Understanding Profits Through BPM

Companies are increasingly using business performance management software to slice and dice their profitability and improve decision-making.

Revenue minus costs equals profit. The equation is concise, simple -- and misleading, as most everyone who's analyzed profitability in detail can attest. Most companies have a pretty good idea of how much they spend on raw materials for each widget they produce. But those that dig no deeper into profitability than subtracting these direct costs from gross revenue are asking for trouble. They are likely basing decisions about R&D investments, sales compensation policies, marketing and customer service budgets, and even divestitures and acquisitions on a flawed view of their own performance.

To analyze how much a given product or customer is contributing to the bottom line, executives must first agree on a definition of profitability. "That may seem really straightforward -- until somebody challenges that definition and points out that while it works for the sales organization, it's not actually working for the company as a whole," says Robert Kugel, vice president and research director, financial performance management, with Ventana Research in San Mateo, Calif. "The way in which the sales organization measures customer profitability or product profitability may ignore all kinds of buckets of costs that are being driven by those sales."

The list of variable, indirect cost drivers that must be included in any serious profitability analysis includes distribution, customer support, warranties, marketing and collections. Revenue calculations can be complex, too. Correct sales figures must take into account fraud losses, credit losses, product returns and any other revenue recognition considerations that may be unique to a particular industry. The good news is that as organizations store more and more customer and product data in operational software systems, it becomes accessible for the types of analyses that strengthen strategic decision-making.

Increasingly, companies are using their business performance management (BPM) software to evaluate profitability by product or service line, brand, customer segment, and sales or service channel. "For any given situation, you're looking at the same thing, but from four or five different dimensions," says Gareth Herschel, Atlanta-based research director with Gartner Inc., a company that provides IT industry analysis. "If I walk into a retail store and buy a certain product, the profitability of that trans-action is reflected in terms of my profitability as a customer. It is reflected in the profitability of that particular product, and it's reflected in the profitability of that particular channel. Effectively, you're looking at the same data and just combining it in different ways, depending on the type of analyses you're doing."