In prior guides, we’ve discussed the importance of building value with your key accounts. When it comes down to it, the success of your key account management strategy will be measured in terms of increased profits and profit margins for both you, the supplier, and your customers. This needs to be considered over the short and long term.
In this guide, we are going to turn our attention to how key account management strategies drive up profits and improve profit margins.
Gross Profit Margin vs Net Margin
Businesses, that is both customers and suppliers, wish to see improvements in a number of key financial metrics. These include:
Gross profit margin
The excess of sales revenue after taking away the direct costs e.g. labour and materials, involved in delivering the elements sold. Such direct costs are sometimes described as the ‘Cost of Goods Sold’ or COGS.
Businesses desire a healthy gross margin, which is gross profit as a percentage of the associated revenue. If a business’s gross profit margin is low it suggests it is having to do too much work produce the item for sale or is not able to price effectively.
Net profit margin
Other costs are also incurred including marketing, selling costs, supply and other overheads. Some apportioning of such ‘total expenses’ is added to the direct expenses; when taken away from sales revenue the net profit is captured.
Net profit margin is the percentage derived when net profit is divided by the associated sales revenue.
Return on Investment (ROI)
Both suppliers and their suppliers have limited resources. When investing both desire a strong return. Return on Investment (ROI) is a measure of the efficiency of investments. Companies use different approaches, either using gross or net profit and dividing this by the investment to gain a percentage ROI.
When judging a potential programme of investment, expected revenue streams will often be over several future years and will have varying levels of risk associated with them. Here concepts such as net present value, risk and free cash flows need to be appreciated.
Understanding how customers take investments decisions through related ROI tools such as payback periods or internal rates of return, will also be important to account managers tailoring their propositions and investment proposals.
Strong Key Account Management can drive Improvements in Margin Growth
Whilst many businesses are good at measuring product profitability, few are good at measuring customer profitability. This is crucial in key account management, as understanding how profitability varies by customer will help guide investments and actions that will improve outcomes. Only by accurately measuring profit margin at a customer level can individual ROI be established and continued investment justified.
In an ideal world, suppliers would understand relative customer profitability and customers would understand the true contribution of different suppliers to their performance. In reality, gaining such clear mutual understanding proves difficult for many organisations. Even when this absolute clarity is missing however, it’s important that suppliers have a strong appreciation of the levers to growth in order to invest their resources in the right initiatives. These initiatives can be broken down into four broad areas of improvement.
- Customer Focus: The Right Opportunities
Suppliers that focus resource on those few customers that offer them the best long-term sales and profit margin opportunities capture stronger returns on investment. By taking a long-term view on the lifetime value a given customer offers, resources can be committed in order to open up significant long-term opportunities that a short-term approach would miss. Placing your strongest talent, innovation resources to target key customers and prioritise supply chain actions is also a route to higher returns.
On the flip side, cutting out low or no-margin customers and activities is also a sustainable way to improve profit performance. Research from Cranfield School of Management and the Financial Times concluded that the profitability of some customers is leaked away through the ‘free’ provision of add-on services which are not justified by the revenue or potential.
- Collaboration and Competitive Advantage
By establishing strong collaborative relationships with selected customers, economies of scope and scale can be achieved. Higher value opportunities may be pursued, effective working practices put in place to drive up productivity and better commercial disciplines followed. Barriers to entry can be built, halting competitors from stealing business, and customer loyalty embedded. In some collaborative supplier / customer partnerships there are integrated supply chain IT links, in others joint innovation teams.
- Cost Reduction, Price Enhancement
The deeper understanding that key account management brings, will focus suppliers to reduce their customers total direct and indirect costs, limit risks and enhance their customers abilities to sell at higher prices. Examples might include delivering a solution that reduces the materials a customer uses by eliminating its waste, building in enhanced health and safety features, or enabling your customers service team to respond faster than their competitors can. Such offerings will impact on the key financial measures we identified earlier in this guide.
- Building the Supplier’s Strengths
Building key account relationships can help in other ways too. From the supplier perspective, a deeper understanding of a customer can help it optimise its own pricing, refine negotiating positions and improve its own productivity – and therefore profitability. Some key accounts are very demanding, forcing faster innovation and business improvements. Meeting such challenges builds the suppliers ‘fitness’, positioning it to win other customers business too.
A disciplined approach to profit and margin management creates performance improvement and real competitive advantage for a supplier. By cementing strong relationships with the highest worth customers- who themselves select the supplier as their preferred supplier, and addressing the key levers that improve their financial returns, significant mutual and sustainable advantages are realised.
What is a good Profit Margin?
Appreciating what a good profit margin ratio looks like is dependent on the industry you work in. There are high profit margin industries and there are low profit margin industries, so it’s essential that you properly benchmark against the average profit margins in your industry. This will involve looking at your competitors as well as comparing with the profit margins of other customers you do business with.
Understanding the internal and external pressures on profit margin is also key. Industry lifecycle, level of competition and the level of risk will all affect the standard profit margin in your industry.
Some questions you should be considering when establishing goals and what constitutes a high profit margin are:
- How do you compare to others in the industry? If better, then what things are you doing well. If you’re doing worse, then does this represent hidden potential or are you on a slippery slope?
- Are your key accounts delivering better than average profit margin compared to other internal customers and your competitors? If you’re investing in them then they should be.
- Is the profit margin growing? If it strong and steady, then that’s probably acceptable (particularly if your overall £/$ profit is rising). If it’s in decline, you need to understand why and address. A good profit margin is one that can be sustained.
- Are you giving away services you could be charging for?
- Have your price negotiations been poor?
It’s worth noting that, as soon as your margin rises above industry norms, it may invite questions from customers and competitors. If you offer excellent value (i.e the customer makes a good return on their investment as well as you) then these can easily be batted away. If you’re seen as not offering this level of value then you may find your find business comes under increasing pressure to do so.