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IF View - Issue No. 25

OPTIMISING
CHANNEL
PROFITABILITY

Issue No 25

Marketing Channel Strategy Consultants
USA - EUROPE - AUSTRALIA - BRAZIL - HONG KONG
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Marketing channels must be cost effective.  To achieve optimum cost effectiveness, companies need marketing channel structures that service end users through the most efficient channels.

Many companies have considerable scope to improve performance by an understanding of the real profitability of individual accounts and identifying factors that influence channel profitability.  The analysis is by way of a channel profitability model.

Profitability Models

Customer and reseller profitability is commonly equated to gross margin generated.  This is over-simplification which distorts marketing channel decision making.

Companies need profitability models that reflect the actual cost of transacting business.  Modern accounting systems and concepts can now provide detailed and accurate information on specific marketing channels, opening the way for individual profitability models.

Without such models it is impossible to:

  • Accurately identify and control those costs which most influence profitability
  • Allocate accounts to the most profitable channel(s).

Model Background

The price of goods and services can be simplistically broken down into four key components:

  • Prime direct cost (e.g. materials and labour)
  • Indirect costs (e.g. picking, packaging and delivery)
  • Overheads (e.g. management and property)
  • Profit Margin

Measurement of account profitability by gross margin ignores the increasingly high percentage of indirect and overhead costs and fails to recognise different cost linkages.

Traditionally, businesses have considered indirect and overhead costs as fixed and:

  • Any positive gross profit is treated as a contribution towards covering them.
  • Allocated them solely on the basis of account value

However the above ignores:

  • The variable nature of many of these costs
  • The fact that very few costs are totally fixed
  • The different amounts of indirect and overhead costs required to service different accounts.

As a result, customersí accounts may not generate sufficient contribution to cover their variable indirect cost or appropriate share of overheads.

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Constructing an Account Profitability Model

An account profitability model is built by identifying:

  • Key marketing channel costs
  • Key marketing channel cost relationships

And constructing an end user profit and loss account for each channel.  Key revenue and cost influencing variables are:

Revenue Influencing Variables                                Cost Influencing Variables

Products purchased                                                       number of orders

Pricing                                                                          delivery frequency

Discount structure                                                          delivery distance

                                                                                    Average order value

                                                                                    Type of sales representation

Each variable then generates a revenue or cost within the model by reference to a series of revenue and cost factors allowing account profitability to be calculated.

Areas of Account Profitability Model Impact

Account profitability models are a tool for creating profit optimisation.  They give organisations a tool to focus on where the greatest impact on profitability can be made and can assist management to optimise both intra and inter channel profitability.

A. Optimisation of intra channel profitability

Account profitability models impact on intra channel profitability by allowing:

  • The profiting and targeting of profitable end user segments
  • The identification and avoidance of unprofitable business
  • The improvement of individual account profitability
  • Effective control of account management

B. Optimisation of inter channel profitability

In most multi-channel distribution environments, the marketing channels used by end users are typically determined by a combination of factors:

  • Historic relationships
  • Size of account (as measured by turnover)
  • Location
  • End user buying preference

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Account profitability models facilitate the optimal allocation of accounts among channels by:

  • Calculating the relative profitability of individual accounts through different channels
  • Identifying the key profitability determinants of profitability

When key profitability determinants have been identified, the customer account base can be segmented to facilitate reallocation among channels.

Reallocation of accounts is also dependent upon external factors such as the strength of existing channel ties and the cost of account transfer.  The complete process is set out in Chart 2.

Chart 2: Inter Channel Profit Optimisation Process

The model can also be used to:

  • Test a new marketing channel(s) prior to implementation
  • Identify the best channel(s) for new products
  • Test the impact of new channel(s) on existing channelsí profitability

Summary

Account profitability models are invaluable for companies seeking to improve their marketing channelsí performance.  It is possible to improve profitability within existing channels and identify those channels where individual or groups of accounts are most profitable.  Although there are limitations on the practical reallocation of accounts among channels and the ability of companies to influence the purchasing behaviour of customers, the potential gains in profitability are considerable.

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