Break With the Past: Get Intimate With Your Customers
 

A good crisis can be a blessing in disguise: it focuses the mind.

When the old strategy is failing to attract and retain the deep-pocket industrial buyers it once did, when the products are no longer differentiated, when the competition is pressing down on prices and margins, and when the bottom line is turning from pink to red – in other words, when everything seems to be heading in the wrong direction – it's time to break with the past. It's time to rethink the old and tired customer value proposition, the one that pays no dividends any longer.

Breaking with the past could well mean finding another angle to attract and keep customers. That implies refocusing the enterprise in ways that align the internal priorities with those of the industrial customers it aims to serve. It means getting intimate with customers.

ABB has broken with its past. Following its recent severe financial crisis, the company has decided to come to terms with legacies of its past including a fragmented organization that prevented any coherent group-wide customer strategy. To attract and retain its prized accounts, ABB management has concluded that it must adopt a “customer centric” strategy, one that refocuses the company on serving the broad interests of its global customers with a coherent value offer. The company is realigning its internal processes to do just that. Having listened closely to what these customers demand, the top management is driving major changes inside their organization to deliver a superior value offer – including tailored products and services, reduced waste, better delivery, supply chain alignment, etc. ABB's new customerintimate offer promises more overall value for the customers at a lower total cost. For ABB, it means growth in the volume of business with its major accounts, improved margins, and greater customer retention. Because both parties benefit, the management is betting ABB's turnaround on its customer centric strategy.

Similarly at IBM, the huge losses of the early 1990's were clear signs that the old hardware-centered strategy was no longer valid in a changing market for computing. The new management had to break with the company's past; a new customercentered spirit had to be injected into the organization.The “Operation Bear Hug” was one powerful tool used to prepare the top echelons for a strategy that was to be far more aligned with the company's customers and their priorities.Accordingly, each of the company's top 50 executives was made to visit a minimum of 5 clients to figure out what issues they faced in their businesses and how IBM could help solve them.These visits were not meant to sell more hardware; instead they were meant to set the company on a different strategic trajectory.The old IBM attitude of “do it my way” was to be replaced by “do it the customer way” . The company's successful turnaround is directly attributable to the painful, but necessary break with its past and the growth of its increasingly customerfocused solutions business.

As these examples show, intimacy is not a new-age sales pitch; it's a different way of doing business. And it requires major changes in what a company does. When SKF, the world's largest supplier of roller bearings, decided to better align itself with the company's customers in the replacement market, the management undertook a major overhaul of its structure,management processes and product offerings. It launched an ambitious strategy to make SKF a “ Trouble Free Operation” company, a mission that went beyond selling good products.The new customer value proposition was about enhancing plant and repair shop productivity, not about bearings. It meant an expanded portfolio of value-added products and services. It was a clean break with SKF's past.

In tough markets characterized by eroded product differentiation and concentration of business among a few but large customers – a typical picture in many industrial sectors – failing to get intimate with key customers can lead to serious consequences: declining prices and margins, inferior returns on investment, and the risk of falling into a “commodity trap” where the pressure on profitability leads to reduced investment in new value-added products and services which in turn leads to further loss of differentiation and even greater pressure on prices and margins. More than a few companies have fallen victim to this vicious cycle.

To avoid the commodity trap, a growing number of industrial companies are redirecting their strategy and business system for a better alignment with their customers and their business priorities.They are investing in customer-inspired changes across a wide array of activities inside their organizations. But not all such well intended efforts have succeeded. They have succumbed to problems, some of them legacies of a successful past. Consider the following short list of hurdles. (Please see  Break With the Past: Get Intimate With Your Customers
IMD l Article)

Implementing a CRM Scorecard - Part 1
By James Brewton
CRMetrix
 

Measurement is increasingly being looked upon as the "missing ingredient" in today's Customer Relationship Management (CRM) strategies.

The enormous failure rate of CRM initiatives - 70% to 90% by most accounts - is forcing many organizations to look beyond the promises of technology and return to a basic tenant of business management - what gets measured gets done. But, to drive CRM performance, not just any measurement system will do.

What's needed is a measurement system that specifically links CRM strategy and customer profitability objectives to metrics that drive CRM performance throughout the organization - a CRM Scorecard. To effectively implement and benefit from a CRM Scorecard, an organization must successfully perform five key steps (Figure 1):

Steps for Implementing and Benefiting from a CRM Scorecard

	Step Activity 1 Define CRM Strategy – Create a CRM Strategy Map 2 Select CRM Strategic Measures 3 Cascade CRM Strategic Measures 4 Select and Implement CRM Performance Reporting System 5 Entrench CRM Measurement in Organizational Culture

This article is the first of five parts focused on successfully implementing a CRM Scorecard. Part 1 focuses on Step 1. Defining CRM Strategy - Creating a CRM Strategy Map.

Step 1. Defining CRM Strategy - Creating a CRM Strategy Map
Creating an effective enterprise CRM scorecard does not start with measurement. A comprehensive CRM strategy is too complex for that. Building an effective CRM Scorecard begins with defining an organization's unique CRM strategy. Without a clear understanding and commitment by the CRM strategy team as to what the CRM strategy is and how, specifically, strategic CRM goals will be achieved, efforts to select and effectively communicate critical strategic CRM measures will quickly become unfocused and unproductive. A powerful tool for defining an organization's CRM strategy is the CRM Strategy Map

The CRM Strategy Map clearly and visually outlines the specific goals of an organization's CRM strategy and the specific cause-and-effect links by which these goals will be achieved. CRM Strategy Maps are powerful communication tools giving everyone in the organization a clear picture of what their organization's CRM strategy is and how their jobs contribute to CRM success.

The development of an enterprise CRM Strategy Map can be facilitated by the use of a CRM Strategy Map template like that shown in Figure 2.

A CRM Strategy Map consists of three key components:

1. Strategic perspectives
2. Strategic themes
3. Strategic linkages

Strategic Perspectives and Themes
The perspectives recommended for a CRM Strategy Map mimic those used by Kaplan and Norton in their Balanced Scorecard Strategy Map with one critical addition - Segment.

Strategy perspectives serve to focus the CRM strategy team on the essential elements of CRM strategy execution. Each perspective has a related strategic theme or thrust that, together, guides the team in identifying and mapping the key success factors and strategy-critical cause-and-effect linkages that will drive their organization's CRM performance and ROI.

The CRM Strategy Map template is comprised of five strategic perspectives and their related strategic themes. The focus of each strategic perspective / theme is outlined below:

1. Segment Perspective / Theme
The segment perspective of the CRM Strategy Map focuses on the specific customer segments targeted for CRM. The strategic theme for the segment perspective focuses on targeting customer segments and their value propositions.

2. Financial Perspective / Theme
The financial perspective of the CRM Strategy Map reflects the strategic CRM financial objectives for each targeted customer segment. The strategic theme for the financial perspective is to maximize the profitability of targeted customer segments.

3. Customer Perspective / Theme
The customer perspective focuses on the strategic CRM customer success factors for achieving desired CRM financial outcomes. The strategic theme for the customer perspective is to maximize the experience and desired behavior of targeted customer segments.

4. Operations Perspective / Theme
The operations perspective of the CRM Strategy Map focuses on the strategic CRM operational success factors for achieving desired customer outcomes for each CRM function (e.g., marketing, sales, customer service) and customer contact channel (e.g., inbound phone, outbound phone, e-mail, Web, field force). The strategic theme for the operations perspective is to maximize the efficiency and effectiveness of enterprise CRM operations.

5. People / IT Perspective
The people / IT perspective of the CRM Strategy Map focuses on the strategic CRM people and technology success factors for achieving desired CRM operational and customer outcomes for each CRM function and customer contact channel. The strategic theme for the people / IT perspective focuses on maximizing the experience and capabilities of CRM operations employees. (Please see Implementing a CRM Scorecard - Part 1 By James Brewton,  CRMetrix. Our Server )

Marketing Performance Management: The CMO’s Ultimate Toolkit
 

Turning Data into Action

Loyalty Programs Must Create Real Value
 

& (A Cingular Challenge: Becoming More Than the Sum of its Parts  Knowledge@Wharton. Our Server ) & (The Lowdown on Customer Loyalty Programs: Which Are the Most Effective and Why Published: September 06, 2006 in Knowledge@Wharton.) & (Customer Loyalty - Are You Wired for It  AMA article) & (The Twelve Laws of Loyalty  AMA article )

You Can’t Gauge Your Business Success Without Effective Measurement

Customer Relationship Management: Challenging the Myth
 

Marketing Shouldn't Always Drive Customer Strategy

Customer strategy lies—or should lie—at the heart of customer relationship management. It defines a company's objective with regard to its customers: acquiring them, serving them and retaining them. It involves understanding the nature of customers, the relationships and the different flavors customers and relationships come in, as well as the factors driving those differences. So what is, or should be, marketing's role in defining and driving customer strategy? Marketing is uniquely positioned with regard to developing customer strategy. It is often the area linked to all the elements needed to develop customer strategy. These include external market information, such as competitive intelligence, data about trends in customer attitudes and behaviors in the market place (not just with relation to the company and its products). It also includes internal company information about overall corporate strategy (is the focus on revenue growth or profit growth?) as well as, in many instances, detailed customer behavior and transaction information, customer profitability (across multiple products), satisfaction data and retention/attrition/loyalty information. Add to this the ability of some sophisticated marketing organizations to analyze customer behavior, develop actionable customer segmentation schemes and build predictive models of customer behavior. Contrast this with the limited information and capabilities that other areas, such as finance, product development, sales or IT, may have and it becomes clear that marketing is uniquely positioned to help shape customer strategy. The next logical question is: Should marketing be driving the development of customer strategy or should it play an important role while not leading the effort? The answer depends on the corporate environment and marketing's place within it. In organizations where marketing plays a central role, has the requisite talent, has a close relationship with lines of business and operating heads and is seen as a credible business partner by the various other functional groups and has the ability to be a "boundary spanner," it can play a central role in developing customer strategy and in orchestrating the execution of that strategy. However, where marketing plays primarily a marketing communications role—or where it is seen as a sales support or staff function—which is, unfortunately, the case in many business-to-business environments, marketing is simply not a credible leader in developing and implementing customer strategy. In these situations, marketing can barely command a seat at the table, let alone commandeer a leadership role. This was painfully obvious in many early CRM efforts, which often took place in sales-driven companies where IT played a prominent role and marketing was relegated to the background, if it was included at all. Passenger or Driver? I can recall many marketing clients complaining (some still do) that their firms' CRM effort would not "reach" marketing until the tail end of implementation efforts. The fact that these were seen as implementations itself says a great deal about how little customer strategy was really involved. In these situations, marketing does well by ensuring that it is on the bus at least as a valued passenger and, if the marketers are good, maybe they get promoted to the head of the bus sometime in the future.           (Please see Marketing Shouldn't Always Drive Customer Strategy By Naras Eechambadi, Quaero, Our Server )

Marrying market research and customer relationship marketing

This paper builds on previous research to demonstrate the power of marrying together
market research data and existing loyalty card data in improving promotional
marketing. In particular, it includes the analysis of real attitudinal data (cognitive,
affective and conative) collected specifically for this task from 3,000 customers. The
approach is illustrated via a case study of a gardening retailer. It concludes that 5 key
factors need to be considered: the relevancy of the product or service on offer,
identification with the brand providing the service or product, perceived value for
money, the accessibility of the brand or product, and the degree of confidence
customers will be satisfied with what they buy. The first two factors are of primary
importance, highlighting that you are who you are (attitude), not what you are
(demographics). (Please see Marrying Market Research and Customer Relationship Marketing Saïd Business School & Ipsos UK,, Our Server )

Generating Higher Profits by Managing Customers as Financial Assets
 

Executing to Plan: How to Close the Gap
By Don Peppers and Martha Rogers, Ph.D.
 

Cognitive dissonance — a term often used by psychologists to identify the difference between what people say they’re going to do and what they actually do — can be applied to business, too. We've seen a lot of companies that don’t do what they say they’re going to do. Call it corporate dissonance. More specifically, there’s a gap between planning and execution when it comes to keeping companies on the path toward maximizing customer value.

Failure to execute to plan has been a thorn in the side of executives for decades. For many organizations, the complexity of today’s hypercompetitive, multichannel business environment has widened the gap between execution and plan. A study of 197 companies published in the July/August issue of Harvard Business Review reports that those businesses lost an average of 37 percent of their overall performance because of breakdowns in the planning and execution process. The HBR study identifies several cracks in the process. One is closely related to maximizing customer value, and that is: Companies rarely track their performances versus their original plans. This ties in to our insistence in our new book, Return on Customer, that companies must balance their short- and long-term goals. Short-term decisions, even marketing-related decisions such as contact center complaint resolution, can have a long-term effect on customer value.

From our point of view, the execution-to-plan gap is caused by poor adoption and poor change management processes. Lack of attention to either one can derail a customer strategy, and they’re completely intertwined.

When executing a truly enterprise wide customer strategy, you have to bring together people playing different roles in a variety of functions across your entire organization. Sales reps, financial staff, marketing managers, contact center personnel, service technicians — everyone in the company must center himself or herself on the customer and take the customer’s point of view.

Managing to Change
Sometimes a new customer strategy that maximizes customer value also requires employees to adopt a new technology. In addition, vendors, partners and customers themselves may need to use the technology. Customer self-service, for example, offers compelling benefits to customers, not just to you. To encourage adoption, executives must balance the company’s needs for using the technology with the customer’s benefit from accessing it. If customers are demanding more self-service technologies, but your goals for maximizing customer value involve a more personalized approach, your company needs to find a middle ground that serves both the customer and your long-term goals.

Adoption is a process, not a destination. It involves everyone in the company. If your company wants to maximize customer value, that mission is not just for marketing or sales. Eventually, it will touch everybody who touches your company. It’s therefore vital that your customer-focused technologies – and the processes they support – accommodate all of the members of your team. Once again, to cite the self-service example, are sales reps on board with how they will treat customers if customers have more self-service access? Does marketing know how its role will change?

This transformation also takes a commitment from senior managers. Everyone in the C-suite must play an active role in instilling a customer-centric culture, as well as implementing the technology necessary to support it. If a company’s goal is to provide a more detailed and singular view of its customer base, and new database software will support that strategy, for example, all information needs to come from that database. C-level executives must be committed to the process of creating that single customer view. They must insist that the relevant database technology is implemented. Without that awareness, adoption of customer-centric processes will flounder.

One show of support from the C-suite is to align the organization’s measurements of success and its incentives with the goals of its customer initiative. Adoption and change management stand no chance without metrics and compensation. Compensation buys compliance, which fuels an organization’s behavior to change. It is a simple equation: No compensation equals no compliance, which equals no behavior change.

Companies should measure and compensate on long-term goals, as well as on the short-term results of their plans. In sales, for example, instead of gauging success entirely on current sales and profits, reward reps for meeting monthly sales and pipeline targets and compensate them for the time invested in gathering key customer data and creating relationships that will pay long-term dividends for the company.

No matter how much you invest in making the changes necessary to adopt a new customer initiative that maximizes customer value and closes the execution-to-plan gap, you won’t effectively execute on it unless you build a culture of trust — one that continuously encourages everyone in your company to see your business from the customer’s perspective. People within your firm must not only understand what it means to be customer oriented; they must also want it to happen. Managers must clearly communicate the benefits of doing so. With that attitude, you can implement the processes, technologies and organizational structure that will help your customer strategy succeed.

When it comes to maximizing customer value, focus on adoption and change management. Only then will your company be able to do what it says it’s going to do, and only then will you execute according to plan. (Please see Executing to Plan: How to Close the Gap By Don Peppers and Martha Rogers, Ph.D., Peppers & Rogers Group, Our Server )

Are All of Your Customers Profitable (To You)?
By Gary Cokins SAS

• Do we push for volume or for margin with a specific customer?
• Are there ways to improve profitability by altering the way we package, sell, deliver, or generally service a customer?
• Does the sales volume justify the discounts, rebates or promotion structure we provide the customer?
• Can we realize our changing strategies by influencing our customers to alter their behavior to buy differently (and more profitably) from us?

(Please see Are All of Your Customers Profitable (To You)?  . By Gary Cokins, SAS     Our Server )

Top Down vs. Bottom Up
By Gregory J. Nolan

Financial service companies are currently implementing or planning to implement the last major improvement to management reporting.

This change will significantly upgrade the quality and quantity of information available to support the professional management of the business. They are moving from a top down design to a bottom up design for expense distributions and activity based costing is at the heart of it.

This change clears away the controversy surrounding management reporting and provides actionable insights into product profitability, customer profitability, line of business profitability, staffing and resource management, productivity, and target re-engineering.

At most financial service companies, internal P&Ls (Organizational, Product and Customer) have been completed satisfactorily except for expense distributions. Revenue accounting, internal funds accounting, risk adjustments and capital allocations are basically in place. While there may be some user discord about particulars, the overall methodology is in place. This is not the case with expense distributions. Expense distributions are the most contentious area remaining and one that precludes user acceptance of the P&L itself.

The issue of expense distributions arises from the following situation. In organizational profitability reporting revenue is booked into profit centers. Expense is booked into every center in the institution and is booked by natural classification: salaries, benefits, occupancy, depreciation, etc. The challenge is to credibly and accurately move the expense to the appropriate revenue. This becomes more problematic in product and customer profitability reporting.

Top Down
Top down originally got its name from the concept of allocating expenses on a percentage basis. Today, however, it represents all types of accounting (including rate X volume) which allocate 100% of expenses to current period revenue. This section addresses the methodologies that are used in top down accounting and the issues and bad decisions that arise from its use.

Expense Allocations
Many of the business managers we talk with are dissatisfied with their organizational and product profitability calculations because of expense allocations. In customer profitability, their dissatisfaction level rises exponentially. Profit center managers, product managers, and customer relationship managers in companies that use expense allocations are frustrated with the profitability information they receive. They do not believe the expense amounts allocated to their P&Ls and cannot understand the validity of the allocations. In addition, they can’t articulate the problem or understand the amounts they should have been charged. As a result they usually wind up blaming back office managers for overspending and bickering with finance managers over the allocation rates and rules.

Expense allocations are adversely impacting management’s ability to make informed decisions regarding customers, products, markets, and channels. In financial services, sometimes it’s hard to see the absurdity in the allocation result because the companies are so large and complex. It’s difficult for users to understand whether a wire transfer really costs $23.00 or $2.30. When the allocations arrive all they can do is complain. A large number of companies that have installed profitability systems that employ expense allocations are currently rethinking their designs because of management’s dissatisfaction.

Business manager frustration rises exponentially when expense allocations are used in customer profitability because allocations result in 100% of channel expense being allocated no matter how much of the channel customers have used. Can you imagine how frustrating and demoralizing it is when you successfully divert a large percentage of your customer base from a very costly channel to a less costly channel and 100% of the costly channel is allocated to your P&Ls anyway? Allocating 100% of the expense of positioning channel resources to current period customer revenues misstates customer profitability and leads to poor decision making.

Using expense allocations is analogous to a supermarket determining profitability by subtracting the cost of all the goods they put on their shelves from the day’s receipts, instead of subtracting just the goods that were purchased. The cost of generating the revenue is the amount of resource consumed by the customers not the amount of resource positioned.

$700,000 Porsche
To better understand the problem bankers are having understanding the information generated by their profitability systems, let’s get out of banking for a minute and go into a business where it’s easier to relate to the amounts. Imagine you put up your capital (so you really have a net income focus) and buy a Porsche dealership. That feels pretty good, owning a company. Now you wait for sales. A lot of people come in to look at the cars. They sit in them; they touch them; but no one’s buying. Finally someone buys a car for $100,000. You get to the end of the month and it was the only car sold. Now you turn on the typical profitability system and it reports that you sold a Porsche that costs $700,000 for $100,000. Now what do you do? Do you try to figure out how to sell Porsches for $800,000? Or do you get out of the business because the product is unprofitable?

Obviously the car didn’t cost $700,000. And yet the profitability system allocated 100% of the actual expenses of the dealership to the product. The total dealership incurred a loss with $700,000 in expense and only $100,000 in revenue. But management needs to know that the Porsche only cost $80,000 and there’s a great margin on the product (product profitability) and you have unused resource to manage. Management also needs to know that the customer that purchased the car is also very profitable (customer profitability) and is the kind of customer you want to profile and target market.

Fluctuating Amounts
Another major issue with expense allocations is the large fluctuations that exist month to month. Since the system allocates 100% of expenses each period, the amounts allocated fluctuate as the distribution basis (volumes, etc.) fluctuates. This creates a moving target that does not support decision making. We assisted a major financial service company that was using expense allocations. They had previously formed a pricing committee of senior executives to review and set prices. Each month they would pick products to address and would ask the finance department to supply the product unit costs. The mistake they made was not asking for the same product two months in succession. If they did, they would have received unit cost numbers that fluctuated materially from one month to the next. The unit costs they received were not product unit costs, they were expense per unit and they fluctuate each period. They should not be used to support pricing decisions.

Rippling Effect
Another problem with expense allocations is the rippling effect. Since these allocations always account for the entire universe any change anywhere in the company ripples through every P&L in the company. We have a great anecdote from a major mid-Atlantic bank. They had sold their credit card division to a mid-Western bank. After the transaction was completed the finance department ran the P&Ls for the next month. Once the reports were distributed they received an irate call from the head of commercial banking. He wanted to know why his net income had declined so materially. The finance explanation, of course, was that the company had sold off the credit card division and the profitability system had allocated the remaining expenses that had been previously allocated to credit card. The executive said: “it doesn’t make sense that the sale of a retail product line should adversely impact the commercial banking P&L”. The unfortunate reply from finance was: “it may not make sense from a business perspective but it does make sense from an accounting perspective”. This is a classic disconnect between finance and the business lines and is caused by the top down approach.

Variations on a theme
Some companies have adopted the top down design and sidestepped the rippling and fluctuating effect. They allocate 100% of expenses but do it with a fixed rate X volume. This creates the same basic problems as a percentage allocation. The price for eliminating the fluctuations is a large variance that accumulates and ultimately needs to be addressed. The common term for this is “true ups”. By definition it implies the previous numbers were wrong and now they will be corrected. The worst case of this we encountered was a large mid-Western bank who accumulated the true ups throughout the entire year. In December they would distribute the variances and cause considerable consternation throughout the company. All of those managers who thought they were operating at the reported level of profitability received a year end surprise that adversely impacted their results and their compensation.

Bottom Up
Bottom up is the distribution of the cost of generating revenue to the revenue that was generated. This is not just rate x volume; it’s accounting for the expense of positioning resources, how customers consume them, and how much resource was positioned but not consumed.

The True Nature of Operating Expenses
There are two important components to measuring and managing the financial service company, and both should be evident in the accounting. The first is measuring how much resource was positioned to service customers and to process the transactions they create. The second is measuring how much of that resource was actually consumed by customers. Operating expenses, for the most part, are incurred in the positioning of resources. What is the expense of positioning resources? It’s the salaries and benefits of the employees who do the work, the expense of the space they occupy, the expense of the equipment and supplies they utilize, the expense of heat, light, and power, etc. It is also the expense of positioning computing resources.

These valuable resources are the employees and the computers of the company that process the work, interact with customers, and handle all of the day-to-day activities that keep the bank operational. Allocating 100% of these expenses to revenue each period, without consideration for what they did or how much they did, creates false pictures of the business and leads to bad decision making.

The second is when activity based costing follows the concepts of full capacity costing and as a result provides true insights into the nature of profitability, how capacity is positioned and utilized, and the impact of customer behavior on net income. Financial service companies that use this method of activity based costing are creating usage-based charges to profitability statements with channel identity. Activity based unit costs multiplied by the volumes processed measure the usage, and the amounts appearing in the profitability statements actually reflect the amount of resources consumed by customers as they purchase products and services from the bank (cost of generating revenue). If capacity goes unused it’s reported as unused capacity.

The key to creating this information is double entry bookkeeping. Most profitability systems are created with the design emphasis on the debit side of the calculation. This results from the emphasis on 100% allocation from back office to front office. However, profitability systems that have been designed to take advantage of the power of activity based costing have placed design emphasis on both the debit and credit side of the calculations. This allows for a charge to the P&L with channel and product identity and a credit to the center that did the work with channel and product identity. Creating information on both sides of the transaction is what links P&Ls with channel utilization reporting.

Shortcuts
There are a number of shortcuts to creating profitability information, but they don’t enhance decision making. One shortcut is to bypass the cost accounting and use industry averages. While this may be expedient, it doesn’t provide credible information. It doesn’t identify how your customers consume the resources your company has positioned. Profitability information is too important to guess at the answer. The decisions arising from this information impact the very core of your business.

Another shortcut is to estimate the costs. This saves money in the short term but is more expensive in the long term. By estimating the costs you are missing the profit opportunities that arise from analyzing properly created metrics. It is very profitable to accurately and credibly create and deploy activity based costs and integrated profitability reports. The expense of the project is easily recovered from the profit improvement opportunities that emerge from the rich information content.

Improved Decision Making
This section presents some examples of an improved decision making environment when using the bottom up approach to expense distribution.

Products and Customers
A profitable offering targeted to specific customers or customer segments is the key to sustaining long term profitability and growth. The key to designing the offering and targeting the proper segment lies in understanding customer profitability. Customer profitability should be calculated showing the products the customers purchased, the channels they used and the cost of the resources they consumed. If customer and product P&Ls are created using expense allocations then the results are not representative of the real relationship or the real offer and will lead to bad decisions. Bottom up accounting provides the insights that are essential to strong decision making.

During a speech at a strategic marketing conference I asked the attendees the following question: “If you are successful in diverting 50% of your customers out of your most expensive channel and into a less expensive channel how much more money does the company make?” The attendees were predominantly marketing executives but knew the correct answer to my accounting question. The bank doesn’t make any more money until the resources in the first channel are reduced or redeployed to reflect the declining usage.

If companies are going to continue to design and offer lower-cost delivery channels to their customers, they must aggressively manage the resources positioned in all channels. Customers don’t announce their transaction intentions or their channel preferences; they move between channels at will. The best companies are identifying the impact of channel usage in their profitability calculations and they are tracking channel utilization to optimize resource management. As a result, they have a competitive advantage and are sustaining profitability and growth.

A local market is defined as a specific demographic area that is serviced by a branch or cluster of branches. Best practice banks want to view local market results from a number of perspectives. They want to know location profitability. That is the profitability of the customers in that location. They want to know this in aggregate to be able to compare markets and to target attractive markets to penetrate. They also want to know individual customer profitability to identify customers for target marketing. Lastly, they want to know how the location is being utilized by walk in customers. This is different from profitability because the walk-in customers may actually be customers of record of other branches or local markets.

The difference between local market profitability and customer profitability is that customers can move to other local markets and still be customers of the bank. The movement of customers over time is very important as it impacts the very nature of local market demographics. We all know how neighborhoods change. Look at property values over time. Wouldn’t it be wonderful to track local market profitability over time to track the results of your efforts to improve profitability as well as the ebb and flow of profitability as customers move in and out of those markets? A very profitable location could become the most unprofitable over time.

Measuring and managing local markets involves the two most important measures of a branch or location: profitability and productivity. How profitable is it to have a presence in a specific location and what’s the productivity of the people who staff the location to service the walk in business.

Local market profitability is the revenue of the customers of record of the local market less the cost of generating that revenue. Unfortunately not many banks are computing the cost of generating the revenue. Most banks misstate branch profitability by taking the revenue of the customers of record of the branch and subtracting the direct expenses of the branch and some allocated expenses. The direct expenses of the branch are the expenses of positioning resources in the branch to service the walk in customers from any branch. This mismatch of revenue and expense distorts results and adversely impacts decision-making.

Leading banks that utilize the bottom up approach are employing profitability measurement functionality known as inter-branch accounting to reconcile branch of record and branch of process and to clean up the mismatched reporting. They are creating two different reports to support the two primary views. One is an integrated P&L showing local market profitability by product and the other is a capacity utilization report that shows how effectively resources are positioned to service the walk in customers.

Customer Behavior
Customer behavior is apparent in the financials when using activity based costing in the bottom up approach. Since the charges to the P&L are usage based and reflect the channels the customer utilized and the resources they consumed, the P&Ls reflect the impact of customer behavior on net income. Behavior is evidenced by the size of the balances in their accounts, the number of transactions they create, the channels they use and the fees they pay. In combination this is the story line behind understanding and analyzing customer profitability.

We worked with one bank that had been creating retail customer P&Ls for a number of years using the bottom up approach. They had retained all of that history in their data warehouse. Someone in their marketing department came up with a brilliant idea. The retail bank had adopted a company wide objective of retaining their profitable customers. The marketing manager suggested that they use their predictive modeling software and look at the last three years of customer P&Ls and search out the profitable customers that had left the bank. They decided to look at the last ninety days of their behavior and apply what the software learns to the existing customer base and identify the customers that are planning on closing their accounts. The software came back with a list of names of customers likely to close out their relationships.

The marketing department assembled lists by branch and sent them out to the branch managers. One of the branches called to say they received the list around noon and found that one of the names on the list had closed out their relationship at 10 a.m. that morning. This obviously enhanced the credibility of the effort and word spread throughout the branches. Their calling efforts succeeded in retaining many of the customers on the list.

There are numerous examples of profitable decisions arising out of bottom up information that provides insights into the businesses. The key is getting beyond the bickering over rates and rules and forming a partnership with line of business managers that result in a consistent approach to sustaining profitability and growth.

Conclusion
Management accounting should align with how managers run their businesses and how they make decisions. If management is that great discipline they teach in business school and the great art that Peter Drucker writes about, shouldn’t management accounting be the accounting for that great management? Moving to a bottom up design will finally provide that alignment and elevate management reporting to its rightful place in the company.

Additional Information:
For more information on profitability, attend Greg's seminar How to Create Real Value with ABM and Customer Profitability Information.

(Please see Top Down vs. Bottom Up By Gregory J. Nolan,  Association for Management Information in Financial Services, Our Server )

Old Rules

In fact, all customers are not equal, at least not when it comes to profitability. While total sales may follow the 80-20 rule, the curve for total profitability typically reveals that the most profitable 20 percent of customers generate between 150 percent and 300 percent of total profits. The middle 70 percent of customers about break even, and the least profitable 10 percent of customers lose 50 percent to 200 percent of total profits, leaving a bank with its 100 percent of total profits. This distribution curve requires the ability to adjust the marketing mix on a segment-by-segment basis to maximize profitability.

Is your organization marketing strategy still powered by the old rules? Under the old rules, marketing uses a "spray and pray" approach to business development. They spray— mass media marketing—and then pray that new sales would follow. As a result, the marketing messages launched reach a large number of the wrong targets and only a small percentage of the right targets.

The wrong targets are consumers who find one or more elements of the marketing mix irrelevant, or, even if they accept it, will not generate profits for the organization. Of course, the marketing programs are launched with all good intentions. Often an entry or core product, is presented with the idea of leveraging the new relationship by attempting to later cross-sell additional products. The logic supporting this strategy is that profitability will materialize and grow over time, as new small customers transform into large loyal customers through the acquisition of additional products and services.

In truth, even if the customer acquires additional products, the incremental revenue created may not necessarily bring proportional profits. A customer's size does not necessarily determine profitability. For example, a small customer who makes few service requests and uses only electronic channels like the Internet and ATMs may be more profitable than a larger customer whose cost to serve is high because of the service demands he or she places on resources.

New Rules
That means that understanding and measuring customer profitability is vital to powering profitable growth and operating under the new rules that characterize today's competitive environment.

Can you analyze customer-buying trends, segment customers with precision, design targeted sales and marketing campaigns and measure ROI? If the answers are no, you are not working under the new rules. The new rules are characterized by advanced marketing technology that is designed to create a sustainable competitive advantage by profitably aligning the right customer with the right product and the right message at the right time.

A primary challenge to uncovering customer profitability will be in monitoring interactions that provide insight into a customer's behavior while pulling the right information together to form a single view of the customer relationship. Customer transactional data from back-office core systems and front-office CRM systems must be linked with financial information so that calculating individual customer profitability reflects the total revenue generated minus the total cost of providing the consumed products and services across the entire relationship.

The technology infrastructure for supporting this single view will include data warehousing and ETL (extract, transform and load) processes, as well as data quality components. In addition, activity-based costing and behavior monitoring type applications will expose the real-time relationships between customer interactions across multiple channels and the cost-to-serve components that drive toward individual customer profitability calculations.

Advanced marketing and predictive analytic applications provide proactive firepower and round out the new rules by taking this complete picture of the customer and delivering highly targeted marketing campaigns that are both efficient and effective.

The rules have changed, and organizations that have the ability to measure, analyze, customize and deliver a tailored marketing mix to their targeted customers will achieve profitable growth and create a sustainable competitive advantage.

Real Time Decision Support: Creating a Flexible Architecture for Real Time Analytics by Greg Barnes Nelson and Jeff Wright,
 

Real Time Decision Support: Creating a Flexible Architecture for Real Time Analytics by Greg Barnes Nelson and Jeff Wright,