Share this content
MyCustomer.com

The silent killer: Can successful CRM destroy your business?

by
8th Jul 2010
Share this content

How can a CRM strategy bring your business to its knees, even if all the traditional measures and outward signs point to it being a success?

Despite so much time and money invested in CRM - collecting data, processing it, drawing conclusions, setting new courses of action – there is still a blind spot that hides a significant risk. What if the CRM strategy designed to build rapid market share with excellent customer service levels is both successful and brings the business to its knees? But worse still, what if all the outward signs of success (physically grew bigger) and traditional measures (gross margin) said ‘CRM policy is on track’, while nobody saw how the seeds of disaster had germinated.

In this case study, I outline a real business situation with a salutary lesson. It describes quite a simple business so anything more complex could be storing even bigger risks.

A wholesale mobile phones business had done well in its early days of high demand, growing both its customer base (retail outlets) and levels of service to become a large and impressive business. To visit and step inside the company was to feel success oozing from every pore. On the one hand, bonuses, based on gross margin, were putting smiles on people’s faces. Every sale had a positive gross margin. On the other hand, on a turnover of £250m, it began to make losses of £1.5m per month. As sales volumes increased so profitability plummeted. Its share price followed, tumbling to 3% of its highest level and causing consternation among shareholders.

What was a mystery was that its strategy had been fulfilled. It did have 90% market share of all the small independent phone retail outlets; it did manage 99.5% next day deliveries; it had moved into new office premises together with its own high bay warehouse.

The CEO had no idea what had caused the problems. When he called us in he was in despair. We suggested he joined us for a walk round his business but we would point out things from a different perspective. It wasn’t going to be long walk as the key processes were about as simple a business model as you can get. Products were replenished direct from the manufacturers and held in a large warehouse. Orders from customers are credit checked, passed to the warehouse for picking, packing and dispatching to UK and Export customers who were then invoiced and the cash collected.

Stock

The walk started in the warehouse. With the growth in business volumes, the company had acquired large warehousing facilities – fuelled by a desire to improve service levels and an eye on opportunistic discount deals on large quantities of products from the manufacturers. But having lots of stock masked a number of underlying problems.

It turned out that a quick analysis of stock levels in relation to demand revealed that highly popular new models were often out of stock. These were the only lines that accounted for the 0.5% of late deliveries but they were also the lines that consumers were hammering on the doors of retailers to get hold of. The company’s retail customers were complaining as the ‘early adopters’ weren’t loyal – they simply wanted to get their hands on the latest models so went anywhere to get them.

The analysis also showed that half the products had stable predictable demand but also had unnecessarily high stock cover. Normally such demand characteristics provide opportunities to use forecasting and so get just-in-time deliveries from the manufacturers. But there was worse news to come.

The warehouse manager showed the CEO the pallets of stock with a thick layer of dust on them. In fact there were mountains of stock of these unpopular lines that turned over less than six times per year. When these products’ prices were scrutinised it transpired that the ability of this stock to retain a positive gross margin fell away rapidly after two months. Customers didn’t want old models. So the 40% of stock in this category had changed from an asset to a liability, and a major source of value erosion.

A history of making large volume purchases fuelled by ‘special discounts’ from the phone manufacturers were the root cause of many serious negative product net margins. Interestingly the purchasing director’s bonus was linked to the amount of discount he ‘negotiated’. Was it possible that manufacturers were giving big discounts on bulk purchases of what were soon to be superseded models? The CEO made himself a note to check this out.

Throughput

The walk through the warehouse, followed by a walk along the stages of order processing, revealed an insight that hadn’t really been noticed before. It became clear that the overriding cost driver was the number of orders. Almost irrespective of the size of the order, ranging from a whole pallet down to a single phone, each order drove much the same set of activities such as ‘order entry’, then ‘credit check’, then ‘pick and pack’, then ‘despatch’, then ‘invoicing’, then ‘chasing payment’. In other words, each order created much the same activity cost in the business and people costs were a big percentage of the total.

Suddenly the key issue dawned on the CEO. For any orders where the gross margin was less than the costs of processing the order through the business, a loss was made. Far from believing that a positive gross margin was always good because it was making a contribution to overheads, if the real net profit was negative then more volume meant ever-increasing losses!

The CEO asked the finance director and the sales director to join him in his office where he outlined what he had found during his walk. He asked them to set their minds on resolving two questions.

  1. Were there particular customers who were placing orders which just lost the business money every time
  2. Why, when volumes were increasing, did growth seem to lead to declining overall profitability?

The analysis of the figures now turned to looking at the characteristics of various customer segments.

Using the insight about cost drivers the CEO had already done a rough calculation and found that for the company as a whole the average cost to process an order was around £50. One particular segment, small high street retailers, mostly ordered small quantities of phones with an average order gross margin of only £15 which meant that on average each order lost the company £35. This segment placed 87% of the orders accounting for over 50% of sales value! This answered both questions. Taken together with other analyses, these customers were the source of the falling profitability of the business as overall volumes and number of customers increased.

The CEO’s blood ran cold when he realised that the next day delivery promise had allowed these retailers to de-stock. A handful of sales to consumers could be quickly replenished by the wholesaler. The strategy had led to an inexorable growth in total numbers of small quantity orders which made for a lot of activity throughout the company needing more and more people in ever larger premises. The company’s apparent successful growth had really been in increasingly unprofitable business. The sales director looked at the finance director then they both looked at the CEO - who was not pleased.

The solution

Setting the minimum order value such that the gross margin was always greater than £50 ensured no further unprofitable orders were taken. Most customers complied with the new minimum order values. Those that threatened to take their business to competitors were encouraged to do so. The competitors would welcome the business. They, like many companies, would add the new business volumes to total sales and feel comfortable that gross margins were positive. But unwittingly they would be taking on a significant loss.

It was now very apparent that the policy of paying the sales force a bonus based on gross margin had also led to the sales force unwittingly driving the business into the ground. Sales people didn’t realise that the processing costs of high volumes of low value orders were crippling the business. If the net profit was negative but the gross margin positive, they and the sales director still got their bonuses. The CEO, however, took the view that the Sales Director and the Finance Director should have seen the root causes of the loss of profitability.

Lesson learnt

The key lesson for this company was the ease with which an apparent excellent CRM strategy led them to become blinded by its apparent success. The founder and MD of the business realised that growing the physical size of the company had taken a terrible toll. Initially the City had measured success in sales volume terms. Also share prices in the sector had rocketed for everyone so a true measure of performance was obscured for a considerable time. Members of the salesforce were generating positive gross margins and collecting bonuses, so they weren’t complaining. No signals came from the sales director of the impending problems as he didn’t have the true knowledge from the right information about what was happening.

The standard financial reports didn’t report on net profit at the product or customer level or on the relationship between costs and cost drivers, so even the finance function was blind to the underlying drift to disaster. No signals came from the finance director of the impending problems. In their case CRM did mean 'Customers Ruin Margins' though it wasn’t the customers’ fault. The customers, the small high street retailers, simply interpreted the strategy to maximise their own profitability.

Tracking the changes to net profit is not ordinarily shown in the management reports. But time and effort should be devoted to uncovering the real relationships between costs and the drivers of costs, and to understand how the relationships to certain customer segments can sow the seeds of disaster as volumes increase.
 

Brian Plowman is a senior partner and managing director of Develin & Partners a UK based Cost Management Consultancy. He can be contacted at [email protected].

Tags:

Replies (10)

Please login or register to join the discussion.

avatar
By David Beard
08th Jul 2010 10:22

 

While appreciating the author's competencies & proposition to the mycustomer community, any strategy that fails to account for the "cost of customers" seems to miss a fundamental point or two.

To my mind, that's not a successful CRM strategy.  

-= David

Thanks (0)
avatar
By johnstonph
08th Jul 2010 11:25

This is a seriously flawed case study. Many of the flaws are in the analysis and solution which is rather more worrying. Even the understanding of CRM is wrong - what is described is an ERP or Business Intelligence system.

For example:

The order processing cost was £50 - way too high for a fast moving, low order value business. It should be under £10. Rather than look at this, the answer given was to drive away 87% of customers. Surely it would have been wiser to create a totally automated order process and push the smaller customers through this, allowing sales staff to focus on key accounts. There is another way of looking at order cost, however. Much of the cost is fixed - staff, premises, vehicle movements etc. Thus simply amortising it across sales is too simple. Cutting the volumes as suggested will simply rocket the cost per transaction as similar costs are spread across smaller volumes.

Secondly faulty buying processes caused most of the problems. Anyone in electronics knows that stock is disaster - last week's must have new technology is next week's doorstop. That's not caused - or solved - by CRM. It is helped by a good ERP system but mostly by a better mindset and teamwork. The minute a deal is proposed, marketing and sales should be asked what they needed to do to shift that stock in a given time period. From this a cost to shift can be calculated and the deal evaluated, before it is done. Any handset - even kin - can be shifted if the right deal is done - but there is a cost to that deal which must be factored in.

The company could learn from the last government. When you set a target there is a focus on meeting it - but many unintended consequences. Setting a buyer's incentive based on discount negotiated is a recipe for buying end of line. Paying bonus on gross margin, with no thought to cost of sale is also a recipe for selling low volume as larger volume customers want better discount.

What they really need to do, though is get back in touch with the market. They should be working more closely with the manufacturers, predicting demand and having stock day 1. They should be maximising margins by having the stuff the manufacturers forget about - the lucrative accessories. They should be working with their downline to have pre-orders so that 80% of stock is pre-sold before it is purchased. They should be doing lucky dip deals with smaller customers - get what you want when you buy what we want to sell you. They should be adding value - shop posters, POS etc. to improve sell-through of key models. Once they've done this they will be driving demand, not meeting it.

Only then should they consider logistics. Once they've sold off all the dead stock they can go lean, with every trunker which comes in divided and out the door same day. Online ordering and automated payment and invoicing means no paperwork and a very low cost of sale. Their small customer sales operation can be franchised to become a "man in a mobile shop" type operation (like Snap-on and similar). The end result is that any dead stock will stand out like a sore thumb, the company can do deals others can't and provide support others can't - it may even make a profit like others can't!

The solution. Get rid of this cost management consultancy and get one in who understands the bigger picture and can turn it into a market driven business, rather than a cost driven one.

 

Thanks (0)
avatar
By pusie23
08th Jul 2010 11:55

In Brian's defense I am assuming that his case study is designed to demonstrate how flawed CRM thinking can sink your ship.

Though Brian does not outline it explicitly, taking the points above, we can thereby see that CRM can appear successful to some misguided business if they are not taking all the costs ie cost of customers into consideration.

Echoing John's post as well, "CRM" is also a dangerous endeavour if it isn't strategic - as John says, this is a bit of business intelligence with a bit of ERP rather than a strategy and programme that is supported by technology, culture, systems and processes.

That's how I'm interpreting this.

Brian?

Thanks (0)
avatar
By johnstonph
08th Jul 2010 12:53

CRM stands for Customer Relationship Management. It consists of capturing data on your customers and refining it, analysing it and using it to serve them better because you know more about them. It has nothing whoatsoever to do with stock in the warehouse, bonus systems for staff or even, as portrayed here "collecting data, processing it, drawing conclusions, setting new courses of action".

It has done a sterling job. It has idenitified new customers well, it has helped retain existing ones. Whether these are profitable or not to the business is not part of its remit.

The system described is not a CRM system - it is an ERP system. Any system is only able to deal with the parameters it is fed with. If it was fed with average transaction value and this is flagged up when it falls below cost of sale, then this company would have been shown a very different result. If stockholding was measured according to how many weeks stock it was and flagged up as a problem if more than one, this company would have discovered a different result. If customer value was set up according to number of orders, value of these orders and cost to service, this company would have seen a different result. Perhaps they would have been acted on appropriately, perhaps not. The fact that these parameters weren't foreseen as of value is not the system's fault.

Indeed blaming CRM is lazy work by either the writer of this case study - sensationalism perhaps - or the Cost Management Consultancy - perhaps they don't know what CRM actually does or is supposed to do. Bad workmen blaming their tools.

But not in any way CRM's fault!

Thanks (0)
avatar
By davewelch
08th Jul 2010 15:27

Your story brought to mind an exercise I was asked to do in the French Headquarters of the European Division of an American Automotive Products Company.

We had been "given" a new Marketing VP from Matel (the Barbie Doll Maker).

His experience had been very high margin products, where Sales Growth was inevitably followed by Profit Growth.

After 2 years of this strategy, in a tight margin competitive market, significant Sales Growth was causing accelerating Losses.

Again unit Value per Order was a Key Issue.

Multiple Discounts were applied on even the smallest order in the hope of building an Agency Network.

Analysis of Discount versus Actual Sales Value per annum, showed that discounts were being given rather than earned.

In a similar way to your case study, agents were relying on quick deliveries and holding minimal stocks. The Paris warehouse was overloaded with slow moving stock; fast-sellers by-passed the warehouse and went direct.

You cannot blame the Dealers/Agents, after all they had been lured away from alternative suppliers with these wonderful discounts.

So, as always, any fool can sell. Making Profit requires applied intelligence.

Think of Cable TV/Broadband, Double Glazing, Energy Contracts; the list is endless.

 

Thanks (0)
avatar
By davewelch
08th Jul 2010 15:35

Such blinkered thinking is why so many IT investments are junked after a few years.

Profit is the responsibility of all parts of the Business and all Systems.

Heaven preserve us from IT people who believe that systems have an independent life regardless of the business.

Thanks (0)
avatar
By johnstonph
08th Jul 2010 16:39

I agree entirely Dave. All a system does is automate processes. If they are bad processes, it effectively amplifies them as there is more of the process going on.

I believe that this was the major cause of the recent bank meltdown. Everyone had set their computers up to buy and sell on the same trigger points so when these were reached it became a catastrophic failure, not a slow and manageable one. With lots of micro-trading going on (shares held for seconds, rather than days) this caused a snowball effect.

Thanks (0)
avatar
By Brian Plowman
08th Jul 2010 21:12

The project started after I was introduced to the CEO by a friend of mine, the MD of the software company that had supplied their ERP system. The MD, new to the software company, was curious to find out why his account managers were scared to visit the Mobile Phone wholesaler. When the MD visited he discovered they had sold an innapropriate ERP system that worked for complex manufacturing businesses with complex bills of materials to a wholesale business that operated entirely differently. The CEO believed all his problems stemmed from the ERP system and mentioning "damages may be due". Some of the problems were about the system but the MD of the software supplier felt there were more serious underlying causes and suggested an outside view might root them out. Hence I got the invite to meet the CEO.

When I visited the following week the CEO told me he had a CRM strategy. Whether I thought it was CRM or not didn't matter. The issue was about the CEO's belief he had a CRM strategy and that though it apparently worked, somehow he was losing a lot of money. He had defined the type of customers that he wanted to have and he had defined the relationship he wanted with them. The sustained rapid growth was in his terms 'a successful CRM strategy'. Its apparent success (by his definition of CRM) masked many of the factors that really showed it was not a successful CRM strategy. He had gone plc to raise cash to implement his ‘strategy’ and grow the physical assets to steal a march on competitors. He’d spent the cash and got a result. Again by his measure it was a sign of his successful CRM strategy.  

When I met him his 40% of the shares in the company had gone down to 3% of their highest value, the bank was asking about the overdraft ceiling being breached, he’d just sold one of yachts moored in Monte Carlo and order throughput was still climbing. For him it was personal and he couldn’t see what the flaw in his business was.  The case study describes what turned up. Is stock part of CRM? The CEO saw it as supporting the relationship of next day delivery so to him was part of CRM. It never crossed his mind that perhaps there was another underlying cause of what was clearly a problem.  

Should low value orders be handled by a different throughput policy supported by a different system? Yes, but again he didn’t see there was a problem in that the rising volume of these orders was increasing the unprofitability of the business. The sales director didn’t see the problem. Neither did the FD. The short term solution (and it had to be immediate) was to set the minimum order value so the haemorrhaging stopped. The impact on volumes caused a need to downsize. Again immediately. Premises were vacated, staff made redundant. Those that clung on were moved to other premises 20 miles away. There were a lot of tears. 

I can’t recall a conversation with him when it would have been appropriate or relevant to discuss if his definition of ‘CRM’ was actually wrong. When you discover you are in the deep stuff up to your nostrils you really want to know quickly how to survive. Given what he paid his directors it was hardly a surprise (except to them) that they didn’t last long.  

For me it was a project that showed that you can have all the theory and all the arguments about the definitions of CRM, ERP or whatever else was thought to be important, but when a company’s chips are really down then you have to find every possible root cause of the problems and fix them. The point of the subject of the article was a simple message to any company that has a CRM strategy of any sort (and this was a simple one that mentioned customers and mentioned the relationship with them) and then believes it is successful by the measures resulting from the strategy. 

In this case the business grew and it should have made money. It didn’t. The CEO found out when it was really too late to do all the right technical things to do CRM, ERP, BPR and any other acronym properly. I believe I helped save him from very deep despair and an even bigger tragedy had the whole lot imploded.  

 

Thanks (0)
avatar
By edepas
09th Jul 2010 14:04

The issue here may be the way finances are reported outside of the US.

In the US even low-end accounting, such as Peachtree and QuickBooks show gross profit and then cost of sales, to produce a net profit. That is the function of the ERP system, not CRM.

CRM implemenations are supposed to improve Customer Relationships, which it appears it did in this case. The resulting losses were a result of the lack of detailed inventory and sales reports in the ERP system.

I have been preaching the value of good reports for almost 20 years and this is a great case study for creating custom financial reports that are meaningful to YOUR business, and not relying on the canned reports that only show a bird's eye view.

-- Ellen DePasquale - The Software Revitalist(TM) Efficient Office Computing www.eocomputing.com http://thesoftwarerevitalist.com

Thanks (0)
avatar
By johnstonph
09th Jul 2010 14:44

Thank you for the update Brian.

As I said, a bad workman blames his tools. Your CEO was blinded by the big ideas and fancy acronyms so much he forgot about the implementation.

Any software product is as good as the information fed into it - garbage in - garbage out.

Worse still, if there is a flaw, it magnifies it.

Last but not least, if you're busy watching the dashboard it generates, you're not watching everything else. If you've left out a key parameter, you won't know until it is too late.

That's why 66% of Business Intelligence Implementations fail.

This man has a history of it. His ERP system was badly chosen. He thinks CRM systems do lots of things they don't. He doesn't know how to manage. He deserved to fail - and he did.

I trust the business is looking for a new CEO?

Thanks (0)