Enabling the CFO as the Chief Profitability Officer Across the Company to Manage ROIC and EVA
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A presentation for finance executives CFOs want their company to be more predictive, insightful and adaptive to change in an ever-competitive and increasingly global business environment. The problem is, while many finance executives are told what they need to do – to get better visibility into their finances – they often aren’t sure how to make that happen. Because every dollar spent comes with a potential risk to negatively impact revenue, today’s finance executive needs instant and reliable visibility into what drives the business in order to best manage resources and financials. So how do you get the most comprehensive view into your organization’s financials? We discuss how a Driver-Based Cost & Profitability Model can answer a CFO’s most pressing questions: • Are we using analytics? • Do we share the same data across the company? • Are we measuring the right things? • Do we really have a handle on cost? • Do we strategize from the top or rationalize from the bottom? • Are we moving the corporation forward or watching from the sidelines? • The market keeps changing, how well equipped is my EPM model to adapt to the changes and still reflect accurate data? Presenter Curtis Mahanay is a Senior Functional Consultant in Perficient’s Enterprise Performance Management national practice and is an avid blogger on this subject.
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Enabling the CFO as the Chief Profitability Officer Across the Company to Manage ROIC and EVA
- 1. Enabling the CFO as the Chief Profitability Officer Across the Company to Manage ROIC and EVA Curtis Mahanay, C.P.A., C.I.T.P. Senior Functional Consultant
- 3. CFO’s Perspective and Need in New Normal
- 4. Success of Cost & Profitability: Defining and Mapping Key Metrics
- 5. Phase I – Driver-Based Contribution Margin for Profitability Management
- 6. Phase II - Integrating Driver Base Contribution Margin with ROIC
- 7. Phase III - Integrating Planning
- 8. Phase IV - Integrating Advanced Analytics
- 9. Architecture and Key Technology (OLAP)
- 10. Conclusion and Q&A2 Contents of Webinar
- 11. 3 Goal of Webinar
- 14. Detail – Blog (link to follow)
- 15. Financial prototype (available upon request)
- 16. Develop business case for cost & profitability as part of EPM
- 17. Find profit dragons affecting
- 19. ROIC
- 20. Enhance Finance planning and close process
- 21. Validate use of Cost & Profitability and expertise…is it proven?
- 22. Provide Industry specific examples4
- 23. 5 “Virtually everything in business today is an undifferentiated commodity, except how a company manages its information. …how you manage informationdetermines whether you win or lose.“ Bill Gates Microsoft You can’t manage what you don’t first measure…..therefore, turning data into information faster than your competitor should be goal #1….
- 24. “By leveraging our reservoir knowledge, we created life-of-the-well solutions to drive down drilling and completion times and to increase operational efficiency.“ Halliburton ‘10 Annual Report (future strategy around managing decline curves) “The incentive problem in higher education that inhibits cost control is the same incentive problem that leads to scandals and bankruptcies in the for-profit sector and that contributed to the current financial crisis.” The Revenue to Cost Spiral in Higher Education – Robert E. Martin “Hospitals need revenues to finance operating expenses, to invest in new capacity, and to provide charity care for the uninsured, yet they receive payments from public insurance plans that lag behind the growth in the costs of care. Positive contribution margins on orthopedic and cardiac procedures for privately insured patients can be used to subsidize less remunerative procedures and patient groups. The average total margin for US hospitals in 2008 was 2.8%, according to American Hospital Association data, indicating the extent to which the double-digit contribution margins documented here are used to support other services. The extent to which the margins documented here are too high, too low, or just right depends on the mandates placed on hospitals by public policy, private litigation, and cultural expectations.” Hospital Market Concentration, Pricing, and Profitability in Orthopedic Surgery and Interventional Cardiology James C. Robinson, PhD 6
- 25. 7 CFO’s Perspective and Need in New Normal
- 26. CFOs Need To Understand Profitability in Real Time Studies show that 50 to 80% of companies’ CUSTOMERS are “unprofitable”. They are subsidized by the profitable ones. The key to profitability, growth, and competitive market advantage is understanding… WHERE the profit dragons are WHAT the trends are WHY they are occurring HAVING a strategy to deal with them And managing the (customer, supplier, product) MIX. 80% of change in ROIC and EVA is due to Change in Contribution Margin (Operating Ratio)….due to lack of managing customer profitability 8
- 27. Questions CFOs Ask Are We Using Analytics? Do We Share the Same Data Across the Company? Are We Measuring the Right Things? What Are the Key KPI’s and Who should “act” to manage them? Are We in the Forecasting Drones? If We Are, How do we change? Do we “really” have a handle on cost? Do we strategize from the top or rationalize the bottom? Are we moving the corporation forward or watching from the sidelines? All Questions Lead to Operating Ratio, Contribution Margin and/or ROIC at a granular level where you manage your business 9
- 28. Skill Set CFOs Looking for to Answer Questions! 10
- 29. 11 Success of Cost & Profitability in Managing ROIC : Defining and Mapping Key Metrics
- 30. Answering CFO Questions – Process Flow Mapping the drivers Across the company is the first step. 12
- 31. Financial Strategy, Planning and Close Should Start with Cost & Profitability You can’t manage “strategy” if you don’t first measure Op Ratio & ROICusing cost & profitability management Managing Business Performance Starts with Understanding the Business Process Manage Lean Accounting Driver Base Forecasting Measure 13 Only the Diagrams are a Copyright @ 2008 Oracle and / or affiliates. All Rights Reserved.
- 32. Revenue Source and Key Driver Transportation Rail, Truck, Air Cargo Healthcare Oil & Gas Exploration Higher Education Manufacturing Industry Revenue Source Key Revenue Driver GTMS Primary – Train Secondary - Waybill/Unit Patient Days Primary – Department Secondary - Patient Reserves (bbl.) Primary – Reservoir Secondary - well Primary – Department Secondary - Student Student hours Direct Material, Direct labor, Overhead Primary – Customer Secondary - Sales Order Start looking at Revenue Source as a Profit Center versus a Cost Center 14
- 33. Overview: Economic Profit Model (Trucking Example) 15
- 34. 16 Phase I – Driver-Based Contribution Margin for Profitability Management
- 35. Contribution Margin: Manage by Family/Individual Direct Cost Indirect Cost Auto Tuitionl Food Primary – Family Secondary - Individual Entertainment Home/Utilities Medical 17 What is good in managing a family…..
- 36. Contribution Margin:Manage by Department & Patient Direct Cost Indirect Cost Admin and legal Nursing Care Ambulatory Lab Pharmacy Primary – Department Secondary - Patient Cafeteria/Food Facility & Utilities Surgery Physician 18 …is good in managing business
- 37. Gross Revenue From Sales Invoice, Waybill Expense Calculated Using Key Drivers Step 1: Driver-Based Contribution Margin Driver Based Contribution Margin Key : Since Contribution Margin is calculated using underlying drivers, you can answer the CFOs question of “why” something changed 19
- 38. Change in Fuel Price * Prior Volume Change in Volume * Prior Fuel Price Change in Gallons per Key Driver Example: Driver-Based Expense Calculation for Fuel Calculated Fuel Expense due to Efficiency Fuel Expense Calculated Fuel Expense due to Price Calculated Fuel Expense due to Volume Key : All Revenue and Expenses have three main components – Volume, Price/Rate, Mix/Efficiency 20
- 39. Cost & Profitability:Contribution Margin View (Non-Driver Based) CFOs WANT MORE DETAIL TO UNDERSTAND GAP…. IN REAL TIME TO DETERMINE PROFIT “DRAGONS” 21 Source:
- 40. Driver-Based Contribution Margin:Revenue/Expense Components 22
- 41. Cost & Profitability:Contribution Margin View (Driver-Based) CFOs QUESTIONS CAN BE ANSWERED FROM A REVENUE/EXPENSE COMPONENT 23
- 42. 24 Phase II - Integrating Driver Base Contribution Margin with ROIC
- 43. ROIC or EVA : Manage Capital by Department & Patient Fixed Cost & Tax (to arrive at NOPAT) Ambulances, etc Building Primary – Department Secondary - Patient X-ray & Computer Equipment Fixtures, Beds, Etc ROIC per Hospital Bed = NOPAT / Allocated Capital Hospital Bed Categories – Insurance Type, Age, Medical Purpose, etc 25
- 44. Step 2: Linear-Based ROIC Capital From Systems * see key ROIC and/or EVA NOPAT Driver-Based Contribution Margin Fixed Cost / Tax Key : By creating the link between contribution margin and Capital at a detail level, you can look for the unprofitable customers, lanes, geographical areas 26
- 45. Cost & Profitability: ROIC View CFOs QUESTIONS ANSWERED FASTER WITH CONTRIBUTION MARGIN LINKED TO ROIC SEAMLESSLY 27
- 46. 28 Phase III - Integrating Planning and/or Rolling Forecast
- 47. Marketing: Units Revenue Moving Beyond Actuals: Calculating the Contribution “Plan” Driver-Based Plan (Using Historical Actuals) Create Trend Reports/Waterfall Analysis : Validate correlation of Key Driver to Expense Driver Base Contribution Plan Reconcile to Finance Plan Expenses = 1 ) Rate per key driver (See next page) Calculate ROIC Plan (optional) 29
- 48. 30 Phase IV - Integrating Advanced Analytics
- 49. Cost & Profitability Model:Optimize Your Business Process 31
- 51. Are you trying to normalize the metrics of the company?
- 52. Are you capturing “unique” data and using it?
- 53. What focus is there among leaders on analytics?
- 54. Is the analytics captured in the EPM framework?
- 55. Is the analytics aligned with strategy?
- 56. Are you trying to keep analytical talent?
- 57. Are you doing any type of predictive analytics with what you have learned?32
- 58. 33 Architecture and Key Technology (OLAP)
- 60. Waterfall Reports & Heat maps
- 61. Monthly Summary Profitability Letters
- 63. Phase II – Contribution Plan/Forecast
- 64. Phase III – ROIC reporting and forecasting
- 65. Phase Iv –
- 66. Predictive Analytics & Exception Reporting
- 67. What-if Modeling & Business Optimization
- 68. Phase V – Integrate Driver Based Forecast with Financial Plan34
- 69. How it All Works ERP Cost & Profitability Model Flat Files Operational Data Stores Hyperion DRM Financial Level Hyperion Planning or IBM Cognos TM1 (Driver Based Forecast) HSF (Strategy : Real Time, Realistic what-ifs) Hyperion Financial Management or IBM Cognos Controller (Lean Accounting)
- 70. Key Component (OLAP): Oracle Essbase or IBM Cognos Olap is a springboard for moving from Reporting to Advance Analytics Data Cube Importance – Slice and Dice helps with the following advanced analytics: Descriptive Modeling and then Predictive Modeling which leads to Optimization of Business Process Management 36
- 72. Customer
- 73. Region
- 74. Segment
- 75. Route/Lane
- 76. Car Type
- 77. Alternative View
- 78. Attributes (Optional)Data Cube Importance – Slice and Dice helps with the following advanced analytics: Descriptive Modeling and then Predictive Modeling which leads to Optimization of Business Process Management 37
- 79. Key Reports Heat Maps Monthly letters, books and web views Waterfalls Mobile (real time) 38
- 80. 39 Conclusion and Q&A
- 81. BI Vision for a Cost & Profitability Driver-Based Model Improving your company by providing business insights to all your decision makers which leads to better, faster, more relevant decisions Powerful, fully integrated, fully extensible BI platform Foundation for company wide BPM Frame work Collaborative, familiar, user-centric tools Cost effective, comprehensive solutions Operating margins are linked to ROIC at a level you can manage 40
- 82. Our Speaker Curtis Mahanay Senior Functional Consultant Perficient 20+ years in the Hyperion BI and EPM space and application development expertise Deep expertise in the process analysis, design and implementation of enterprise-scale Hyperion applications around finance, operations including cost & profitability Deep understanding for the need to link the enterprise to enable performance management to become a reality Certifications CPA (State of Texas) AICPA Certified Information Technology Professional 41 Contact: Curtis.Mahanay@perficient.com
- 83. Follow us Online! Perficient.com/SocialMedia Daily unique content about content management, user experience, portals and other enterprise information technology solutions across a variety of industries. Facebook.com/Perficient Twitter.com/Perficient
Notas do Editor
- In today’s tough economic environment, the business dynamics inside and outside of the companies have reached a speed that is very difficult to manage in the new normal – life after the great recession of 2007/2008 (what is the New Normal). The CFO is looking for ways to manage customers/segments etc more effectively so that they can better manage the financials…customers/segments first and financials second. In essence become the Chief Profitability Officer while juggling a number of other balls in the air. How many balls can be juggled before they all fall.Questions come faster and more complex with every passing month…..why are we making our ROIC and Operating Ratio this month but not over the next 6? What if we add this to our strategy? What happens when fuel goes to $4.50 a barrel in 2012 (which it probably will). Questions, questions and more questions. They need quick and relevant answers to maintain a competitive advantage. Why? Why? And mor Why’s.To try to answer them from the financials alone is impossible. The data is not granular enough. You need to answer the questions from the level where profitability is managed….and link back to finance. Then you are managing (strategy and financials) and measuring (customer profitability) is in sync.Hopefully this webinar will give you a peak under the hood of “how” you can do that in 5 easy steps.For the past 10 years prior to working for Perficient, I worked for a Fortune 100 Transportation company. Prior to that I worked over 15 years in various areas of Finance. I came to realize that the solution was not a faster close or even just moving a current process into a better tool. The answer was to link the company. To make it easy to manage the overall process in a world outside of Excel spreadsheets.I came to realize from my Accounting lenses that the real issue is to understand the cost & profitability of the company including managing two key metrics at the right granular level – Operating Ratio and ROIC.You can’t manage your financials until you first measure your customers, lanes, geographical areas……the heart of your company.
- Here are the areas I am going to cover over the next 30 minutes or so. After which will be an opportunity to answer any questions you might have. I suspect that this webinar can bring up additional questions. Feel free to contact us at Perficient at anytime. We would be glad to sit down with you and go over Cost & Profitability and how it would benefit you in the future.I am also going to have a 8 week blog on the subject with more detail. The first blog will be posted tomorrow.Our goal at Perficient is to add value to your EPM solution you have in place. Gain synergy and ROI out of your investment in Hyperion Planning, Essbase, HFM or IBM Cognos.First I want to cover what CFOs are asking and looking for in analyst and technology from their birds eye view. This should sit the focus for everything else. The CFO is the place to start to see if they have what they need and if not what else would the need to add value.Then I want to go over the five steps from moving to reporting on your actuals in a cost & profitability model to using the solution you have developed to move into predictive and advance analytics.The goal is to allow you to move from Reporting to Predicting to Optimizing your business process in “real time”. It can be done and you would be surprised that it does not take a huge investment to do so.
- The Goals of the Webinar are to provide you the information you need to make a decision as to if a Cost & Profitability solution can add value to your current EPM solution.I am going to paint the picture and then hopefully make it purpose practical enough that you can say that it makes sense, that you now see the direct connection between Cost & Profitability and Planning. Also the need to do this to manage operating ratio and ROIC in real time will allow you to be more proactive.
- The 4 p’s to validate the solutionProfessional information – Provide the information you need to make a decisionProbable – Show the needProof – It has been donePractical – Aim it specifically to your industry (Healthcare, Oil & Gas, Higher Education, Consulting, etc)
- Here is a interesting quote from Bill Gates. From when he first quoted this to now it was almost prophetic almost scarry for a lot of companies that rely on their current EPM solutions built in Excel, Operational Data Stores and even ERP which are not linked across the company.In reality, I would go a step further and say that the goal is to do this faster than your competitors. And that is not only domestic competitors but the new and increasing competitors from global competition. The game has changed. Your EPM solution to keep up with this change needs to be enhanced also.
- To start with, here is a interesting quote from Bill Gates. From when he first quoted this to now it was almost prophetic almost scarry for a lot of companies that rely on their current EPM solutions built in Excel, Operational Data Stores and even ERP which are not linked across the company.In reality, I would go a step further and say that the goal is to do this faster than your competitors. And that is not only domestic competitors but the new and increasing competitors from global competition. The game has changed. Your EPM solution to keep up with this change needs to be enhanced also.
- To set the stage, let’s look at some who, what why from a CFO perspective……
- Here is the crux of the issues. In a normal scenario here is what happens…..it is played out 1000’s of times in any given month…..no week for every company.Something happens maybe in planning the activity for a customer : a price is set or maybe the number of units are determined in a plan2 months later when the books are closed there is a large variance in the net income…..what happenedAnalyst A starts to create a spreadsheet to “analyze” what happened. In reality he spends hours to create the spreadsheet and 10 minutes to come up with a answer he hopes the CFO will buy intoFinance starts talking with Operations and/or Marketing asking questions…….Before you know it hours and hours have been spent on finding out something that should have taken 15 minutes.Worse yet is since the process is not linked nothing is really solvedThe company continues to “manage” from a reactive mode instead of a proactive model.Here is a better answer that is really very simple to integrate. The key is to step back and look at how you analyze your process and then select where you can streamline and connect. The answer will lead to something like this:Something happens maybe in planning the activity for a customer : a price is set or maybe the number of units are determined in a plan (same as above but with a cost & profitability solution connecting the companyAnalyst uses a model that was a one time setup to first identify the customer, geographical areas, etc. where the issue occurredDrive back in real time to the underlying drivers to see if the issue was either due to Revenue (Mix, Volume or Price) or Expense (Efficiency, Volume or Rate)Provides answer to CFO within 15 minutesIs promoted as some type of geniusI can guarantee you that the second scenario can be your future…..
- Do you ask yourself any of the questions above. What are your answers…….For example Analytics – the only way to find the real issues that are causing the most pain. Most companies business process is to Report, Model/Analyze and then Plan…using judgment. A better method is to Report, Predict and then Optimize the business….not the plan. It is hard to manage your business by “planning”. Nobody buys it any…..right…..especially after 2 months….even with a rolling forecast. Don’t get me wrong, you need a rolling forecast but it needs to be enhanced with a driver based forecasting solution.By the way, Reporting, Predicting and Optimizing (RPO) is trying to be accomplished by a lot of companies and consulting firms. I will show you later why this can only be accomplished when you at least have a multidimensional tool as part of your solutoin…..I will explain later. But for now the persons helping the CFO needs to be able to get their hands on the information quickly and also be able to look at different views…..Data Across the Company – That is linking financial data which is at a account level with cost & profitability level at a customer and/or geographical level. Hyperion DRM as a technology is a good tool to do this. Cost & Profitability in and of itself is not the end goal. You need to link all the data especially from C&P to Financials.Measuring the right things – companies spend hours and hours trying to managing “everything”. The truth is if you concentrate on your top 5 metrics which have a direct affect on Operating Ratio and therefore ROIC, you are managing “everything”. Also a note, you need to manage at the right level…..Forecasting Drones – you know you are doing this and you have 10 minutes to complete the forecast and you make the tweaks…..and say we will get to them next monthInsert more around questions.
- The CFO is looking to move outside of Finance to manage the corporation. To become the Chief Profitability Officer. The above lean from becoming reactive to proactive. You can’t manage in the New Normal in reactive mode. You will never catch up…..there are just so many journal entries you can record and/or forecast adjustments you can make before reality catches up.Go thru some of them applicable to Cost & Prof
- The first step or domino is mapping your metrics. A lot of times when a company puts in a new technology they just take their old process and put it in a new tool. Once you do this you will never go back and do it the right way……this is for cost & profiability as well as financial planning.And I would recommend to first just concentrate on the top 3 expenses and related drivers.For all the industries represented in this audit that would be labor, utilities initially. Don’t try to map every driver in your company. The goal is to map the drivers to the related expenses for the top expenses.Also as will be shown later, selecting the correct view to map the drivers is important. It must be a granular enough level where you “manage” your business. That is part of the issue with most Finance models is that they are to high a level…..
- As said, mapping drivers is the first step. You cannot manage business process unless you first understand your process…..and key drivers along that processMost companies and maybe yours, takes the Revenue and Units (at a summary level) and integrate directly into your financial tools for closing and planning.When you do this you bypass the flow of the revenue and units. Once you do this it is very difficult to back track to see what happened….By taking a driver based forecasting approach and building a cost & profitability solution, you can link your revenue by any level with your financials.To do this even though it sounds simple will require you to consider changes you possibly will need to make to your current culture.You look at this and say it sounds simple enough, why are we not doing it. The wrong answer you will here if you start inquiring in your company is it is because the link (represented with the blue box) is off in 5000 spreadsheets.Don’t start with the spreadsheets. You will never get there. Start with your Revenue and work forward. You are not trying to enhance your current mouse trap (i.e. your Excel world) you are trying to trash that process because it is not working.Want to see how easy it is. Start with a blank sheet and take revenue for a customer……then put down fuel expense. Ask the question, “How much does Fuel change if I __________?
- For most companies, each process stands to a certain extent on its own. Usually off in 1000’s of spreadsheets and operational data stores….disconnected and disjointed. Don’t you want to leave this behind. The strategy is usually not seamlessly linked to the operations. The close and planning process is done at a level where the CFO just hopes the judgment used in making accruals or “predicting” the forecast are at least 80% accurate. There is a better way. The key is to link your process where the business is managed to your financial processes. By doing this you can in real time monitor and become proactive instead of reactive in making decisions. Being reactive is a problem that compounds itself over time. Of course you have come to realize that. A lot of companies have tried to account for this by doing rolling forecast. Probably a good The reality the issue is not in moving the forecast forward. The better solution is to link the underlying metrics to the expenses. Therefore when drivers change the link to the expenses can be automatic and “accurate”.The key is a driver based cost & profitability solution which “drives” your financial processes. This will help you to gain sustainable competitive advantage. This will help you “win”.If you don’t win, your competition will.Note: Emphasize the two quotes – they are the why’s. C-level read this and say, hmm. That is what I want to do…HOW?
- In mapping the drivers, the first step is to identity the revenue source and key driver. Until you do this you cannot identify all the remaining drivers. Here are the revenue sources and key driver for some of the industries represented in the webinar.Also, you want to start looking at the primary and secondary revenue source as profit centers instead of cost centers. The reason being is that you then start to understand the importance of deriving the contribution margin at that level and eventually the ROIC generated by the revenue source. This is the level that you should manage your business process. Think about it, if I told you that department a had expenses of $500,000 and department b had expenses of $300,000, how would you know where improvements need to be made. Which are the most profitable. How to determine future pricing? Improve effeciencies? Determine contracts with physicians?
- Using as an example of mapping drivers, I want to take trucking from the previous slide. The process works the same for each expense for any industry. First, determine point of view to differentiate the cost and profitability. For Trucking it is by product type and lane. For a Hospital it would be payor type, patient type, etc. For Higher Education it would be by academics department for example. And so onNext identify the Primary Operational drivers. These are the one which would be used to calculate the key revenue driver. For Trucking that would be GTMS. Primary drivers which are foundational would be those that derive the key revenue source. Healthcare – patient days Oil & Gas – Reserver (bbls) – for example historical decline curves; dry hole rates (risk element) maybe in the form of a ratio Higher Education – Student Hrs/Count – works the sameAs this question……How is the key revenue driver calculated. It does not just occur. It is created from something.I know that this example does not resonate completely with each Industry, but the key concept does……”there are underlying primary drivers which in combination will equal the key revenue driver”.Also the linear flow as shown by the arrow is important……moving from drivers to the finance primary drivers. By doing this you can always go back to compare “what happened” between time period/years, etc. This is where you would manage….the underlying driver.
- Once you have mapped the drivers, the next step is to develop a way to view Contribution Margin actuals. This will give you a lot of insight in and of itself in understanding not only “what” happened (this is all that can be accomplished at a Finance level) to why….
- As in personal planning……..
- As shown in the previous slide, the goal is to moving to looking at your revenue source as a profit center instead of a cost center. This is an example for Healthcare. What are the drivers that because they occur ends in a result of ambulance, nursing, etc cost for the patient.It is a step basis 1) Patient provided revenue because they were hurt at a ballfield, etc 2) Something happened to cause the ambulance expense – distance took extra time (effeciency), overtime for paramedics (rate), type of patient (mix) 3) Caused a ambulence expense for patient a versus patient b
- At a high level, this is the flow for any business : Revenue to Expenses which gets you a certain Contribution Margin.The difference between a Driver based versus Expense based Contribution Margin is simple: 1) Driver based is a “push” method from left to right – Cause and Effect 2) Expense based is a “pull” method from right back to left – Effect and then trying to determine causeAt this point don’t discount the difference. I will explain in the following couple of slides what happens if you choose a pull versus push method for your business process. In reality “Pull” is not a business process. The real process is push revenue thru to derive the expenses and then Contribution Margin. What comes first, Revenue or Expenses…..then that is the way your analysis should be accomplished.It is in the pull method that causes the disconnect and in reality why so many Excel spreadsheets exist. A analyst or a accountant only has limited time to “analyze”. A note here is if you move to a driver based cost & profitability solution you will have to work with your team and 1) Move from build once and use one time – Excel model 2) Move to Build once and many times – Essbase model with the drivers and expenses in one placeMore will be explained later.
- I would like to take Fuel Expense as an example to show how a driver based calculated fuel expense is derived. I think that once you see this you will say “I can see where that would help us to get to the issues faster……remember the quote earlier, data is a commodity. The one who makes the data information first, “WINS”.Fuel as well as any expense in reality has three components – efficiency, price and volume. To a certain extent this is derived from the old cost accounting methodology.Efficiently For example : for fuel for a transportation company (Rail, Truck or Air) is based on how gallons are managed. No different than your car when you drive. When you go up a hill you can be more or less efficient based on how you drive up the hill.For Price (or Rate) and Volume they are more straight forward.Therefore your fuel expense is derived based on the sum of how efficient you are, how much rate (fuel prices) and volume related to the Revenue.A couple of notes : This is a simple model and there could be underlying drivers for example that you would need to derive prior to deriving gallons. Also you can calculate a driver based expense at a very granular level and across different points of view if you use the right tool.Again referring to our prior screen, when Contribution Margin changes you can first go back to the expense which cause the change and then directly to the underlying driver that caused the change.
- To further emphasize the difference:When you calculate expenses based on judgment of what happened in the future, all you can see is that expenses change. You can see “what” happened but you really need to know “why”. You need the answers to your questions now. Your questions are there in a big blue box……..Don’t you just wish you could “click” the little red box and all your questions are answered.Picture that little red box a world back into the cost & profitability of your company…..at your finger tips.Then you could manage your business in real time.
- You see when you take a driver based approach, you world goes from being one red box to a real view of the “why’s”.In the example above you can see that the “why” is defined by 1) Revenue – Volume, Market Price and Mix 2) Expenses – Volume, Rate/Inflation and EfficiencyThis works for any company in any industry. Your analysis becomes easier. You can now see the connection thru your company between Marketing, Operations and Finance. Instead of managing each of them on their own you can work seamlessly with everyone…..and add real shareholder value.The GAP becomes much smaller…..you become proactive in managing and not reactive…..YOU WIN.
- Once you have developed your solutions to look at Contribution margin and the underlying drivers, the next step is to integrate ROIC. In reality, 80% of the change in ROIC is due to variability in Contribution Margin. Therefore if you can integrate ROIC with Contribution Margin at the same level you have a direct link by patient, well, student etcThen you can start to say, 1) Why did my ROIC change in total – CM, Fixed Cost, Assets and then 2) Which Revenue Source caused the largest change
- Here is a visual to emphasize allocating the assets down to the patient and/or department for a hospital. Again for other industries you would just substitute the source as well as type of assets.
- Once you have derived your driver based Contribution Margin, you can derive your ROIC in a linear approach.You may ask what is “linear”? Don’t we do that now?Linear is when you derive your contribution margin on a driver based perspective and then “connect” the CM to your capital at the level that you manage your business…..not at the level that you report.You reports at a asset type level on your annual reports, etc.Let me give another scenario…..what if your ROIC went from 11% to 9% in a year. Would you want to know in “real time” what customers/segments/regions were the cause of such a decline. And then if it was due to variable or fixed cost or the underlying assets.Sure you would. Then you could manage your ROIC as it would be connected with your contribution margin at the level that you manage your business.This again can be accomplished with a Cost & profitability tool……it starts there and pushes up threw your company….cause and affect….again you WIN…..you manage faster than your competition.
- Using a waterfall report to paint the picture, you can see that one big item that was the big cause was volume. No surprise at this point.But “Is there particular volume that caused most of the change?” And should I then entertain the next question “Why?” Also what if I want to move the ROIC back to say 10%. What do I need to realistically do to make that happen.Is managing from a cost & profitability solution starting to look like it could benefit you?A side note for both looking at contribution margin and ROIC from a driver based perspective is that you can do this over various time periods, points of view and versions.
- For Phase III, you can start to develop a driver based plan and or forecast.This can help you become more proactive in managing your plan from a mix, volume and/or effeciency perspective instead of just using judgement to try to identify the needles in the haystack.Again the goal is to move into a proactive versus reactive mode.
- Ok we have gone thru actuals from a cost & profitability perspective. What if you now want to use what you have learned from the drivers, etc. to create the plan. That is use the key drivers to determine what your expenses would be related to certain revenue dollars and units.Well, since you have moved to a driver based method, the answer is not as difficult as you might first think.I want to walk thru the above diagram to show you how it would work.Again since you are doing this from a build once use many times, the build is rather easy.Also since it is driver based, when actuals are different from plan (or forecast) you can quickly drill back to the drivers to see what happened.You can also become better at “predicting” and therefore optimize your business. You have moved form Reporting, Analyze/Model, Plan to Report, Predict and then Optimize. Remember optimizing your business is more important than making a perfect plan. I think this is the paradigm in a lot of companies.The main key in being able to derive a driver based plan or forecast is to understand the “key” driver for which when it changes your expense will change. There could be different drivers for expenses especially in industries such a Manufacturing, Healthcare and that is ok. For some Industries such as transportation, there will usually be one driver.You know you have the right driver by doing some analysis and shown in the green box above. Upfront you spend some time doing some statistical analysis to look at correlations of expense to a driver. That is when driver changes nth the expense will change nth. You want to shoot for a correlation between driver and expense of .85 to .95.
- RPO is the end goal of integrating Cost & Profitability into your EPM solution.What is the value add: 1) By becoming predictive by understanding the underlying drivers better you can more effectively optimize your business model.You would know what areas are causing the pain and why and adjust as needed – price, contracts, asset aquistiion, etc.
- So where do you want to get to with your new Cost & Profitability tool.The answer is to a evolving point where you are not just reporting which is step 1 (remember our Waterfall reports) to step 2 of being able to do powerful analytics (that is the value of the cube) to step 3 (modeling your drivers with your expenses) To Optimize your business.At this point you have arrived at the EMP holy grail – the point where your company is completely connected and you can understand the business process and where there are issues.You can answer your question in real time. Any question. You can: 1) Manage your strategy better because you are measuring (Op Ratio and ROIC) at the level that your business happens – customer, segments, etc.You can also: 2) Manage your business performance better because you now have a better understand how revenue affects drivers that affect expenses.
- If you are not for sure you are doing advanced analytics or just want to know what it is the best place to start is to ask some questions. Here are some key questions that you can ask yourself.Again, integrating advanced analytics must be part 4 of your cost & profitability solution. The first steps are to develop a framework with actuals and then plan.
- To accomplish building a driver based cost & profitability solution and integrating it with your Go Slow, Go Far – build in a incremental approach. This helps you to build, test, and then visualize for the next component.The phases are listed. They are based on linear on how you see your process….actuals around contribution margin, plan, roic and then link to financials.For phase 1, if you focus on actuals and then just build some then that is the best approach.You can actually reduce your risk by building a prototype. Perficient can help you with this and will be glad to answer any questions you have.
- Along with the process that is important of a driver based cost & profitability solution, the architecture is also as important as a enabler.This architecture will get you where you need to 1) Link your enterprise and answer the tough questions 2) Manage and report your key metrics in real time (as sales invoices are recorded for the day) 30 Move from being reactive to proactive 4) Gain synergy for your current tools 5) Reduce the time that is spent in creating excel models by 100…..to 1000%In summary on architecture, you would want to build your cost and profitability cubes/marts by business area (Marketing, Cost & Profitability and Finance) and then use top EPM tools such as Hyperion (HFM, HSF and Planning) to link Cost & Profitability with your Financial planning.