How to improve profitability without hacking at costs

Bouts of indiscriminate, siloed cost-cutting cause significant damage to businesses. But there is another way. Discover two powerful strategies for improving profitability without undermining growth.  

For many organisations, the lurch from cost-cutting to growth is all too familiar. As soon as pressure mounts, costs – including headcount, tech spend, project spend and investment plans – are slashed in a bid to achieve financial targets. These, often reactive, initiatives do reduce costs abruptly, but they also have a longer-lasting and damaging impact not fully considered at the time. They hinder firms’ ability to bounce back and grow profitably at a later date.  

Our experience working with a wide range of clients proves that it is possible to both reduce costs and achieve profitable growth. Here are two powerful ways to improve commercial profitability in your organisation.  

Get granular on cost allocation 

To understand profitability, many organisations apply broad cost averages across their whole product portfolio and customer segments. But achieving enriched profitability demands a different approach – developing a detailed understanding of exactly where you make the most profit, by individual product and customer segment.  

This might sound straightforward, but in almost every organisation, systems are set up for Profit and Loss (P&L) reporting by business unit or category, not by individual client or product.  

Often, clients we work with declare they know their customer and product profitability. But in reality, unless finance and commercial teams have got together to examine cost allocations at a line-by-line level, the profitability they are seeing depends on a merging of costs. This often distorts critical measures, such as channel, category or customer segment performance.  

By taking often fragmented and messy data from various sources, stitching it together and reframing it, business leaders can make smarter, more strategic commercial decisions. These could include deciding to double down on high-performing channels, exit underperforming markets, cut unprofitable products or invest in smaller niche but highly profitable areas.  

Using this approach, we typically see clients with less differentiated products and services making EBITDA improvement of 4% to 8% in the first 12 months. More differentiated products and services mixes are even more likely to capture the full 8%.  

Making an impact with accurate cost allocation  

Here’s how this works in the real world. A client told us they were turning off an online channel. Their data showed the channel generated relatively little revenue and wasn’t making much money. However, the analysis was flawed. The organisation had misallocated CAPEX costs from their field salesforce across all channels. This made the online channel look unprofitable, while inflating the performance of direct sales channels.  

By analysing profitability at the product and customer level, we uncovered a different picture. Some brands, products and channels were performing far better than assumed. Through this exercise, we identified untapped value worth over 10% of revenue. More importantly, we demonstrated that, with further investment, profits from the online channel would exceed those from non-digital sources, even at lower volumes.  

With a clear investment case, our client optimised the digital channel to attract customers and drive sales. The result? Improved sales volumes and stronger profitable growth. Taking it further, our client then redesigned their entire go-to-market strategy, prioritising high-value, high-growth areas, while turning off or automating low-value segments.  Understanding profitability isn’t just about adding EBITDA improvement in year. It’s also about ensuring your business is targeting profitable growth for the long term. Knowing which customers and products to focus on via the right channels and markets is critical to ensure you're focusing on the right areas and not just prioritising areas based on legacy data. 

Plug the leaks – take a forensic approach  

We see a similar lack of attention when it comes to commercial leakage. By leakage, we mean the money stuck between the sofa cushions – the 1%, 2% or 3% of EBITDA that is simply forgotten about. In a turbulent market, plugging these leaks is critical. Once again, the key is to scrutinise every detail – quantitatively but also critically and qualitatively.

Commercial leakage comes in many forms: over-discounting, paying rebates when thresholds are not met or tolerating late payment from customers. This last one is especially common. In one sector, for example, we found that invoices are paid, on average, on day 83, despite 60-day payment terms. This resulted in 0.25% overall profit leakage on an annualised basis due to capital charges. In isolation, this sounds small, but when you add in over-discounting, recovered surcharges and prices that have not been increased in several years, the cumulative impact on EBIT is significant.  

Realising hidden value 

Identifying hidden value is one thing – realising it is another. Often businesses are so focused on developing a shiny new tool for the long term, they forget a lot can be achieved in weeks, not months. The smartest businesses take immediate action for the short term – putting in manual workarounds to plug the gaps – while simultaneously designing a more permanent solution for the long term. We have seen an increasing number of clients set up value creation offices (sometimes alongside transformation offices) where the focus is much more on the short-term, immediate fixes that realise the value in a year.

Success hinges on a clear tactical plan, including: 

• a structured governance process to engage leadership and teams in the process, including the CFO, COO and Head of Marketing, Sales and Pricing
• a comprehensive performance management process, with a clear set of leading and lagging KPIs to measure success for each initiative on an ongoing basis
• a clear link from each benefit line to a specific cost centre and baking benefits into specific budget lines.

Implementation is driven by leadership engagement, clear acountability and a path to decision-making - the keys to achieving change in any organisation.

Taking back control of your profitability 

We know that when businesses understand and act on value insights, they can unlock sustainable, profitable growth without resorting to indiscriminate cost-cutting.  Translating your data into value insights, understanding commercial leakage and ensuring you are set up to realise value, are the key ingredients to taking back control of your profitability. With these in place, you have  the information you need to build a targeted, profitable commercial strategy.