We often come across situations where a business has plateaued in profitability and management is not quite sure how to address the situation. In some cases, they have grown the top line considerably, however the bottom line remains the same, which translates into more work without a higher payoff.
There are a number of ways to evaluate profitability that can lead to systemic changes in how you run your business, and ultimately gets you moving towards optimizing performance. In this blog post, we outline a simple, yet effective tool to evaluate an important aspect of a business: customer sales mix.
Most people have heard of the Pareto Principle, or the “80/20 rule”, in which 80% of the output/results is generated from 20% of the input/effort. The Pareto Principal can be applied to sales productivity where, in most cases, 80% of your sales is produced from 20% of your customers. The path to great profitability is directly related to understanding the composition of your customer mix. Analysis of your underlying sales records is the first step in achieving better results.
For starters, sorting your sales by customer will help to categorize your customers into two buckets: the “A-list”, which are the top 20% of customers generating 80% of sales, and the “B-list”, the 80% of customers generating 20% of sales. This will allow you to strategize on how to optimize your allocation of resources; simply put, a business should be deploying more time and resources to A-list customers to strengthen those relationships.
Taking the analysis a step further, if your systems allow for accurate tracking of a measure of profitability by customer, you can break down your B-list customers into those that are generating a profit (the “C-list”), and those that are profit-draining and costing you money (the “D-list”).
With this information, you might consider treating different categories of customers, well, differently. That’s not to say that you treat the B-list customers poorly (which is never a good strategy), but that you treat them differently than you treat your A-listers. For example, you could consider some of the following strategies:
The objective of this activity is to free up resources so you can focus on strengthening relationships with existing A-listers by providing value-added, non-standard attention. This can be achieved by reducing the value-added attention and perks provided to B-listers.
The Pareto Principle can also be applied to your product mix where 80% of sales/profitability are generated by 20% of your product lines. If you combine the customer and product mix analyses, you have a basis to start making business decisions that have a significant impact on profitability, such as eliminating skus that are profit-draining without affecting your A-listers’ needs.
If your operating results have not grown or improved, or even if they have, conducting a meaningful sales mix analysis is a powerful technique to evaluate whether you are deploying resources optimally.
As transaction advisors, our team conducts sales mix analyses for our clients during the pre-sale preparation phase of a divestiture, as well as while performing due diligence on a prospective acquisition of a business.
If you are considering evaluating your sales mix, contact us directly, start a live chat or click on the Get in Touch With Us button above and one of our trusted advisors will reach out to you directly.
CPA, CA, CBV
Partner - Advisory Services
Mike has over 25 years of experience providing accounting and business advisory services, with a focus on the Canadian insurance industry.
CPA, CA, CBV
Alex Wong is a partner at Smythe Advisory and is focused on being a trusted business advisor to his clients.
CPA, CA, CBV
Director of Valuation Services
Paul Woodhouse focuses on providing financial advisory and litigation support services to clients.
CPA, CA, CBV
William Tam is a senior manager at Smythe Advisory, and is focused on providing valuation and financial advisory services to his clients.
Gagandeep specializes in M&A advisory engagements, as well as business valuations in the contexts of management buyouts and succession planning.
Arthur’s mandate is to assist Smythe clients in Western Canada in preparing for and executing business divestitures or acquisitions.