the command module. Under enormous time pressure the ground crew at NASA come together and find a way to eliminate every nonessential power drain in the command module, ensuring all available energy is applied to propelling the spacecraft back to earth.

This remarkable story of innovation and ingenuity can teach business much today. Let’s mash up a typical business predicament with the Apollo 13 story to demonstrates how.

The astronauts are now your sales team. Their mission is not to explore space, but to secure revenue growth at an acceptable margin, in the present quarter. The NASA ground crew are every function sitting behind the sales team. They are the operations, logistics and other related specialists who source and supply the “end product” for customers.

The plot unfolds like this:

On a routine sales mission, a distress call is issued: “Head office – we have a problem … our competitors are discounting, and we can’t compete. If we don’t lower our prices, we’ll surely miss our target for the quarter. Do you copy? Over.” A disaster is unfolding for the business. Tensions are high. How can management save the day?

I’m going to propose there are three possible endings to this unfolding routine crisis.

1. Abort the mission and write off the quarter.

  1. Continue the mission and absorb a price reduction.
  2. Continue the mission with a price reduction and a lower service cost.
    But first, let’s return to NASA and consider what they would do?

   Option 1 is out. NASA never give up.
   Option 2 is unacceptable because the loss of resulting margin is unsustainable, especially if net margin is already slim.
   Option 3 is the audience favourite. If there is no choice but to match lower prices, then the “cost to serve” must also be reduced, to maintain acceptable margins.

The cross functional NASA team would come together immediately and set about re-engineering their sourcing and supply model. A new value proposition would be designed.

All unnecessary costs would be eliminated, and a new supply solution tailored that would ensure the “customers can buy at a competitive price, but under conditions that maintain margin”.

This may mean slower delivery; shorter payment terms; lesser warranties etc. Whatever it takes.

The principle goes that you can’t expect a first-class flight when you can only afford an economy fare. The Apollo 13 astronauts didn’t have the necessary power supply to return to earth in style, but they still made it home.

Facing a similar margin catastrophe, could your business find a solution, or would all be lost?

NEED HELP?
If you need help, try the following.

  1. Invite your finance manager to a “customer profitability” meeting (they may pass out in shock).
  2. Request a customer specific gross margin breakdown.
  3. Then ask for expected overhead/operational costs, also known as “standards”, to be added to the cost summary. This equates to “expected” net-margin, but beware, it’s not the real picture.
  4. Bring to the table each respective functional “lead” who can attest to the accuracy of the respective overhead/operational costs. I.e. logistic manager, quality manager etc. Adjust the report accordingly.
  5. Congratulations. This is your consolidated view of a single customer’s net-margin, or EBITDA.
  6. From here, you can determine what you need to reduce or modify to ensure you maintain an acceptable margin, if your market price needs to drop.
  7. Finally, always ask the following – are we giving the customer what they want on our terms, or theirs?

Paul Allen is the director of Margin Partners and the author of Take Back Your Margin. For a limited time you can order a free copy of his book at www.marginpartners.com.au/NZManagement