CSCMP's Supply Chain Quarterly
Strategy
May 22, 2018
Strategy

Driving profitability via analytics-based value chain segmentation

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Designing supply chains based on the segmentation of products and customers helps companies profitably meet different channel and customer requirements. This overview of segmentation success factors and a case study of The Clorox Company's value chain segmentation program explain how it's done.

Creating tailored supply chain operations that profitably meet different channel and customer requirements, and thus effectively leverage market opportunities, is an ongoing mandate for companies and their supply chain executives, but this is an increasingly difficult task. Shorter product life cycles, product customizations to meet local market needs on a global basis, and the need to satisfy the order-fulfillment expectations of online consumers are just a few of the complexities that have to be addressed. Clearly, the days of the "one-size-fits-all" supply chain are over.

So how do you gain clarity on the best approach to handling these competing complexities while also driving sustainable increases in profit performance? One proven approach is to design solutions that recognize the segmentation of products and customers based on specific performance attributes and requirements. This analytically driven approach is defined below and further discussed in the case study of The Clorox Company that accompanies this article.

Article Figures
[Figure 1] Segmentation activities
[Figure 1] Segmentation activities Enlarge this image
[Figure 2] Customer segmentation based on profit
[Figure 2] Customer segmentation based on profit Enlarge this image
[Figure 3] Customer scorecard examples
[Figure 3] Customer scorecard examples Enlarge this image

One key consideration in product and customer segmentation should be the historical and desired profit performance of products handled through each go-to-market solution. The analytics begin by categorizing different combinations of customers and products into different segments. Grouping customers by their revenue contributions or products based on a type or market category is commonplace. But zeroing in on discrete segments based on their exact contributions to bottom-line profits is another matter. Certainly, companies work toward that objective using gross revenue contributions and standard cost allocations, but in the end, precisely separating one customer from another based on exact differences in financial contributions is a significant challenge that can be addressed by a more robust segmentation approach.

How can we state that with such confidence? Competitive Insights, a software-as-a-service (SaaS) solutions provider, and the Scheller College of Business at the Georgia Institute of Technology have talked to executives at hundreds of companies about this very issue. Most said they are working on developing more accurate cost-to-serve models and improved ways of measuring the positive or negative impact of different order-fulfillment programs, inventory-deployment strategies, and/or sales incentives. They are finding that there are real challenges associated with this effort. Here are three common themes:

  • Even with the adoption of enterprise resource planning (ERP) systems, much of the required data sits in functional silos. This disjointed data makes it incredibly difficult to create precise and detailed profit information as a common foundation for segmentation.

  • It is a challenge to get different functional groups within the organization to accept the accuracy of the financial insights being demonstrated after analysis work has been completed.

  • Business conditions are constantly changing, but segmentation analyses are often treated as "one-off" exercises and are not updated over time. Therefore, the organizational support for understanding the insights gained through those analyses and how they impact customer and product performance is lacking.
  • These barriers are real, and they are difficult to solve using the technologies and methodologies that have been adopted by organizations over the last five years. While companies talk about the need to have accurate and precise financial information for every product sold to every customer, only a few have broken the code. How have these few done it? By taking advantage of the power of cloud computing and advances in targeted business analytics, and by adopting a cross-functional team approach to build and govern this information.

    Segmentation based on performance
    Channel-, customer-, and product-segmentation activities are critical to tailoring supply chain operations to contribute the most value to the organization. Value is derived from having adaptable operational configurations that meet prioritized needs while reaching certain levels of financial performance. These differentiated operating models generate maximum return when based on a sound analytical approach.

    Segmentation activities should be based on a number of criteria. As shown in Figure 1, these considerations must incorporate the different priorities for each channel being served and the customers that are in that channel. In addition, product-specific information, including the business objectives for different product offerings, needs to be integrated into effective segmentation activities. Once these priorities have been selected, different go-to-market strategies and their respective supply chain solutions can be defined and implemented. Thus, business analytics plays a key role in driving segmentation strategies for effective leveraging of market opportunities. Almost all companies will have some form of standard product cost that is tied to the cost to make or buy the product. Companies often use these standard sets of costs and assign or allocate additional costs that are associated with servicing customers' orders in an attempt to understand the total cost to serve that customer. This can also be the case for the actual net revenue associated with the selling of products.

    Naturally, the goal is to have accurate total costs and net profit figures for every product sold to every customer served. This can be a daunting task. But cloud-based computing provides the scalability needed to handle massive amounts of data and the processing power required for efficiently handling enormous numbers of calculations. Using cloud-based technology as the operating platform, powerful business analytics that go beyond historical capabilities can be provided on an ongoing basis for most companies. In addition, cloud computing can now support rigorous data-governance efforts. These governance efforts ensure that the organization has confidence in the information needed for segmentation activities.

    Effective product- and customer-segmentation activities should be based on accurate and actionable financial performance insights that identify specific profit contributions by customer, channel, vendor, and product. To be actionable, the profit contributions must be based on the actual realized net revenue for each product sold to each customer as well as all costs required to service that order from the sourcing of the product to the order-fulfillment activities.

    Once established, segmentation insights can be used by cross-functional teams to truly understand the specific drivers of profitability—for every customer, in every channel, for every product purchased. Knowing this information can empower an organization to develop and implement strategies that drive profitability one product and customer at a time.

    Identifying true profit performance
    Segmentation activities based on financial performance can lead to the identification of multiple opportunities to increase the profit contributions of customers and products. Typically, financial segmentation efforts will start by grouping products or customers into similar performance categories. Let's look at an example of financial segmentation that's focused on customers.

    Figure 2 shows a bar-chart distribution of customers grouped by profit performance. In this case, 43 customers represent the top 20 percent of profit contributors. This is not atypical. When they add exact profit insights to their segmentation activities, companies will typically find that 10-20 percent of their customers yield up to 80 percent of their total profit.

    An even more interesting aspect of this example is the fact that over 100,000 customers are marginal in terms of their financial contributions to the business.

    Based on this type of segmentation insight, the goal may not necessarily be to "fire" the less-profitable customer, but rather to investigate their poor performance relative to profit contributions and then determine how to incentivize these customers to emulate or act like better-performing customers. To do this, you must have the ability to identify what is driving poor performance for specific customers.

    From a supply chain perspective, poor performance can be driven by a number of considerations. For example, is this performance related to costly order-fulfillment requirements, or is the amount of inventory being held for customers in a particular channel out of balance? Naturally, poor financial performance for products and customers can go well beyond the realm of the supply chain. Drivers of poor performance can be attributed to many considerations, such as selling price, order mix or discounts, or a retailer's execution of promotions, to name a few. (See examples in Figure 3.) Innovative supply chain executives are therefore expanding participation in segmentation analysis to include representatives of sales, marketing, and finance. Doing so creates a cross-functional team capable of gaining a clear understanding of product and customer financial performance and what the drivers are for that performance. By factoring in additional marketing and customer-requirement information using appropriate analytics, the team can realign how products are offered and how orders are fulfilled—with the express purpose of increasing profit contributions.

    Additional considerations
    Many companies continue to find it a challenge to create significant and repeatable customer- and product-segmentation insights. Here are some of the reasons:

    People. A common problem is often simply the resistance to change. Taking the time from a hectic schedule to consider the insights gained from accurate segmentation activities and then determining a new cross-functional course of action can be difficult in many organizations. Additionally, many companies' functional groups still operate with siloed financial objectives that may drive functional actions that have an unexpected detrimental impact on overall corporate profitability.

    Gaining the most benefit by tackling the "people issues" is reflected in the following comment from Mark Grohe, senior vice president revenue management for ConAgra Brands:

    "The challenge is to have the entire organization embrace specific financial insights and cross-functionally change historical business practices. For this to happen, executive leadership must continually communicate and prioritize the importance of using these insights to drive sustained improvements in operational performance."1

    Process. It is essential that cross-functional teams look at the root cause of why products or customers are unprofitable or marginally unprofitable. Specific reasons for poor customer or product performance will extend across functional boundaries. It may be difficult for some companies to recognize this and be willing to change their traditional processes.

    Technology. Some companies have tried to tackle segmentation activities, with unsatisfactory results because of the number of sources of data, the quality of the data, the analytical tools being used, and/or the fact that the insights gained were not sufficient to justify continued investments. Cloud computing, which is providing rapid advancements in segmentation analytics, can help companies overcome these drawbacks. Recognizing and addressing these challenges before undertaking segmentation efforts can lead to far more meaningful results.

    Segmentation as a competitive advantage
    Getting the right product to the right location and in the right quantity is still the No. 1 mandate for any supply chain organization. However, with customer- and product-segmentation insights, companies can create cross-functional, targeted strategies that encourage (or discourage) specific forms of channel, customer, product, or supply chain activities that have a material impact on their profitability.

    More and more companies are adopting cloud-based segmentation analytics and methodologies to gain competitive advantage. These companies now have the financial-performance insights to manage the life cycle of their market offerings and their expansion or contraction strategies by channel, region, and customer segments. They are also best positioned to capitalize on dynamic conditions in the marketplace. And they are improving their ability to work as a cohesive team, strategically maximizing the profit contributions of products and customers while fulfilling order requirements.

    If your organization has tried segmentation in the past, experiencing false starts due to issues such as those noted above, it might be time to re-evaluate. With the newer technology that's now available and a better understanding of the opportunities and potential roadblocks, now is a better time than ever to take advantage of the financial and strategic benefits of customer and product segmentation.

    Note:
    1. Mark Grohe, personal communication with one of the authors, 2017.

    Soumen Ghosh is Nancy and Lawrence Huang professor of operations and supply chain management in the Scheller College of Business, Georgia Institute of Technology. Mark Hersh is director, supply chain strategy for the Clorox Company. Richard Sharpe is CEO of Competitive Insights LLC, a provider of cost-to-serve and profit-analysis solutions.

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