When we interact with CEOs, particularly those of larger firms, one common item on their wishlist is that their managers are acutely aware of their cost structure.Managers on the ground, particularly those in sales, tend to equate gross margins to profits, while ignoring overheads and other hidden costs associated with each sale.
Employees, particularly those in sales, tend to equate gross margins to profits
This leads to conflicts - for example, if your sales team is asked not to reduce prices (and therefore margins) for a large order, sales managers find it hard to comprehend the reasons, as well as the numbers decided upon. Add to that a competitor quoting a lower price - and you have the makings of a mudslinging match between your sales team and the rest of your outfit.Another complication which may arise in the above example - as sales can’t see all your overheads, the common assumption (as to why they have to price higher) is that their input costs are higher than the competition. They believe their sales targets are paying the price for the procurement team’s inefficiency. This is an inaccurate and damaging assumption that deserves closer scrutiny.Illustration: Simple cost structureSales+Variable Cost (Sourcing Cost)-Gross Margin=Salaries-Travel-Marketing Costs-Administrative Costs/Corporate Over Heads-Interest-Tax-Profit=LegendHigh VisibilityModerate VisibilityLow VisibilityLets start by identifying major cost drivers. In larger companies, procurement is often centralized, streamlined and takes full advantage of the clout that comes with scale - so their input costs are consistently lower than smaller peers. So where do the extra costs come from? As your company grows, overheads tend to grow, with administrative costs, marketing costs, travel costs, compliance and process costs, even safety costs (for some industries), rising with scale and complexity.Lets illustrate this with an example: A vacuum cleaner company that offers it’s flagship product at INR 10,000 to authorized resellers. Let’s say they also have a direct sales division in which their representatives demonstrate and sell their product directly at the customer’s home location. Now, when a salesman from this division makes a sale for, say, INR 12,000, he may very well believe that the entire 2000-rupee difference is a profit that he is bringing in to the company – and be delighted with the sale. The costs that are hidden from him could include:
Building acute cost structure awareness in your sales force can significantly boost profitability
Most decision makers at the top, can identify these costs and raise their margins and break-even volumes correspondingly. However, building acute cost structure awareness in your middle management and sales force can take this to the next level, significantly boosting profitability.