Research Paper on how you can use data analytics/data mining to determine customer profitability

In today’s economic climate, many companies are throw-ing an abundance of resources at profitability, or “value capture,” initiatives. While the intention of these initia- tives is good, the reality is that companies are correcting a flaw that should have been noticed earlier and without the added resources.

Ideally, businesses would identify these value capture items in real time and then identify the potential strategic ad- vantages that can be created from them. The concept of Total Profitability Management is a process in which every company should be regularly engaging, so that one-time initiatives be- come a thing of the past.

When engaging in this concept, there are three questions that every company needs to answer: � How do we create the shift from value capture

“events” to profitability as a constant, pervasive mind- set of the entire organization?

� How do we ensure that the data provided is acted on, rather than just being received?

� How can we use the data to create a strategic advan- tage that keeps competitors playing catch up?

Creating the Shift from Value Capture Events to Profitability Value capture initiatives take place when companies dedicate time and resources toward identifying areas in the business where there can be large profitability improvements. These consist of product rationalization, customer rationalization, product de-featuring and changes in manufacturing processes, among others. However, what they represent is a flaw in a company’s organizational structure.

Usually, those performing value captures make presenta- tions to executive teams that illustrate how many millions of dollars have been saved, which is often met with congratula- tions and applause. Rarely do companies ask, “Why didn’t we catch these in our regular job functions?”

In fact, value captures are really a reactive event that has left real dollars on the table. Saving money from a value cap- ture means companies were already losing because of ineffi- ciency. Instead of considering a value capture as a profitability enhancement, it should be thought of as the end of an unprof- itable, wasteful process.

How can the reliance on value captures being eradicated

Business Performance

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A Powerful Framework

Total Profitability Management:

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and integrated into the daily work approach? The most signifi- cant need is highly accurate data delivered at a granular detail level. Many companies use an activity-based costing system that constructs costs on what is actually driving them.

While activity-based costing is considered unnecessary at many companies, it is undoubt- edly the best system of detailing the concept of Total Profitability Management. The reason this data is integral to robust profitability analytics is because it’s pulled from a detailed, driver-based level that no standard costing system allows from a management perspective.

When a company gains the detailed analytics that such a system provides, it can now enable and drive pervasive use of it. Following the roadmap (on the next page) a company can get all functions of the business utilizing profitability analytics to make better business decisions.

A company needs the business users involved in develop- ing the data model. For example, the marketing department knows more about how its costs should be allocated to prod- ucts or activities than someone in finance. Empower and trust

“Value capture” initiatives can give the appearance of

achieving great savings for a company. They can also

expose a flaw in the accounting process that should

have been corrected earlier.

By Kevin Collins

that knowledge by allowing the marketing department to deter- mine how its costs should be assigned to products, customers, etc. Getting involvement of the various departments upfront pays off significantly in the long run. Once they have provided their input, the finance function can model it and produce the finalized data set.

Usability is a key to the process. The finance function needs to make the data usable for other business functions. The best way to do this is to config- ure different models for each business function. Do not simply provide business users pivot tables and compli- cated Excel equations. Offer them an easier way to pull the data and incorpo- rate scenario planning. If finance expects the sales team to use complicated pivot tables and Excel equations, they will not gain user support.

Define reporting packages released monthly or quarterly that illustrate both the top and bottom indicators/performers for their respective functions. At each release, challenge the users in some way to create action plans for the bottom tier. It is just as important to identify the traits of profitable performers as it is to iden- tify those of lower tier performers. These traits should be called out at a high level in the reporting packages.

The company must then define spe- cific toolsets for each functional depart- ment. This goes hand in hand with usability, but is more specific. The finance department must deliver spe- cific analytical models that allow each business user to do the majority of the “digging” on their own.

For instance, if sales representatives can look at a profit and loss statement and identify an unprofitable customer, finance needs to give them a toolset that allows them to find out why with- out having to ask for assistance from their finance partner.

There are not enough finance people to go around if every business user re- quires their support. If the finance de-

partment expects business users to con- sistently use and act on this data, then they must develop a sense of independ- ence and self-reliance to answer their own questions and queries.

In today’s world, business users need their data fast. Removing finance from the equation for one step allows them to get information much more quickly. This does not mean finance is not involved. Finance must create appropriate controls in the toolset so that a user can’t alter or misin- terpret it. After the company has deployed its initial analytical models, it must moni- tor how often the models are being used.

Over time, the company should be tracking its action plans and the bottom tier should change as indicators/perform- ers show improvement. For example, negative (20 percent) operating income may have been the previous low for a certain product, but over a year the new low may be negative (10 percent), which is a significant improvement.

To get each functional area even more engaged, create short-term, realis- tic wins for them. Their first action plan doesn’t need to be to move a product from negative (40 percent) operating income to positive (10 percent). Moving a product from negative (40 percent) to negative 35 percent is a 5 percent im- provement in profitability. This in itself is a positive behavior.

Lastly, the company needs to find a

way to recognize the business leaders using this data to improve the business. Recognizing certain individuals or teams in front of their peers will create a competitive aspect that will push other individuals/teams to utilize it even more. At this point, all that is needed is the continued support of these tools and the proper guidance to enable more action planning.

Ensuring That Data Received Is Acted Upon Many companies will find that after they present these remarkable tools to the business, functional areas are pri- marily receiving this data versus actu- ally acting upon it. There are four steps that will help alleviate this situation within any company.

First, the finance department needs to realize that this actually happens. Too often, the people who present this data to the business will be so enamored by the euphoric reception of the newfound ana- lytics that they will blindly assume it will be utilized to the fullest extent. In reality, just because business users say they will use it does not mean they actually will.

Next, finance needs to provide a structure that offers honest, unques- tioned feedback from users and learn from it. If the company pushes the “use it or you’re gone” approach before soliciting constructive feedback, it will

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User Involvement In Data

Re-evaluate Usage And Adjust

Provide Tracking Methodology-Create

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Data Set Functional Toolsets Recognize Leaders And Business Users

Usability of Data Timely Reporting Packages

Provide Continued Support

Creating the shift from value capture events to profitability

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never get true usage. Instead, it will get a false sense of security that users are engaged when they are not.

Use a survey or focus group and allow people to question the data, toolsets, etc. Once the root cause of why they don’t want to use it is understood, address it in a specific way to eliminate those concerns.

Benchmarking usage and acceptance is the next critical step. The easiest way to do this is through surveys. Use the exact same questions the company has used in the past and measure how many more people actually use the data or how many feel more comfortable using it. This is crucial to understand if the ap- proach is working and to adjust if it’s not.

Finally, work with the business lead- ers to identify short- and long-term goals. Push a vice president or general manager at the company toward a goal of increasing the profitability of his or her segment by 3 percent. It can even be more specific. For example, the goal could be to raise the profitability of the bottom 10 customers (by operating in- come) by 5 percent each.

By making it the GM’s performance goal, the company is in essence making it the goal of sales, marketing or engi- neering functions within the GM’s busi- ness unit. It is also crucial to driving aligned, pervasive use.

Using Data to Create a Strategic Advantage When such a detailed profitability model is created — something the vast majority of the competition doesn’t have — it would be foolish not to use it to a strate- gic advantage. The series of steps in the chart above shows just how to do that:

First, identify an opportunity. For example, when using the data, it is no- ticed that extremely high margins are made for an upgrade of one of the prod- ucts, yet the pricing is at the average market price. Someone in the marketing department believes that if the price were reduced 15 percent, there would be a significant increase in volume. A potential opportunity was just identified.

Instead of only looking at ways to

profit from this opportunity, the com- pany should be looking at ways to exploit it. Analyze a very dramatic change instead of just a small one and try to predict how the competition would react. The goal here isn’t always short-term profit.

If, after analyzing the scenarios, the company predicts that one scenario would create a short-term loss but could have a severe impact on the competition that also offers this product upgrade, then it should test that prediction. The benefit of having these data and toolsets is that the company knows how long it can hold this position (price reduction) be- fore the losses outweigh the gains.

In the next steps, companies must understand the profitability drivers of the scenario and then test their decision. Understanding the profitability drivers simply means that the company under- stands the hypotheses and assumptions of how profitability could be impacted. The point is to also force the competition to be reactive.

Implementing a dramatic price change can cause the competition to react quickly, as most marketing/sales teams would follow suit immediately to

hold volume. This is dangerous for com- petitors, as they don’t know the rationale underlying the company’s strategic pric- ing decision because they are likely to be without the detailed analytics the other company possesses.

Finally, the company needs to track the reaction by the customer and the competition. It is likely that the reaction isn’t going to be exactly as planned, so understanding the profitability of the ac- tual reaction is necessary. Every couple of months, the company should revisit the opportunity and re-analyze it, or it should be identifying new opportunities.

Responding to the three questions posed at the beginning is a tough task for any company, but it absolutely can be achieved. The concepts and processes of Total Profitability Management represent a powerful framework to help make value capture events a thing of the past and profitability a constant, pervasive mindset of all departments.

Kevin Collins is manager, Business Profitability, at Elkay Manufacturing Co., a manufacturer of plumbing and cabinetry products, in Oak Brook, Ill.

Track Reaction and Document

Unintended Benefits

Force Competitors To Be Reactive

Identify/Revisit Opportunity

Analyze Ways To Exploit Opportunity

Understand Profitability Drivers

Test Your Decision

Using data to create strategic advantage

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