Learnings from a EBIDTA improvement program
Remember the famous scene from movie Jerry Maguire where 'Ron' the baseball star makes ‘Jerry’ shouts his lungs out to keep repeating "Show me the money" before signing up Jerry as his consultant.
That scene is getting played out now quiet frequently where clients are asking consultants to show the money…the real money not the money that’s only on paper.
To be fair to my tribe, we have always been showing money and providing great value to our clients, but the added dimension now is that clients are asking for it to be on their P&L rather than a functional saving in manufacturing, sales, procurement which many times never quiet showed up on the P&L. A great project delivered in a functional area with 30-40% improvement in a financial metric generally kept the CXO’s unimpressed even though the functional head and consulting team went gaga over their achievements.
Partnering with clients on this journey where measure of success is based only on the P&L is an exciting proposition but comes with several challenges which need to be carefully evaluated by both sides before starting the engagement.
First of all, to achieve a sustainable improvement in EBIDTA, both sides will be need to let go of the typical client-consultant mindset and realise the need for true partnership driven by long term goals. It will also be critical and important to evaluate a few aspects & cost parameters listed below, before framing up targets and implementation plan of this journey.
1. Industry outlook: Gaining an insight in the industry/sector outlook will help in understanding organisations outlook in taking big bets or being conservative. It’s quite possible that during the exercise, the changes in industry outlook may lead to contradictory behavior such as; unplanned investments, maverick spends, capacity upgrades of unconstrained machines which have the potential to derail the expected results. The idea here is not to shy away from investments for driving growth but to adopt the right posturing for the profitability improvement journey.
2. Product Mix & Lifecycle: Companies with products in maturity & decline phases need to invest in innovation and significantly increase spend on new products & services while also maintain the sales of existing products. This also translates to an ever-increasing sales & marketing spend to push declining products which further may keep impacting EBIDTA margins on a on going basis.
3. Pricing & its Governance. In every organisation, Sales teams are busy taking multiple pricing calls and decisions and not all of these decisions are positive on EBIDTA. Technically, due to different price points and margins the give away on EBIDTA is happening every day and probably going unnoticed/uncontrolled. For example, Pricing decisions to retain a customer account or to penetrate newer accounts may adversely impact EBIDTA and hence these decisions need to be in the engagement scope and a best fit operating model is required where consulting team and client team can operate in a seamless manner on these issues etc
4. Customer & product/SKU optimization: This improvement lever is a favourite with many; identify customers and product groups/SKU with lower or negative profitability/gross margin and if possible prune the list. Even though this makes lot of sense, it is another idea with very limited benefit potential. Most customers buy a mix of products/SKU and the low profitability one’s are also table-stakes and one would end up spending lot of time convincing sales folks on removing these SKU’s from the list.
5. Fixed Costs: These costs may seem easy to address and control however in reality, return nothing to the P&L. A reduction in people costs maybe just offset by salary increments and separation costs and yield no impact on P&L. Also, dealing with these costs have adverse impacts on social, cultural and employee morale which also takes the focus away from more serious and impact areas like pricing, sales acceleration etc.
6. Procurement & Supply chain costs: Procurement is another complex category where the local benefits may not translate to the P&L due to multiple factors such as change in yield, change in consumption norms, changing commodity prices, product mix changes etc. Having said that, its inevitable to not focus on this area but a lot of caution is required in selecting the right focus areas.
7. Accounting policies: The last of my list is the probably the most important. Clear understanding of the accounting policies, cost allocations methods and various provisioning done by the accounting team is crucial to see how the impact of various initiatives will translate to the P&L. In my experience, all the hard work & decision making can be undone by a certain provisioning & allocation method.
Key Success Factors
It may be evident by now that adopting a functional cost improvement approach to drive EBIDTA will not results in radical results. Key enablers which can help in defining & developing the right approach are
a) Having an Integrated view: As outlined above, approaching EBIDTA improvement by working on functional cost elements may provide only incremental value. Instead, developing an accurate & integrated view of product level competitiveness, pricing, gross margins, costs and the impact of an increase/decrease of these parameters on the P&L can help in identifying the right focus areas. To illustrate, focusing on functional costs of a low margin & low growth product group will be a totally non value adding exercise
b) Align the accounting system: I’m no expert in this area but the experience here is that there are multiple adjustments which are done by accounts team to get the P&L out. And as you may have guessed it, its not a straight process at all. Inaccuracies in stocks, consumption parameters of materials, provisioning in sales, receivables etc can totally throw all efforts on profitability out of the gear and leave the team driving the change very frustrated.
c) Game changers: You need to have at least 2-3 game changing ideas from the very start of the journey. Not easy but if you don’t have it, the truth is the results are going to be only incremental. Best way to do this is to “realise” upfront that this is not a traditional improvement program; so plan and go an extra mile to involve lot of industry and innovation experts. Dedicate cross functional resources to properly bake the ideas and take them to pilot implementations. Even if the efforts are not successful, the internal team would gain significant insights on the current business model, the limitations and ways it can be structured better.
To wrap up, I recommend anyone approaching this exercise to develop a fit for purpose approach which is radically different from the traditional cost improvement approach and developing & mapping ideas which bring a clear impact on P&L.