Time To Flush Out Some Margin
Originally Published: NZ Business, Mar 2020
Paul Allen explains a step-by-step process for looking at your existing customer contracts as the quickest path to recovering significant profit.
So, it’s business clean-up day and the last thing anyone is probably thinking of is tackling that untidy filing cabinet that houses all your customer contracts?
But here’s the thing. That filing cabinet is probably your quickest path to recovering significant profit that deserves to be in your pocket. Inside you’ll find copies of contracts, long ago signed with key customers, that haven’t seen the light of day since, and which are probably now heavily flecked with dust. The unfortunate truth is most companies never revisit contracts until it’s time to roll them over or deal with a major issue.
Worse still, most B2B suppliers routinely leak upwards of 15 percent of their net-margin customer entitlements per annum because staff are not cognisant of what’s been agreed in these very contracts. This is money that is unknowingly lost under the guise of maintaining a customer centric service focus. In other words, we signed the deal, put the paperwork in the cabinet and just kept doing what we have always done. No wonder the bottom line looks a mess!
So pause for a moment and do the following calculation in your mind or on paper.
Take your biggest customer. Write down the annual revenue they deliver. Subtract the standardised “cost of goods or services sold” and you have gross margin. Now deduct (pro-rata) everything else that gets bundled up and apportioned as overheads. This is your customer net-margin. Look at it carefully. How would you feel if it increased by at least 15 percent within 90 days?
If you are willing to make good on the three common margin mistakes, routinely made by senior leaders, you will find out within the next three months:
- Low contract compliance between supplier and customer.
- Excessive service freebies given to customers.
- Gradual cost to serve “creep” as customers demand more.
Each of these three items are within a suppliers control – if they chose to manage them. Most don’t, so things get untidy. Don’t let this be you. Instead, try the following on ‘Business Clean-up day’.
The Margin Flush:
- Rank all your customers from highest to lowest by revenue.
- Dust off the contract of your largest customer.
- Insert the name of the staff person that should be responsible for each material clause.
- On a whiteboard create three columns with these headings – More, Less & Same.
- Gather staff and by material clause, ask the following question: Do we do more, less or same, when it comes to this clause?
- Categorise the answers in the relevant column and allocate a “value” to each item of variance.
- Add up the variances and divide by your customer net-margin (expect it to be greater than than 15 percent).
- Give each staff person 14 days to fix their variance issues.
- Gather again in 14 days and mark off the gains.
- Now repeat the process with your second largest customer. And so on … and so on.
This process will be a game changer for business and culture. Expect to hear plenty of the following:
- “I never knew we weren’t meant to do all that we do for free …”
- “Why have we always done it this way …?
- “We get taken for granted …”
- “And all this time I thought that customers came first!”
- “The customer says they are happy to pay more but we have never asked them to …”
This process can be messy and uncomfortable. It will highlight area’s where business owners have been sloppy in protecting their own profitability. But don’t worry. A little pain will deliver plenty of upside.
If you take the step to clean up your contracts and really flush out your service variances, you can be assured of a brighter and more profitable future.
Example – Calculating Net Margin:
- $6m COGS
= $4m Gross Margin
- $3m Overheads
= $1m Net Margin
+ 15% Contract entitlement
= $1.15m OR an extra $150k of profit