Wednesday, December 21, 2011 | By: Bernard Quancard
The senior leadership at this large capital goods global company began to question the value of large accounts to the organization because of lower gross margins figures for large accounts versus small accounts. These large accounts had order intakes of between $100 and $500 million. When compared to smaller accounts ($1-10 million), the gross margins of the large accounts were significantly lower.
The head of the strategic accounts program made the case for the value of large, strategic accounts by performing a dedicated ad hoc pro forma study which challenged conventional accounting metrics that were often inaccurate and limited. There were three areas where the true value of large accounts had not been properly measured. First, the value of assets employed was not considered. Second, the true cost of serving small accounts versus large accounts needed to be re-evaluated. And third, ancillary and/or "pulled-through" sales of products and services were not considered as part of the sales figures for large accounts.
After considering these three factors, the value of large accounts to the top management was readily apparent. Each of these factors is discussed in detail below.
The Benefit of Assets Employed
These large accounts were buying two major product lines, but also services and systems for large manufacturing equipment used in production sites. Interestingly enough, the capital employed to produce for the large accounts was much less relatively compared to small accounts. At first glance, the cost of goods sold for the small accounts is much lower and therefore, the profitability of these sales is higher. however, this does not account for the cost to the organization of idle assets. The cost of maintaining idle manufacturing facilities may often be greater than the value of the gross margins of small account sales. This factor was not historically considered in senior leadership's view of the value of large accounts to the organization as a whole.
Cost to Serve Customers - Activity Based Cost Accounting
Small accounts are measured in terms of gross margins. However, gross margin does not account for the cost to serve customers, a function of both overhead and administrative costs. Thus, it is not a good measure of overall profitability.
When it comes to allocating the cost to serve customers among large and small accounts, most companies allocate them as a flat percentage of sales across all accounts. For example, if a company sells 100 units per year, 80 to large accounts and 20 to small accounts and the cost of goods sold is $10, the cost to serve customers was allocated at 10% among both large and small accounts or 8 for large accounts and 2 for small accounts.
However, it is well-known that it costs more to sell to a small account than it does to either sell or maintain an existing large account. This difference is reflected in activity based accounting – where the actual cost to sell to small accounts is accurately recorded and kept separate from other types of accounts. In the previous example if the true cost to serve customers was 5 for large accounts and 5 for small accounts, the profitability of each changes dramatically. Suddenly, the cost of selling to small accounts increases to 25% while the cost of selling to large accounts has decreased to 6.25%.
Many companies do not perform activity based cost accounting for large accounts because they are too complex, global in scale, and therefore too hard to measure. As the above example illustrates, however, even small changes in cost allocation can have a dramatic effect on profitability.
Account for Pulled through Sales
Large accounts at this major capital goods supplier created an installed base of capital intensive equipment. This heavy machinery required a large number of “pulled-through” sales – or those sales which are a necessary consequence of the larger sale. For instance, at each location where the equipment was installed, the customer also needed to purchase replacement parts and servicing contracts to keep the equipment and the line running smoothly and continuously. While these sales accounted for a small percentage of the total value of the initial sale, they were extremely profitable because very few resources were needed to produce the sales.
Originally, these sales were not accounted for in the sales numbers for large accounts. Once these pulled-through sales were included in the sales numbers for the large accounts, the margins rose dramatically.
At first glance, large accounts can appear significantly less profitable than small accounts and lead senior management to question to value of these accounts to the organization. In this situation, the true value of large accounts became apparent by re-evaluating the following three factors:
After performing this ad hoc pro forma dedicated study of these large accounts, it was clear that they were at least as profitable as the small accounts and sometimes more profitable.
Tags: Best Practices