The silent killer: Can successful CRM destroy your business?by
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.
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.
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.
- Were there particular customers who were placing orders which just lost the business money every time
- 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.
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.
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.