Driving meaningful and sustainable profit growth is every manager’s goal, but often the methods employed to deliver that profit growth are overly simplistic. They also tend to overlook important insights and ultimately yield sub-optimal results.
A more sophisticated approach can drive greater profit growth, without getting too complicated. Start by recognizing that not all revenue is good, and not all costs are bad. Revenue can be unprofitable when specific customer segments require excessive support and incur high costs. Conversely, costs that create a competitive advantage and drive profitable revenue are good, such as investing in higher quality products that command premium prices.
Next, reallocate resources differentially to accelerate growth in the most profitable segments while reducing investments in the least profitable segments and fixing or exiting unprofitable ones. Companies that have adopted this approach have delivered tremendous profit growth far exceeding industry averages and have entirely transformed their portfolios.
Understanding Profit Variation
Given the enormous disparity in profit growth, why have more companies not embraced this approach? The answer is that few managers have experienced this approach in action, which itself is driven by the lack of visibility into granular profit contributions across and within each business unit.
To reallocate resources towards profitable segments and away from unprofitable ones, the organization must first have a comprehensive understanding of profit variation across the company. Unfortunately, most financial reporting systems do not provide the necessary level of detail because these systems are designed to aggregate results into performance units, creating two interrelated problems — insufficient granularity and incomplete costing.
While transaction systems capture granular detail, including who (customer) bought how much (volume) of what (product), where (location/channel), when (date), and at what price, costs are not tracked at a similar level of detail. Instead, costs are aggregated and recorded in “cost centers,” leaving profits to be reported in aggregated performance units.
The loss of the rich transactional fidelity in standard profit reporting obstructs visibility into the complete economics of a product, customer, or transaction, which we call “insufficient granularity.” Unfortunately, the common workaround of most organizations is to focus on more readily available gross margin data instead. That is misguided, as the exclusion of key costs often creates misleading signals.
Moreover, corporate organizational hierarchies are often structured to exclude certain costs from measured performance units; for example, corporate overhead like human resources, information technology, and finance is often excluded, or costs are booked in different units.
The exclusion of these real and necessary costs that support the overall functioning of the business creates a false impression of profitability across the performance units. In extreme cases, this “incomplete costing” distorts profitability signals such that performance units that appear profitable become unprofitable when the costs are included.
The Power of Granular Profit
Only through comprehensive costing and complete granularity is it possible to achieve true visibility into profit concentrations across customers, products, geographies, and channels to inform better resource allocation decisions. Building that visibility across multiple dimensions is most insightful, as unexpected dimensions often emerge as the primary driver of profit variation. The application of granular profit is extensive; beyond resource allocation and prioritizing investment, an organization can:
- Focus the salesforce;
- Optimize marketing spend;
- Inform pricing decisions based on the total cost to serve;
- Manage customer relationship profitability; and
- Adjust supply chain sourcing decisions.
After witnessing the power of granular profit in action, leaders invariably remark, “I don’t know how I ever managed the business before granular profit.” Yet granular profit has not seen wider adoption due to three common misperceptions:
- Granular profit measurement is difficult and time-consuming;
- The necessary cost allocations are imprecise, compromising the accuracy of the results; and
- Maintaining granular measurement is challenging, requiring excessive manual effort or significant systems investment.
Experts in granular profit measurement can typically develop the measurement methodologies in as little as 6 to 8 weeks, including sensitivity analyses to compare alternative approaches and build consensus around the recommended methodology. While the results may not be 100% precise, insights from the relatively fully loaded profitability signals are far superior to a false impression of inflated profitability from excluding certain costs.
Finally, ongoing reporting of granular profit has never been easier with the advent of new software-as-a-service (SaaS) solutions that leverage existing systems and require limited systems investment to deliver continued strategic insights over time.
Granular profit measurement does not aim to replace existing financial reporting systems and processes. Instead, it complements the current reporting with powerful granular insights to enhance strategic and tactical decision-making. By harnessing the power of granular profit and preferentially reallocating resources, businesses can unlock profitable growth and build sustainable competitive advantage.
After nearly 25 years of measuring granular profit for more than 100 businesses as a strategy consultant, Dennis Kubaile co-founded Granulytix to empower management to drive better decisions through ongoing reporting of Granular Profit.