Why You Can’t Afford to Ignore Margin Management

Margin improvement is pretty simple in theory – increase prices and/or decrease costs, and profit margins will improve. The complexity of this exercise occurs when theory meets reality. Companies need to answer important questions such as: What is an appropriate margin? Which prices should be increased? How are cost-cutting measures identified? How should data be used to improve the business?

In the past, many business executives perceived margin improvement measures as tactical and analytically unimportant. Their companies were not concerned with margin pressure because competition was sparse, or in many cases, non-existent.

Fast forward to today’s ultra-competitive marketplace, and it’s clear to see just how important margin management has become. In a 2015 survey by CFO Research, 76% of senior finance executives said that they will be looking to improve their margins over the next two years. Leading organizations have realized the need to prioritize profitability and have instilled its importance in their culture. And frequently, it is these companies that achieve market dominance and force competition to react accordingly.

If you want to gain better control over margins at your company, unfortunately, there is no magic cure. As is the case with all effective management practices, planning and execution are the keys to implementing effective margin improvement measures. However, you can take steps to get started now.

We recommend this four-step process to lay the foundation for an effective margin improvement culture:

1. Gain enterprise-wide support
2. Segment into profitability focuses
3. Optimize pricing
4. Contain costs

Gain enterprise-wide support

Instilling a culture of profitability requires senior management to emphasize the importance of margins and provide support for employees to succeed in helping the company reach its margin improvement goals. You should establish metrics that show the performance results you want to track, and employees should understand how their actions affect the bottom line.

For example, the sales force should understand the profitability of each of their customers and products. On the cost side, managers should have the ability to measure the effect of purchasing practices on margin.

Segment into profitability focuses

Once an acceptable margin is established, the data should be segmented into four sources of profitability for the company to identify where to focus its efforts:

1. Customer profitability
2. Product profitability
3. Vendor profitability
4. Channel profitability

By defining an acceptable margin percentage, company executives can make decisions about which customers, products, vendors and channels to target for acquisition and improvement. For example, analysis may find that, while the volume of sales to a customer is high, the margin may not be acceptable.

Optimize pricing

Pricing is the most powerful profit lever a company can use to influence margins because it has a direct and immediate impact on profits. Price optimization uses a mathematical model to estimate how customers will respond to price changes. This exercise will provide initial customer/product pricing, promotional pricing and markdown (or discount) pricing.

Management should hold the sales force accountable for complying with this pricing (or pricing grid). You may want to require management sign-off for cases in which the sales team wants to decrease the proposed pricing for a specific customer. This way, overall acceptable margins will still be obtainable.

Contain costs

Effective cost-cutting measures primarily occur by either minimizing waste through efficiency gains (e.g., automation or standardizing processes) or executing a strategic sourcing program.  Strategic sourcing leverages a company’s purchasing power and negotiation skills to continuously tighten its costs and improve its supply chain network.

So it’s time to ask yourself: Does your company have the infrastructure to create a margin improvement culture? Contact us to learn more about how you can start improving margins today.