Driving profitability via analytics-based value chain segmentation

Creating tailored supply chain operations that profitably meet different channel and customer requirements, and thus effectively leverage market opportunities, is an ongoing mandate for companies and their supply chain executives, but this is an increasingly difficult task. Shorter product life cycles, product customizations to meet local market needs on a global basis, and the need to satisfy the order-fulfillment expectations of online consumers are just a few of the complexities that have to be addressed. Clearly, the days of the "one-size-fits-all" supply chain are over.

So how do you gain clarity on the best approach to handling these competing complexities while also driving sustainable increases in profit performance? One proven approach is to design solutions that recognize the segmentation of products and customers based on specific performance attributes and requirements. This analytically driven approach is defined below and further discussed in the case study of The Clorox Company that accompanies this article.

Article Figures

[Figure 1] Segmentation activitiesEnlarge this image

[Figure 2] Customer segmentation based on profitEnlarge this image

[Figure 3] Customer scorecard examplesEnlarge this image

One key consideration in product and customer segmentation should be the historical and desired profit performance of products handled through each go-to-market solution. The analytics begin by categorizing different combinations of customers and products into different segments. Grouping customers by their revenue contributions or products based on a type or market category is commonplace. But zeroing in on discrete segments based on their exact contributions to bottom-line profits is another matter. Certainly, companies work toward that objective using gross revenue contributions and standard cost allocations, but in the end, precisely separating one customer from another based on exact differences in financial contributions is a significant challenge that can be addressed by a more robust segmentation approach.

How can we state that with such confidence? Competitive Insights, a software-as-a-service (SaaS) solutions provider, and the Scheller College of Business at the Georgia Institute of Technology have talked to executives at hundreds of companies about this very issue. Most said they are working on developing more accurate cost-to-serve models and improved ways of measuring the positive or negative impact of different order-fulfillment programs, inventory-deployment strategies, and/or sales incentives. They are finding that there are real challenges associated with this effort. Here are three common themes:

These barriers are real, and they are difficult to solve using the technologies and methodologies that have been adopted by organizations over the last five years. While companies talk about the need to have accurate and precise financial information for every product sold to every customer, only a few have broken the code. How have these few done it? By taking advantage of the power of cloud computing and advances in targeted business analytics, and by adopting a cross-functional team approach to build and govern this information.

Segmentation based on performance
Channel-, customer-, and product-segmentation activities are critical to tailoring supply chain operations to contribute the most value to the organization. Value is derived from having adaptable operational configurations that meet prioritized needs while reaching certain levels of financial performance. These differentiated operating models generate maximum return when based on a sound analytical approach.

Segmentation activities should be based on a number of criteria. As shown in Figure 1, these considerations must incorporate the different priorities for each channel being served and the customers that are in that channel. In addition, product-specific information, including the business objectives for different product offerings, needs to be integrated into effective segmentation activities. Once these priorities have been selected, different go-to-market strategies and their respective supply chain solutions can be defined and implemented. Thus, business analytics plays a key role in driving segmentation strategies for effective leveraging of market opportunities. Almost all companies will have some form of standard product cost that is tied to the cost to make or buy the product. Companies often use these standard sets of costs and assign or allocate additional costs that are associated with servicing customers' orders in an attempt to understand the total cost to serve that customer. This can also be the case for the actual net revenue associated with the selling of products.

Naturally, the goal is to have accurate total costs and net profit figures for every product sold to every customer served. This can be a daunting task. But cloud-based computing provides the scalability needed to handle massive amounts of data and the processing power required for efficiently handling enormous numbers of calculations. Using cloud-based technology as the operating platform, powerful business analytics that go beyond historical capabilities can be provided on an ongoing basis for most companies. In addition, cloud computing can now support rigorous data-governance efforts. These governance efforts ensure that the organization has confidence in the information needed for segmentation activities.

Effective product- and customer-segmentation activities should be based on accurate and actionable financial performance insights that identify specific profit contributions by customer, channel, vendor, and product. To be actionable, the profit contributions must be based on the actual realized net revenue for each product sold to each customer as well as all costs required to service that order from the sourcing of the product to the order-fulfillment activities.

Once established, segmentation insights can be used by cross-functional teams to truly understand the specific drivers of profitability—for every customer, in every channel, for every product purchased. Knowing this information can empower an organization to develop and implement strategies that drive profitability one product and customer at a time.

Identifying true profit performance
Segmentation activities based on financial performance can lead to the identification of multiple opportunities to increase the profit contributions of customers and products. Typically, financial segmentation efforts will start by grouping products or customers into similar performance categories. Let's look at an example of financial segmentation that's focused on customers.

Figure 2 shows a bar-chart distribution of customers grouped by profit performance. In this case, 43 customers represent the top 20 percent of profit contributors. This is not atypical. When they add exact profit insights to their segmentation activities, companies will typically find that 10-20 percent of their customers yield up to 80 percent of their total profit.

An even more interesting aspect of this example is the fact that over 100,000 customers are marginal in terms of their financial contributions to the business.

Based on this type of segmentation insight, the goal may not necessarily be to "fire" the less-profitable customer, but rather to investigate their poor performance relative to profit contributions and then determine how to incentivize these customers to emulate or act like better-performing customers. To do this, you must have the ability to identify what is driving poor performance for specific customers.

From a supply chain perspective, poor performance can be driven by a number of considerations. For example, is this performance related to costly order-fulfillment requirements, or is the amount of inventory being held for customers in a particular channel out of balance? Naturally, poor financial performance for products and customers can go well beyond the realm of the supply chain. Drivers of poor performance can be attributed to many considerations, such as selling price, order mix or discounts, or a retailer's execution of promotions, to name a few. (See examples in Figure 3.) Innovative supply chain executives are therefore expanding participation in segmentation analysis to include representatives of sales, marketing, and finance. Doing so creates a cross-functional team capable of gaining a clear understanding of product and customer financial performance and what the drivers are for that performance. By factoring in additional marketing and customer-requirement information using appropriate analytics, the team can realign how products are offered and how orders are fulfilled—with the express purpose of increasing profit contributions.

Additional considerations
Many companies continue to find it a challenge to create significant and repeatable customer- and product-segmentation insights. Here are some of the reasons:

People. A common problem is often simply the resistance to change. Taking the time from a hectic schedule to consider the insights gained from accurate segmentation activities and then determining a new cross-functional course of action can be difficult in many organizations. Additionally, many companies' functional groups still operate with siloed financial objectives that may drive functional actions that have an unexpected detrimental impact on overall corporate profitability.

Gaining the most benefit by tackling the "people issues" is reflected in the following comment from Mark Grohe, senior vice president revenue management for ConAgra Brands:

"The challenge is to have the entire organization embrace specific financial insights and cross-functionally change historical business practices. For this to happen, executive leadership must continually communicate and prioritize the importance of using these insights to drive sustained improvements in operational performance."¹

Process. It is essential that cross-functional teams look at the root cause of why products or customers are unprofitable or marginally unprofitable. Specific reasons for poor customer or product performance will extend across functional boundaries. It may be difficult for some companies to recognize this and be willing to change their traditional processes.

Technology. Some companies have tried to tackle segmentation activities, with unsatisfactory results because of the number of sources of data, the quality of the data, the analytical tools being used, and/or the fact that the insights gained were not sufficient to justify continued investments. Cloud computing, which is providing rapid advancements in segmentation analytics, can help companies overcome these drawbacks. Recognizing and addressing these challenges before undertaking segmentation efforts can lead to far more meaningful results.

Segmentation as a competitive advantage
Getting the right product to the right location and in the right quantity is still the No. 1 mandate for any supply chain organization. However, with customer- and product-segmentation insights, companies can create cross-functional, targeted strategies that encourage (or discourage) specific forms of channel, customer, product, or supply chain activities that have a material impact on their profitability.

More and more companies are adopting cloud-based segmentation analytics and methodologies to gain competitive advantage. These companies now have the financial-performance insights to manage the life cycle of their market offerings and their expansion or contraction strategies by channel, region, and customer segments. They are also best positioned to capitalize on dynamic conditions in the marketplace. And they are improving their ability to work as a cohesive team, strategically maximizing the profit contributions of products and customers while fulfilling order requirements.

If your organization has tried segmentation in the past, experiencing false starts due to issues such as those noted above, it might be time to re-evaluate. With the newer technology that's now available and a better understanding of the opportunities and potential roadblocks, now is a better time than ever to take advantage of the financial and strategic benefits of customer and product segmentation.

Value chain segmentation at The Clorox Company: A case study

The Clorox Company needs little introduction. Today, it is a US$6.0 billion publicly traded company with over 8,000 employees worldwide. It has a diverse portfolio of product brands offered through multiple channels to more than 100 markets around the world. Clorox products target a number of categories, including laundry and cleaning; food; bags and wraps; cat litter; charcoal; water filtration; "away from home" (institutional health care); and natural personal care. More than 80 percent of the company's products are No. 1 or No. 2 in their categories.

In the United States, Clorox serves multiple retailers across different channels, servicing them from several different route-to-market models. These include supplying from a regional warehouse, supplying directly from plant locations, and through distributors.

Clorox is very aware that understanding the diversification in consumers' cultural and shopping patterns is critical for consumer product companies. The company also recognizes that the consumer landscape is undergoing significant changes that will continue for years to come. "Consumers are looking for product and service attributes they value," says Mark Hersh, director, supply chain strategy. "They are value-conscious and have access to real-time data that influences their purchase decisions. Shopping patterns and preferences are becoming more diverse over time."

For many years Clorox has worked with its internal and retail partners to tailor offerings that fit the needs of their targeted shoppers. In today's fast-changing consumer market, this has become more important than ever. Hersh notes that as retailers change store formats and continue to adapt to an increasingly omnichannel environment, they are looking for their suppliers to offer innovative ways to help them lower working-capital requirements while increasing the differentiation of their products and services in order to meet the evolving needs of their customers. "Retailers, like all businesses, are also looking for ways to improve margins and profitability," he says. "Clorox's supply chain capabilities must quickly and continuously adapt to meet these changing needs."

Hersh and his colleagues realized that the company's "one-size-fits-all" supply chain approach, focused on scale and efficiency, was no longer appropriate to win in the fast-changing consumer marketplace. "Our supply chains needed greater agility in some areas," he recalls. "We needed greater speed of response for our more innovative businesses. We also had to get better and faster at customization matched to the needs of our consumers."

An end-to-end approach to segmentation
To proactively address these market requirements, Clorox undertook several key initiatives. The first step in that journey was to enhance its internal and external Voice of the Customer (VOC) process to better understand the multiple priorities. The intent, Hersh explains, is to learn from all voices: consumers, shoppers, retailers, and suppliers, along with internal cross-functional partners. The Voice of the Customer process has four key steps:

1. Ask/Learn/Listen—understand the internal and external customer's strategic direction, objectives, priorities, and capability needs, now and in the future, and Clorox's gap compared to these needs.
2. Assess—conduct modeling and analysis to identify ways to improve performance in the areas of cost, efficiency, agility, and growth.
3. Activate via Planning Process—build and create plans, operationalize, and measure performance.
4. Refresh and Recap—refresh plans to ensure continuous improvement.

"Knowing what is really important to Clorox's internal and external customers versus using a 'one-size-fits-all' model is the crucial first step" in the process [of value chain segmentation], Hersh says.

In parallel, Clorox focused on building stronger, more collaborative relationships with its suppliers, including third parties such as warehousing and transportation providers and contract manufacturers. "We are doing this for two reasons. First, our third parties bring unique insights and ideas that can help us improve performance," Hersh says. "Second, we've found that everyone is trying to solve similar problems, and working together for holistic and integrated solutions maximizes the value potential." Ensuring stronger communications with both customers and suppliers is a cornerstone of Clorox's success and an integral part of its value chain segmentation process, he adds.

With the information and knowledge gained from customers and suppliers, Clorox began to formulate a program called Value Chain Segmentation (VCS). The mission of VCS is to continuously design globally integrated, end-to-end supply chains that reach from Clorox's suppliers through its customers' supply chains, and ultimately to end consumers. The VCS approach helps both Clorox and its customers drive improved growth and profitability by implementing the right capabilities to win with the consumer. The VCS approach translates product needs (for example, current and future portfolio, innovation strategy, product life cycle, and business objective for the product line) and market needs (such as current and future channels, degree and types of customization and differentiation, growth projections, and demand predictability) into the right supply chain capabilities and design.

Because analytics is an important enabler of this mission, Clorox put in place a supply chain analytics team that is responsible for conducting analytics across all areas of the value chain—from the company's suppliers all the way through to its retailers. These activities include scorecards, dashboards, performance root-cause analysis, drill-down report capability for decision makers, and more advanced analytics like network modeling and simulation.

Clorox knew that for VCS to be successful, it required full, cross-functional participation by sales, marketing, research and development, finance, human resources, information technology, and product supply. Each of these functions brings critical input to the process based on its specific expertise and knowledge. "Through this process and the use of analytics we continue to tailor the supply chain designs and capabilities to match the needs of both the product and the market," Hersh says.

The key to this effort was to utilize a five-step methodology to segment Clorox's customers' needs based on the things that really mattered to them the most. Those steps are:

1. Gather the five-year design inputs for product and market/channel. For product, these include information on the future portfolio, new products and capabilities, and the top priority for each product line—responsiveness, cost, or a balance of the two. For market/channel, these include future channels, degree and types of customization and differentiation, growth projections, market-share targets, profitability targets, and level of volume predictability.
2. Define unique product/market/channel groupings based on the inputs in Step 1.
3. Define the current state of performance and capability for each grouping.
4. Identify the desired value chain attributes and gaps against the current state.
5. Using analytics, build a business case for change that includes the trade-offs. For example, a supply chain focused primarily on responsiveness may need to operate at a higher cost than it currently does. A supply chain focused on efficiency and cost may be less responsive than other supply chain designs.

Four differentiated operating models
The Clorox team identified the priorities that were most important for the internal and external customers. Priorities ranged from responsiveness (speed) at one end to efficiency (cost) at the other end of the continuum. In many cases, both responsiveness and efficiency (a combination known as agility) would be required, with one of the two being favored depending on the needs of the customer.

The result of this analysis was four value chain operating models: Disruptive Innovation (unique new products that don't fit well within current supply chains); Promotion Related (retailers that heavily use promotional and merchandising events, which require a high degree of responsiveness); Balancing Response & Efficiency (high-margin products where agility is important, so that products are always on shelf at pricing attractive to the consumer; both responsiveness and efficiency are important); and Efficient & Low Cost (having world-class low costs for that market segment). Within each of those supply chain types are capabilities and practices based on requirements in areas like planning, product customization, asset flexibility, information flow, demand visibility, capacity planning, route-to-market design, collaboration, and leader skill sets. Figure 4 summarizes the four models and their primary characteristics.

VCS provides systemic thinking coupled with analytics to intelligently create supply chains that address differentiated requirements and put the right capabilities in place to provide competitive advantage. For example, in supply chains where responsiveness is a dominant priority (Disruptive Innovation and Promotion Related types) Clorox has shorter supply chains and cycle times, surge capacity to manage unpredictability, a high degree of customization capability, fast information flow across partners, and systemic collaboration with customers. For supply chains where efficiency (Efficient & Low Cost type) is the dominant priority, Clorox has lean applications across the end-to-end value chain, high asset utilization, limited capital investment, run-size and inventory optimization, cost-focused customization, and targeted information flow and collaboration. For supply chains that have to balance speed and cost (Balancing Response & Efficiency type), Clorox's supply chain team looks at all of the above elements and decides on the right level of capability.

The results
By all accounts, VCS has been a success, and the program has been embedded into the company's annual strategy-refresh process. Supply chains are checked annually as the company's strategy and plans are updated. VCS allows Clorox to balance how it positions products and markets for growth while enhancing profitability, reducing costs, and improving service. Hersh notes that under the program, supply chains focused on efficiency drive improved profitability by removing costs across materials, manufacturing, and logistics, while supply chains focused on responsiveness and agility drive improved profitability through speed of response to customer requests, which results in increased sales. "VCS allows us to do that by having tailored supply chains with capabilities matched with product, market, and company strategy requirements," he observes.

Clorox's investment in VCS will also allow the company to integrate acquisitions faster and see value sooner by putting those products into the right supply chain type, Hersh continues. The responsive supply chains will deliver the increased speed and high service that are critical for new product offerings that are early in their life cycle, he adds.

"We are developing core capabilities to meet the changing needs of the future," Hersh sums up. "We are focused on delivering the company's and business units' strategies with supply chain capabilities that enable Clorox's product, market, and strategic objectives."

Note:
1. Mark Grohe, personal communication with one of the authors, 2017.